The Stalwart: Barron's Roundtable 2006

This weekend Barron's Magazine published the first part of their always-interesting roundtable. Like last time it featured, among others, Bill Gross of Pimco, the doomsayer Marc Faber, Abby Joseph Cohen of Goldman Sachs, and Fred Hickey, the editor of the High-Tech Strategist newsletter. You don't have to try very hard to guess the big themes of the discussion: the trade deficit, energy prices, China, oil, productivity, the negative savings rate, and geo-politics. Yes, all the good stuff that people have been talking about ad nauseum for the past year. The only difference is that we have another year under our belt in which the dollar didn't collapse, and no rogue dictator accidentally launched a nuclear missile. Oil didn't go to 100 either. As for a dominant theme or sentiment, things were decidedly mixed. Here are a few segments that stood out:

What do you think, Marc?

Faber: We have a fairly optimistic, unanimous consensus about the global economy for 2006. The forecast calls for benign inflation and a Goldilocks scenario in which things are just right. People dismiss the low savings rate and the U.S. trade imbalance by saying that as long as asset prices go up, there's nothing to worry about. As a result, the markets' risk premiums and volatility are low.

But, frequently, events happen outside financial markets that then have an impact on them. I've done some work on the war-cycle theory, which says commodity prices rise, international tensions increase, war results and prices go through the roof.

Is that what you're anticipating?

Faber: For the first time in modern history, both China and India are economic factors. China is the second-largest user of oil in the world, and India is expanding rapidly. Some people in the world, notably in the U.S., believe the U.S. is a superpower, but the rise in oil prices has changed the equation dramatically. Suddenly Hugo Chavez [president of Venezuela] has become a powerful man. [Iranian President] Ahmadinejad has become a powerful man. The U.S., measured by the number of nuclear warheads, may be the world's superpower, but Vladimir Putin today is much more powerful. If he were as smart as one of you hedge-fund managers, he would have cut oil production by 50% a long time ago. The price would have gone up two or three times, and he would still have the oil in the ground.

***

Hickey: Mortgage applications have been declining week after week after week. Refinancings absolutely collapsed. HELOC [home-equity line of credit] loan rates have gone from 4.75% to 7.75%, and those loans have fallen sharply. We're going to see a slowdown in the amount of debt taken on. The government is intervening to put a stop to some of the crazy mortgages that have been passed out in recent years.

We are starting to see it in the economy. We are seeing it at the low end first. The people with $7 trillion of real-estate-wealth gains are still spending, but at Circuit City [ticker: CC] and Best Buy [BBY], while Christmas sales were good, store traffic was down, Wal-Mart's [WMT] same-store sales rose only 2% despite all the promotions. Auto sales are down. The question is, how fast does the high end slow?

Gabelli: On the outlay side, the consumer has an inordinate tax, which Oscar talked about. The gas bill for my house was up even in 45-degree weather.

Hickey: The average median gain last year in existing home prices was more than the gains in 2003 and 2004 combined. It was all fed on debt. The consumer will find that the asset prices are variable, but the debt isn't.

Samberg: Isn't there a difference between this and the TMT bubble? That was partially built on non-real companies delivering non-real products to non-real uses. A house is a core asset, and the Federal Reserve in its studies believes it is a bankable asset. Fred is probably right that the wind has gone from your back to your face, but people will not change spending patterns dramatically if they think their houses are bankable assets.

Neff: When you anguish about this, don't forget that the average equity stake in residential housing is 50%. It's not as if it is on 2% margin.

***

Cohen: We've tried to estimate the buybacks. Cash on corporate balance sheets has increased dramatically. First companies used it for defense purposes, such as dividends and share repurchases. About four-five quarters ago, companies started using it much more aggressively for capital-spending purposes. Personal-consumption spending decelerates this year to about 2%-2½%, in large part because of fewer home-equity withdrawals. But business fixed investment could grow 10%.

Hickey: I disagree that cap-ex spending will offset the consumer's weakness. Corporate surveys show very little pick-up -- maybe 2%, 3% increases in IT [information technology] spending. The reason is IT prices are plunging. There's just too much of everything. When personal-computer unit sales rise by double digits for three consecutive years, revenue is up only by single digits. Free open-source software has led to price compression in the software industry. Companies are shifting a lot of their service work overseas to places like India, where costs are a fraction of U.S. costs. Corporate execs say they're getting a lot more IT but not spending any more for it.

Cohen: According to industrial-production numbers, business fixed investment is growing 9% to 10% in dollars. In IT unit volume, it's running 20% to 25%, which is a function of price deflation. The worker who gets to use the new equipment doesn't care if the company spends an extra 9% or 25% for it. Some of this helps explain why productivity gains have remained stronger than expected.

Hickey: I don't believe those government numbers. I see Cisco [CSCO] sales going down, and the growth rate going down, down, down. Dell's [DELL] growth rate is going down. IBM [IBM] and Hewlett-Packard [HPQ] have single-digit growth.

Gabelli: Both of you are right. You're looking at servers and routers and I'm looking at servers and routers, but mine are called pumps and valves. Oil-equipment and aircraft expenditures and fixed plant and equipment are accelerating. Architects are planning numerous projects. Commercial construction is going up. State and local governments are ordering fire engines and ambulances and infrastructure, and Brazil, Russia, India and China are buying capital equipment. The companies I talk to that sell capital goods for water and infrastructure plays around the world are getting the benefit. In a narrowly defined way, Fred, you are right. Abby, your numbers are right. But the servers and routers we need to talk about are pumps, valves, equipment for liquefied natural gas and coal degasification, Boeings and Airbuses.

***

Bill, how about some individual picks?

Gross: I have two closed-end bond funds and two exchange-traded funds. My first pick is BlackRock Global Floating Rate Income Trust. These are recently created funds that invest in bank loans. In many cases the assets are rated BB, Baa. You're not investing in triple-A assets, but these are loans banks made to viable corporations. They were issued on a floating-rate basis, and yields have gone up as the Fed has raised rates. If the Fed lowered rates, they might drop a little.

Typically, closed-end funds are issued at $15, or par. Within 12 to 18 to 24 months, they drop in value to a 10% to 15% discount to net asset value. The actual loans are selling at 85 or 90 cents on the dollar. The attraction here is the drop in price. Late last year, with tax selling, the price accelerated on the downside.

This particular fund is 30% invested outside the U.S. It's a currency play to some extent. Some of the largest holdings include emerging-market debt and Fannie Mae and Federal Home Loan Bank instruments. For the most part, it's double-B oriented. It's yielding about 8%. If I'm wrong and the Fed goes to 5% or 5½%, the fund will benefit because those loans are correlated with short-term rates.

My second pick is Pimco Corporate Income Fund. Most Pimco closed-end funds sell at premiums to net asset value. This one trades at net asset value.

So there you pretty much have it. A lot of the same old debates we've been throwing around here all year. At what point did this economy start to feel like a court-trial in which we're perpetually waiting for the jury to come back from deliberation? C'mon housing bubble, burst already! Just so we can see what happens to the consumer. Alright China, stop sopping up our extra dollars, we need to see if our currency can stay up on its own! Hey Bernanke, do all your rate hikes at once so we know where you'll top out.

It's an unpleasant and psychologically taxing state of affairs, and at times the debate sounds like a scene from Sartre's No Exit. Of course, we'll be reading reporting on the second half of the discussion next week.

Comments

When will you have Peter Lynch, the greatest stockpicker of all time, on the Roundtable?

Posted by: Tom Crangle | January 31, 2006 at 10:03 AM

Im a professional money manager who knows about a quarter of your panelists personally. you really need to upgrade your panelists. Some of the people-OSCAR, ART SAMBERG, MARK PRICE, your midwest lady, are world class. Frde Hickey is an embarassment. To have him diss art samberg about technoogy is really an embarassment to your publication. Fred has been singing the same tune for 20 yearsand is DOESNT MANAGE OTHER PEOPLE"S MONEY. John Neff was a leader, but is retired and is out of touch. Abbie is a strategist, with no stock picking ideas of her own. Get more professioinal money managers on the panel.

Posted by: Michael Weisberg | February 04, 2007 at 03:47 PM