online.barrons.com http://online.barrons.com/article/SB50001424053111904681004579320804042634762.html? mod=googlenews_barrons#articleTabs_article=0 By LAUREN R . RUBLIN | MOR E ARTICLES BY AUTHOR Wher e To Fin d V alue in 2014 We wish we could share the official view of the Barron'sRoundt able regardi ng t he economy and markets in 2014. But it was imposs ible t o f ind much common ground t his year among o ur pass ionate, principled, and occasionally pugil istic paneli st s, whether t he discussion veered toward interest rates, st ock prices, GDP , orlunch. The schi sms wer e apparent f rom the start of our annual conf ab, held on Monday at t he Harvard Club of New Y ork, and they are l ikely only to widen as QE3 -- or is it QE4? -- makes its way f itf ully back to port. Theref ore, we f eel obli ged to of f er two co mpeting out loo ks f or t he new year , which seems a t ad more chall engi ng already than its bubbl ic ious predecess or. Table: 2013 Roun dt able Report Car d The Roundtable's optimists expect the global economy to pick up, bonds to tick up, and stocks to mosey higher, not withst anding the errant hiccup. The pes simi sts, emboldened perhaps by the return af ter a o ne-yearabsence of Marc Faber (wearing a woo len wonder of a hat that put hipsters to shame), see crippl ed economies here and abroad, rotten government policies, and a selloff in stocks that could rekindle fears of, yes, systemic risk. Y et, s omewhere between t hese poles, all say, lie plenty of investments wort h a wager , on the lo ng side and the short . Table: 2013 Mi dye ar Roun dt able Report Car d Af ter a mor ning o f macro debat e and discu ss ion , chro nicled f ait hf ully in t he pages ahead , Wall Str eet vet eran Oscar Sc haf er walk ed us t hrough the hidden charms o f six lesser-known U.S. and European companies whose st ocks, he said, c ould li f t of f in coming months. Al so in this week 's Ro undtable i ssue, the f irst o f three, Swiss money manager F eli x Zulauf shares his f orebodings about Hong Kong, Turkey, and Japan, and conf esses to a new found af f ec tion f or gold. Barron's: After a stup endou s year fo r U.S. stocks, 2014 is looking rat her diff erent. Since the F edera l Reserve andthe bond market will be setting the tone, let's start with our bond maven, Bill. What will everyone be "Yellen" aboutthis year? Gro ss:Moves in the U.S. and global bond market have been directed in recent years largely by central-bank asset purchasing, or quantit ative easing. Thes e polici es have kept interest rates abnorma lly, if not historically, low. In the U.S., the Fed is beginning to pull back. Yields on 10-year Treasury bonds are 120 basis points, or 1.2 percentage points , higher than t hey were 12 to 15 mont hs ago . We'v e had a bear-mark et run, so to speak. At Pimco, we do n't expect yields t o keep rising, even in t he f ace o f Fed tapering [t he Fed has st art ed cur bing it s bond-buying]. When i ts asset purchases end, likely in late 2014, go vernm ent bond yields will be dependent on the po li cy rate [t he Fed's t arget f or t he federal - f unds rate, currently 0. 25%]. That brings us to Janet Yellen, who beco mes chair of the F ed on Feb. 1. She is do vish with a capital D, m eaning she wo n't increas e the po licy rate, whic h is key f or t wo- , five- and 10-year bonds. That wi ll allow levered borrowers, banks, investment banks, and hedge f unds t o have a reliable source of f undi ng at a reliabl e pric e. Absent higher i nf lation and a policy -rate change, the U. S. bond market, and other bond markets, wil l be s table.
Transcript
7/27/2019 Online.barrons.com-Where to Find Value in 2014
We wish we could share the official view of the Barron's Roundtable regarding the economy and markets in2014. But it was imposs ible to f ind much common ground this year among o ur passionate, principled, and
occasionally pugilistic panelists, whether t he discussion veered toward interest rates, stock prices, GDP, or
lunch.
The schisms were apparent f rom the start o f our annual confab, held on Monday at the Harvard Club of New
York, and they are likely only to widen as QE3 -- or is it QE4? -- makes its way f itf ully back to port . Therefore,
we feel obliged to of f er two competing out looks f or t he new year, which seems a tad more challenging alread
than its bubblicious predecessor.
Table: 2013 Roundtable Report Card
The Roundtable's optimists expect the global economy to pick up, bonds to tick up, and stocks to mosey
higher, notwithstanding the errant hiccup. The pessimists, emboldened perhaps by the return af ter a one-year
absence of Marc Faber (wearing a woolen wonder o f a hat that put hipsters to shame), see crippled economie
here and abroad, rotten government policies, and a selloff in stocks that could rekindle fears of, yes, system
risk. Yet, somewhere between these poles, all say, lie plenty of investments worth a wager, on the long side
and the short .
Table: 2013 Midyear Roundtable Report Card
Af ter a morning o f macro debat e and discuss ion, chronicled f aithf ully in the pages ahead, Wall Street veteran
Oscar Schafer walked us through the hidden charms o f six lesser-known U.S. and European companies whosstocks, he said, could lif t of f in coming months. Also in this week's Roundtable issue, the f irst o f three, Swiss
money manager Felix Zulauf shares his f orebodings about Hong Kong, Turkey, and Japan, and conf esses to
newf ound af f ection for gold.
Barron's: After a stupendous year for U.S. stocks, 2014 is looking rather different. Since the Federal Reserve an
the bond market will be setting the tone, let's start with our bond maven, Bill. What will everyone be "Yellen" abou
this year?
Gross: Moves in the U.S. and global bond market have been directed in recent years largely by central-bank
asset purchasing, or quantitative easing. These policies have kept interest rates abnormally, if not historically
low. In the U.S., the Fed is beginning to pull back. Yields on 10-year Treasury bonds are 120 basis points, or 1.2percentage points, higher than they were 12 to 15 months ago. We've had a bear-market run, so to speak.
At Pimco, we don't expect yields to keep rising, even in the f ace o f Fed tapering [the Fed has started curbing i
bond-buying]. When its asset purchases end, likely in late 2014, government bond yields will be dependent o n
the policy rate [the Fed's target f or t he federal- f unds rate, currently 0.25%]. That brings us to Janet Yellen,
who becomes chair of the Fed on Feb. 1. She is dovish with a capital D, meaning she won't increase the po licy
rate, which is key for t wo- , f ive- and 10-year bonds. That will allow levered borrowers, banks, investment
banks, and hedge f unds to have a reliable source of f unding at a reliable price. Absent higher inf lation and a
policy-rate change, the U.S. bond market, and o ther bond markets, will be stable.
The Barron's Roundtable member makes the case f or Orkla, Interxion, and Northgate.
Is the market overly discounting a rise in the policy rate in 2015 or 2016?
Gross: Yes. Eurodo llar f utures indicate a policy rate of 3% to 4% in early 2018, but t hat is a long way of f . It's
another way of saying that the market sees a rate hike in early 2015.
And what are the chances of that?
Gross: Slim to none. First, the Fed has to f inish the taper. Then, as it has suggested, there will be aconsiderable amount of time before it raises rates.
Cohen: In her early academic work, Yellen spent a lot of time thinking about labor markets . Although the
recession technically ended in the U.S. in mid-2009, we are just beginning to see better gains in employment.
Her work indicated that the labor markets need to get much tighter bef ore middle-income and lower-middle-
income workers see the benef it in job creation and wages. Given current conditions , a rate change is unlikely.
We must also consider how the new leadership at the Fed, including the new vice chairman, Stanley Fischer,
communicates with investo rs. The Fed has t ried to be clear about its intentions , but the message isn't always
received in a clear f ashion. Of ten, investo rs f ocus on one o r two words in a Fed statement and ignore the res
People have forgo tten that t he Fed is data-dependent. It will make decisions no t based on what it said it wouldo, but on what t he data show.
Why Zulauf, a Barron's Roundtable member, f oresees a correction o n Wall Street , believes Hong Kong banks
are f ragile, and expects more trouble in Turkey.
Zulauf: Why offer guidance, then?
Cohen: It is just one too l to let the markets know what it is thinking, especially since policy rates are close to
zero . In this case, the Fed has conveyed that it is a long way f rom wanting to tighten aggressively. Implicit in
this conversation is that the bond market already has t ightened, meaning that intermediate- and long-bond
yields already have risen.
Rogers: Can I dispel the not ion that the Fed can engineer precisely what is happening with interest rates? Wit
the economy doing all right, some labor-market s lackness disappearing, and the f ixed-income market
disappointing investors last year, it seems t he pressure on 10- year yields is upward, not downward. I have
tro uble seeing how the 10-year bond could rally. I have trouble seeing bonds earning their coupon this year.
Zulauf: The U.S. bond market is mispriced relative to other major bond markets, except Germany's, perhaps. It
doesn't make sense that comparable French government bonds yield 50 basis points less than the 10-year
Treasury. If the do llar holds up or st rengthens s lightly against ot her major currencies, it will create an arbitrage
situat ion that puts downward pressure on U.S. yields.
Gross: If the Japanese yen weakens even mildly, a Treasury bond denominated in dollars is an ideal investme
f or a Japanese investo r.
Brad Trent for Barron's
Cohen: So there might be international demand f or U.S. bonds. There might be corporate demand, mainly f rom
pension f unds. All this could serve to mute a rise in interest rates . Yet, I'm in agreement with Brian. Economic
growth in the U.S. will be OK. Demand will push rates s omewhat higher. A major inf lection point occurred in the
bond market some months ago. The magic spell was broken. People had argued that rates would never, ever
go up again. But they have, particularly on intermediate- and long-term bonds. They could drif t higher f rom
here.
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Cohen: The Goldman Sachs economics team is forecasting gross-domestic-product growth of 3.3%. The
sources of growth include less f iscal drag than last year, when the payroll tax was increased, and some
improvement in domestic demand. We are seeing improvement in the labor markets and household disposable
income, and spending has increased. This is evident in auto sales and housing. Also, U.S. companies with
st rong balance sheets are likely to divert money f rom dividend increases and share repurchases to business
f ixed investment.
Black: The most recent rounds of quantitat ive easing have had little impact on economic growth, but a saluta
ef f ect on f inancial markets. Unless we do something to improve f iscal policy, the economy will stagnate. From
2000 through the end of 2013, real [inf lation-adjusted] growth in GDP has been 1.8% a year. It has been the
slowest period since the end of World War II. I don't see how you get t o 3.3% GDP growth. Looking at t he
National Income Accounts f or the lates t quarter, housing and an invento ry build-up dro ve the 4.1% increase in
gross domest ic product. Government s pending was down sharply. It doesn't s eem possible that real GDP cou
grow by much more than a high-2% rate in 2014.
Gabelli: So what? The point is, the U.S. economy is improving at an accelerating rate.
Zulauf: Retail sales are a big part o f the U.S. economy. In est imating GDP, it is important to gauge the outlookf or consumer inf lation. To the surprise of many, the consumer price index has remained low in recent years.
There is a change occurring in the world economy. Since the early 1980s, the U.S. has been running ever-
increasing def icits, which released tremendous s timulus in the rest of the world. Now those def icits are
shrinking, in part because labor is becoming more competitive here. There has also been a domest ic energy
boom. This means surplus economies are slowing. I have problems with the consensus view that the world
economy is improving or normalizing. People conclude as much by studying statist ics, such as the purchasing
managers index. But they are sentiment stat istics, driven by how the sto ck market perf orms, and the stock
market has been driven primarily by the Fed's liquidity provision.
What do you see, then?
Zulauf: The world economy will disappo int. The U.S. will perf orm best. China is s lowing dramatically, causing
contraction in the emerging world. Europe has seen an improvement in bond yields, due to arbitrage
opportunities, but has virtually no economic growth. The U.S. could be the exception in seeing 2.5% or 3%
growth, largely because consumer prices will remain depressed. If I'm right, commodity prices will remain so f t,
and the U.S. dollar could be stronger.
Marc, do you agree with him?
Faber: First , nobody could have a more negative view of the Federal Reserve than I. It is run by a disast rous
group of academics, who have no clue about what is happening in the real world. They believe money-printing
can create jobs. They are going to bankrupt the world. Mr. Bernanke [current Fed Chairman Ben Bernanke] saidthe intention of QE3 [the third round of quantitative easing], which then turned into QE4, was to lower long-
term bond yields. As it happened, yields on Treasury notes and bonds bo tt omed on July 25, 2012, and have
been rising since. The policy was a f ailure.
QE also was intended to lower the unemployment rate, which has fallen.
Faber: Af ter World War II, Hong Kong was in a depress ion. But the economy developed rapidly thereaf ter und
the leadership of John James Cowperthwaite, a British civil servant and f inancial secretary of Hong Kong f rom
1961 to 1971. Asked later what he did to achieve this economic miracle, he replied, "I didn't do anything. I just
prevented others f rom taking bad measures."
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Employment would have improved even more without the money-printing of the past f ew years. The Fed acted
correctly to save the f inancial system during the f inancial crisis, which it created with its easy-money policies i
the late 1990s and early 2000s. But Ms. Yellen could be s itt ing on a barrel of gunpowder, pouring gaso line on
top of it, and lighting a cigarette, and she wouldn't know the danger of bubble creation.
Gabelli: She doesn't smoke.
Hickey: When the Fed's easy money created the technology bubble in the late 1990s and the housing bubble
the 2000s, the economy was gro wing by more than 6% a year. Now we have 2% GDP growth, and bubbles inhous ing, art, f armland, junk bonds, fancy cars.
Faber: And government regulation.
Hickey: U.S. household wealth grew by $30 trillion, to an est imated $80 t rillion or more, between 2009 and
2013. What happens if some of that $30 trillion disappears as the sto ck market declines?
Faber: Who got the $30 trillion? Not ordinary people.
Gabelli: That's not true. Ordinary people have 401(k) retirement plans. This idea of only the 1% having equity
exposure needs to be f leshed out.
Jennifer Altman for Barron's
Marc Faber, with hat, center: The Federal Reserve "is run by a disast rous group of academics, who have no
clue about what is happening in the real world."
Black: Because of the intransigence of our po litical parties, we don't have good f iscal policies. By default, we
had to pull out all the s tops on monetary policy to get the economy growing. As a result, the Fed's balance
sheet has grown to $4.1 t rillion f rom $850 billion. Tapering is a euphemism, because balance-sheet assets wil
top $5 trillion by the end of the year.
Faber: Ten-year and 30-year yields eventually will be much higher. But I bought some 10-year Treasuries whenthe yield ros e to 3%, because in the near term, yields could retreat t o 2.5% or 2.2% or even 2%. The economi
recovery is in its f if th year. On March 6, the bull market in stocks will be f ive years o ld. That's long, by histo rica
standards. Sometime this year, the stock market could see a big tumble, as in 1987. Then the long bond will
rally and reward Bill Gross.
What will precipitate this crash?
Hickey: Money-printing has been driving this elephant. Aft er a f our- year rally, the Dow indust rials added 27%
last year. The Standard & Poo r's 500 rose 30%, and the Nasdaq composite, 38%. Amazon.com (ticker: AMZN)
trades for 538 times earnings. Google's (GOOG) market capitalization grew by $90 billion in the last three
months of 2013. That's not normal.
Witmer: It looks like there's more greed than f ear in the market.
Hickey: When QE1 ended, the market f ell by 13% in a matter of months, which caused the Fed to launch QE2
When it ended, the market f ell by 17.5%. If Bill is right that t he Fed will stop buying assets by year end,
somewhere between now and then we are going to blow the s tock market up. Valuations are much higher toda
than when QE1 or QE2 ended. The market is f ar less stable.
Gross: Stocks also have rallied because of corporate buybacks. Corporat ions, helped by money-printing and
more cash f low, spent $500 billion, or 2% of the S&P 500's market's capitalization, buying back their own
Gabelli: Around the world, the German economy is improving; Bank o f Japan Governo r Haruhiko Kuroda is
f ollowing Bernanke and European Central Bank President Mario Draghi; President Xi Jinping is making posit ive
changes in China.
Hickey: Japan is printing too much money, which will cause import prices to soar. The average Japanese citize
is seeing his cost of living rise.
Zulauf: Japan will run into a disappointment in the f irst half .
Gross: The key is growth in manufacturing jobs. We can all give each other back rubs o r wash each other'shair. We need to make things to sell to o thers.
Gabelli: U.S. energy independence is a game changer with regard to global competit ion and job creation, if we
ever get policy support .
Hickey: If domestic energy was t he be-all and end-all, Russia would be an economic powerhouse, which it isn
The U.S. has lost two million manufacturing jobs since the recess ion began. We have added back only 500,000
Onshore drilling has created only 80,000 jobs , if that .
Zulauf: The U.S. economy is doing well -- relative to others, that is. But median household income isn't
growing much. You're not gett ing the reacceleration you'd normally see at this point in the cycle. That 's t hepoint at which interest rates too k of f .
Faber: China has grown extremely competitive in the quality o f its earth-moving and const ruction machines.
What they produce is better than what Deere [DE] and Caterpillar [CAT] produce. The problem in America is tha
you have a lot of Facebook geniuses who s it around all day loo king at their own pictures. They don't have
competitive jobs. I met a diver in Shanghai the o ther day who repairs plat f orms and pipelines. He makes
$180,000 a year and works half - time. The point is, there are lots o f jobs t hat would pay well, but not many
Americans are qualif ied to do them.
Gabelli: We have to retrain people to make sure no adult is lef t behind. BMW [BMW.Germany] is adding capac
at its South Carolina plant. It needs to train employees, and is do ing so. It is a f ree market. You train employeef or your own self- interest.
Faber: Yes, but how much capacity has BMW added in China in the past f ew years? Who cares , globally, abou
the U.S.? Whether it grows 2% or 3% o r contracts is irrelevant f or most people in the world.
Jennifer Altman for Barron's
Scott Black, center: "Large-caps are much less expensive today than small- and mid-caps."
Cohen: I disagree. The U.S. economy is the world's largest by far. The Chinese economy is 40% the size o f th
U.S. China is f acing challenges. It was clear at the Third Plenum [a gathering in November of Communist Party
leaders] that China's new leadership believes the economic model of the past two decades needs t o change.
The model was based on low-cost labor and export s and significant government investment in inf rast ructure.
will be replaced by something less liquidity-driven and t ied not just to external but internal demand. That raises
questions about f uture growth. Goldman believes China's economy will grow by 7.7% this year, a bit above
Returning to the U.S., share repurchases and dividends too k 40% of cash on balance sheets, 10 percentage
points higher than bef ore t he f inancial crisis. Where did the money come f rom? Long- term investment. The
government also has cut its support f or basic research in science and engineering. It was 4.5% of GDP as
recently as the 1970s. Now, it is down to 2.5%. This has a negative impact on productivity, competitiveness,
and economic growth. Nor have we held our leadership in education. The U.S. used to be No. 1 in the
percentage of young people with a college degree. Now it is No. 12. The unemployment rate f or people in the
U.S. with a bachelor's degree or higher currently is 3.3%. We have to do a better job o f creating educational
opportunities f or people in the middle-income category. In addition, many of today's manufacturing jobs requi
some college training. If state and local governments can't do it, as Mario notes , companies will step in.
One more thing: The Fed isn't perfect, but inadequate at tent ion has been paid here to the many challenges it
f aced amid a horrendous economic situation, not just in the U.S., but around the world.
Zulauf: Which it created.
Cohen: Excuse me, I'm speaking. We have to look long and hard at U.S. histo ry to f ind a similar situat ion in
which the government made a deep recession even worse by creating f iscal drag. Additional pressure was put
on t he Fed because other central banks and governments didn't step up to protect themselves. Early in the
global f inancial crisis, the European Central Bank was more concerned about protecting the value of the euro
than about economic growth in Europe. The Fed also has done a much better job, along with o ther U.S. bankinregulato rs, o f gett ing the U.S. f inancial system back on t rack. The balance sheets of U.S. banks are stronger
than their counterparts in Europe and elsewhere. We are years ahead of ot her nations . The Fed deserves a lo
of credit.
Hickey: Why? They haven't go tt en a single forecast right. They said there would be no subprime-mortgage
problem. They said there wouldn't be a housing bubble. They created the tech bubble. All of our problems were
created by the Fed, including today's gigantic valuations o n many speculative stocks. The crash that will occur
will be the result of the Fed.
Cohen: You know a great deal about technology. I want to return to your comment that the Fed created the
tech bubble.
Hickey: It did.
Cohen: Other factors contributed, including great investor enthusiasm for many things related to the Internet
that didn't come to pass in 2000, but happened later. You are also overlooking government po licy. The
government gave a huge tax deduction to companies that invested in computer systems ahead of Y2K [the
year 2000].
Hickey: The Fed was worried about a Y2K problem that didn't exist . [There were concerns that critical
computer operat ions would fail with the calendar's rollover f rom 1999 to 2000.]
Cohen: Was it only the Fed?
Hickey: No, but by pumping $50 billion into the f inancial system, the Fed put a massive cherry on top of the
stock market rally.
Can we please get back to 2014?
Rogers: Inst itutions sometimes do well and sometimes don't. Sometimes, in the back of the ambulance, you
ust have to stop the bleeding, and the Fed did that amid the f inancial crisis. Reasonable people would disagre
about the Fed's behavior in terms of the housing bubble.
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Rogers: I expect buyback activity to cont inue this year, which is good news f or stocks. The problem is that
CEOs histor ically have had a bad record o f timing purchases; they buy when their shares are high. We saw
investors tiptoe back into equity funds last year for the first time since 2006. Speaking of cocktail parties,
every place I go, people ask me about the next IPO [initial public of f ering]. There are pockets of irrational
exuberance, including some IPOs, but in general, stocks could keep rising. Barring an expansion in
price/earnings multiples, which I have trouble seeing, add a 2% yield and 5% earnings growth, and you get a 7%
to tal return. Compared with other asset classes, t hat so unds OK.
Gross: Peaks are made not just by cocktail-party att endees, but also by institut ional investo rs who get carrieaway with enthusiasm. With ref erence to s tocks, the era of gett ing rich quickly is over. The era of gett ing rich
slowly might be over, too .
What other eras are there?
Gross: That's the po int. Equity returns could be 5%, plus o r minus, and bond returns 3%, plus or minus. That
is insignificant in terms of saving for college or retirement. It's not enough to pay the bills.
Cohen: Like Scot t, we're expecting S&P earnings o f $116 in 2014. If there is no P/E multiple expansion, that
gets you to a level of 1900 on the S&P 500. If core inflation stays under control this year -- it could rise by les
than 2% -- history suggests that stocks could trade for 18 to 20 times earnings. Assuming an 18 P/E, and
running a simplistic scenario analysis, you get a target price of 2088. We are seeing enormous dispersion in
relative valuation, not just between, but within, sectors. Also , correlation [the degree to which sto cks move wit
each other] has moved dramatically lower. A couple of years ago, the correlation within the S&P 500 was 0.65,
which meant you had to decide to be in or out o f the market. Now it is 0.27. This year, if people are moderatel
const ructive on the market but s pend mos t o f their time on security selection, they will be better served.
Equities will perf orm better than f ixed income, but there will be variations here, too. I am not enthusiast ic abou
government bonds. There may be better opportunities in corporate credits.
Commodity prices are a big question. In the U.S., natural-gas prices are under control, as are energy prices
generally. But the global picture is challenging. Commodity prices rose f or many years, in part because of
enormous growth in places like China and India. Growth there has slowed, leading to weakening demand f or indust rial metals . Perf ormance in 2014 depends on the commodity.
To what extent has the drop in commodity prices resulted in the waning popularity of commodities as an asset
class?
Cohen: Global enthusiasm in recent years led to demand for commodities by pension f unds and active money
managers. Now there is an unwinding, with the slowdown in emerging markets. We look at supply/demand
balances. On a 12-month basis, we're not that enthusiast ic about commodit ies as an asset class.
How do you feel about emerging markets? Their valuations are much lower than they were a year ago.
Cohen: There are also wide variations. We like some, such as Mexico, more t han others. If the U.S. grows, ouNorth American trade part ners will benef it. Mexico saw weak economic growth in 2013. The currency
depreciated and there were concerns about stock-market valuation. This year there is a reform story to be
to ld. Growth could re-accelerate toward the end of the year. An energy-ref orm story could take a f ew years to
play out, but is just one indication that the new government is looking to take advantage of its energy assets
in an appropriate way. [Among other changes, the Mexican government will now allow private investment in the
country's energy secto r.]
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Zulauf: Just a minute. Mexico is a great story, but it has received the biggest f oreign-capital inf lows by f ar.
Everybody and his brother is invested t here, particularly U.S. managers. I don't question the long- term story,
but if something unexpected happens in the world that prompts f oreign capital to f low back home, the Mexica
market will get hit badly. As capital f lees, the currency could f all 10%, and the bond market could suf f er. And I
expect some bad surprises this year.
Cohen: Much of the U.S. capital that went into Mexico came in the form of f oreign direct investment - - t hat is
companies building operations in Mexico.
Gross: The Tequila Crisis in the mid-1990s almos t took Mexico down because the country had so much dolla
denominated debt. Now, 90% of the debt is peso- denominated, which, in addition to the ref orms Abby
mentioned, puts the country on sounder footing. It doesn't mean the currency couldn't come under pressure
and precipitate a problem, but Mexico is a dif f erent count ry than it was 10 years ago.
Cohen: When the market sensed that the Fed would taper, all emerging markets f ell. This year, we will see
more selective investing, based on individual markets' f undamentals, no t their inclusion in the benchmark inde
East Asia and North Asia are looking better, too . Manufacturing is picking up and exports are improving.
Felix, where do you see markets going this year, in the U.S. and the world?
Zulauf: The U.S. stock market is highly valued on a histo ric basis, but valuation alone doesn't lead to a bear market. Bullish sent iment is also excessive, but it isn't a t iming tool. Prof essional money managers are well-
exposed to equities. Af ter several years of a bull market, your career or business risk is so high that , if you
aren't in the market, you're in t rouble. Momentum is OK. The t aper is akin to raising interest rates f rom a deep
negative level to a less deeply negative level. We don't know when the market will tip over, but the world has
become more f ragile. There is more sabre-ratt ling in Asia between China and Japan. The Chinese economy is
slowing more than the world recognizes. You can't believe China's o f f icial statist ics; they're on automatic pilot
China will grow 3% or 4% this year.
Interest rates have popped up in China, not because of central-bank tightening but funding stresses. There is
a credit bubble. If something goes wrong in China, it could set of f a panic in other stock markets. The Russian
and Asian crises in the late 1990s t ouched of f a 25% drop in the U.S. in a matter of weeks. The market is
building a top in the f irst quarter. In the f ollowing months, there will be a window f or such a panic.
Can't the People's Bank of China engineer a way out?
Zulauf: If it supplies more liquidity to the market, the currency goes down. China also has a social problem.
China's version of social security is that once a son marries, he receives a home or apartment f rom his
parents, with the understanding that the newlyweds will take care of the parents when they get old. Now that
real-estate prices have risen, fewer people can buy apartments. China can't let its money supply explode. The
Chinese government is the smartest by far, and knows t he country must go through a painful adjustment
process . They like to do it in a cont rolled way.
Well, good luck with that.
Zulauf: If we have a market panic and the S&P goes to 1600, the t aper will be over. All the cent ral banks will
provide liquidity. Some will buy stocks f or the f irst t ime. They are af raid of systemic risk.
Gross: T he global economy remains highly levered, with no margin of saf ety. Many policy options have been
exhausted. Leverage permits the poss ibility that the f lutter of a butterf ly's wing could set o f f a global crisis.
7/27/2019 Online.barrons.com-Where to Find Value in 2014
Zulauf: You saw the butterf ly ef f ect when the Fed mentioned t apering. Emerging markets quickly became
victims. Today's slogan is: There is no alternative to equities. Gold hasn't functioned for the past two years a
an investment alternat ive.
Marc, are you warming your thoughts in that hat?
Gabelli: He's getting his bullish thoughts together.
Faber: I lean toward Felix's view of 4% growth in China. To clarify a point about the s ize of the U.S. economy
and its importance in the world, China imported 12% of global metals consumed in 2000. Now it imports up to47% a year. China's growth has a major impact on emerging economies. The U.S. has no impact because it is a
service economy. China has gone f rom sending less than a million travelers overseas in the mid-1980s to 100
million now. You hardly see American tourists in Asia any more.
Are you going to forecast the market or pick on America?
Faber: All asset prices are in the sky, whether it is Picassos o r Warhols o r the f lat that Steve Cohen is trying
sell. [Cohen, f ounder o f SAC Capital Advisors, has a Manhattan duplex on the market f or $98 million.] We are
a bubble. We are the bubble. It is only a question of which asset is in a lesser bubble. The U.S. is expensive,
compared to the European market and especially emerging economies. Based on t he level of today's secular
adjusted P/E, returns in the next seven to 10 years will be minor, if not meaningless. The Mexican stock markewent up 343 t imes between 1984 and '87 because of money-printing. Then the currency collapsed. The dollar
can't collapse, so gold will come to the forefront. Or Bitcoins.
Gabelli: Let's discuss Bitcoins on the Brooklyn Bridge. I want to sell you bo th.
Faber: It is poss ible that a well-run bond f und will do better this year than the stock market. The market hasn'
had a correction of more than 11% since Octo ber 2011. Enthusiasm about t he U.S. market reminds me of the
talk I heard nine months ago in Indonesia and T hailand. Subsequently, tho se markets f ell 35%. While it is t oo
late to buy the U.S., it is t oo early to buy the emerging markets. They aren't incredibly cheap, except f or
Vietnam and Iraq, and capital could st ill f low out. I agree with Abby on Mexico, although I would rather buy
property than the stock market.
Speaking of Iraq, to what degree have investors factored in potential geopolitical crises?
Faber: Geopolitical tensions are rising. You can't ho ld the Fed respons ible for t hat, although without money-
printing, the price of energy would be lower. I was in Ethiopia and Egypt at this time last year. The Asians have
f uture; they can advance, and tighten their belts . But a country like Egypt is much worse o f f today. The Nile
Valley can't f eed the people. Many countries in the Middle East could go up in f lames.
Zulauf: The U.S.'s s tep-by-step withdrawal fro m the region is increasing the risks and dangers.
Gross: History will record that during periods o f slow or negative economic growth, geopolitical problemsalways grow more intense.
Faber: Pretend you are the leader o f China's army. The Americans are enlarging their bases in Australia, trying
to st ir up trouble in the Philippines and Vietnam, and lif t ing an embargo against Burma. America also has a
defense pact with Japan. The Chinese depend on o il, copper, and iron, all import ed commodities. What would
you do to protect your border? The tensions in Asia are real and rising, and could cause a market panic, just
like the f inancial crisis Felix discussed. The Chinese have decided to shrink their government's share o f the
economy and make markets f reer. Everywhere in the industrialized world, you f ind the oppos ite.
7/27/2019 Online.barrons.com-Where to Find Value in 2014
China has a dark side, too. In the U.S., someone can be highly critical of the government and s tay alive. If you
write something negative about the leadership in China, you can be put in jail f or a long t ime. There is only one
Nobel Peace Prize winner behind bars -- Liu Xiaobo, in China.
Thank you for reminding us. Let's move on to this year's investment picks. Oscar, you can start us off.
Schafer: Since the U.S. equity market is one of the most expensive in the world, I have three companies
overseas, and three in the U.S. I recommended several rental companies in the past, including Hertz Global
Holdings [HTZ] and United Rentals [URI]. While these businesses are cyclical and capital-intensive, their
balance sheets are of ten more resilient than investo rs believe. When the economy slows, they can generate a
lot of cash by deferring purchases and de- f leeting. Buying rental companies when they are shrinking can be
rewarding. It is a good time to replicate t his investment across the pond.
Northgate [NTG.U.K.], based in England, has a market capitalizat ion o f £740 million [$1.2 billion] and is a
dominant provider of light commercial van rentals in the U.K., Ireland, and Spain. With a f leet o f 53,000 vehicles
it is three t imes as large as its nearest U.K. competitor. Its shares t rade for about f our t imes 2014 est imated
Ebitda [earnings bef ore interest , taxes, depreciation, and amort ization; the f iscal year ends in April.] The
company pays a 2% dividend and has a conservative balance sheet.
Oscar Schafer's Picks
Company/T icker 1/10/14 Price
Northgate/NTG.U.K. £5.63
I nterxion Holding/INXN $24.63
Internap Network Services/INAP 7.66
Orkla/ORK.Norway 46.33 NOK
BioScrip/BIOS $7.52
ANI Pharmaceut icals/ANIP 22.79
Source: Bloomberg
What type of customer does it serve?
Schafer: Northgate operates a network of retail depots renting vans to a range of corporate customers. The
average rental time is three to four months. The company serves the needs of seasonal businesses including
landscapers and f lorists, as well as governments and corporat ions undertaking special projects. It went into
the f inancial crisis with nearly 60% of its revenue f rom Spain, mos tly exposed to the const ruction industry.
Fleet ut ilization in Spain dropped to 83%, and Northgate breached its gross debt covenant. A new managementook over, restructuring the debt and raising equity, causing substantial dilution. The company's two largest
competitors went under, liquidating their f leets.
In the past five years Northgate has focused on returns on invested capital. It shrank its fleet considerably to
maintain a 90% utilizat ion rate. It also cut f ixed cost s and f inally integrated a f ew decades of acquisitions,
going f rom 20-plus brands run by local dealers to a s ingle brand operated with standard processes and strict
quality cont rols. The balance sheet was de-risked and a refinancing cut the company's interest rate in half .
Now, management is f ocusing on growth. The company is expanding into southern U.K. It has s ix new
locations , with 20 more on the way. Even in a f lat economy, new locations could add £50 million o f incrementa
Ebitda. Operating ef f iciencies and an improving macro environment could boost Ebitda to more than £350
million by 2016. We value the shares at £9, versus £5.63 now.
Gabelli: Are you buying this because you think it will be a takeover target?
Schafer: No. We are buying it f or the operational turnaround. But, given its dominant market share, a compan
wanting to get into the business ought to buy it. We are paying only 1.5 times t angible book value and the
business has a f ree-cash-f low yield of 10% on a steady-s tate basis.
Jennifer Altman for Barron's
Schafer: "We aren't in bubble territory because there is t oo much worry out there—about the def icit, the Midd
East, whatever. You rarely go to a dinner party where people talk about stocks."
At t he midyear Roundtable ["Shifting Winds," June 17, 2013], I mentioned Interxion Holding [INXN], a Europeandata-center operator. The stock declined, and I like it even more at t oday's $24.63. Inf ormation technology
cont inues to transf orm the way we work, communicate, and play. I have no idea which hot start- up will be the
next big thing, but all this innovation is driving demand f or the cloud, streaming video, mobile chat, and more
bandwidth and computing power. The best way to play these trends is to bet on the data centers. Their stock
declined in the second half of 2013, as investors worried about oversupply and competition from companies
such as Amazon.com [AMZN]. They need to dif f erentiate between commodity wholesalers and unique
operators, and identif y companies that can compete on more than price.
Such as Interxion?
Schafer: That's one. It is a cloud- neutral, pan-European data-center operator based in Amsterdam. It o wnsexcellent real estate t hat will allow it to collect growing rents over t ime. The company recently announced a
€100 million [$136 million] expansion in Amst erdam. Yet, despite superior o rganic growth, Interxion trades at a
discount to its closest peers, Telecity [TCY.U.K.] in the U.K., and Equinix [EQIX] in the U.S. There is an overhan
in the form of a large private-equity holder that could sell shares. By my math, Interxion trades f or 10 to 11
times core recurring f ree cash f low. The stock has 50% to 75% upside. It could compound in value f or a long
time if it remains independent.
Mario mentioned my other data- center pick, Internap Network Services [INAP], at a previous Roundtable. It has
a $400 million market cap and is based in Atlanta. Its legacy bandwidth- resale business generates a lot of cas
but is in decline, masking the company's o verall growth rate. If you loo k under the covers, t here is a hidden bu
growing data-center business that caters to midsize customers and of f ers a broad suite o f services. Since
2010, this business has grown by 13% a year, compounded annually, while segment operating margins have
expanded by 13 percentage points . There is s till room fo r margins to expand, as new company-owned data
centers are less than 60% utilized. The data-center business now represents more than 50% of revenue. It
could make Internap the t arget o f a large telecom or inf ormation- technology services company. Internap trade
at less than seven times my estimate of 2015 Ebitda. Historically, such transactions have occurred at 10 t imes
Hickey: There have been many acquisitions of such companies. That could continue. My only concern is that
tons of money poured into Internet-hosting capacity expansion in the dot-com bubble years. Companies
thought they had carved out niches, but when the bubble burst, prices f ell across the board. Now there is eve
more investment. If the economy weakens sharply, what happens to excess capacity and pricing?
We'll find out.
Schafer: My third European pick is Orkla [ORK.Norway], a Norwegian consumer-packaged-goods company in
the middle of a multiyear selloff of noncore assets and operating-margin improvements. When the
rest ructuring is complete, t he new Orkla will be the dominant consumer-brand company in the Nordic region,
making everything from frozen pizza to laundry detergent to toothpaste. It will be a regional peer to global
companies, such as Procter & Gamble [PG] and Nestle [NESN.Switzerland]. The shares sell f or 46 kroner
[$7.43] and yield 5.5%.
The driving f orce behind the transf ormation is Chairman Stein Erik Hagen, a Norwegian billionaire who owns
20% of the company. Hagen made his fortune building and selling the region's largest discount grocery store,
which was Orkla's largest customer. Since beginning the t ransf ormation in 2011, Orkla has so ld of f or listed a
number of business lines. Mos t recently, it announced a joint venture with Norsk Hydro [NHY.Norway] for itsglobal downst ream aluminum business. The venture will yield significant s ynergies and could issue shares in a
few years. Orkla also has purchased two consumer-products competitors in the region in the past two years.
How has the stock done?
Schafer: It has perf ormed poorly. The transf ormation has been slower than expected and the core branded
business is deteriorating, having lost share to private- label and international competitors. Earlier this month,
the company announced that the CEO will step down. This is a compelling time to invest. Orkla will continue
selling assets, and there is a t remendous opportunity to improve margins in the core business. The company'
brands dominate the Nordic market with a No. 1 or No. 2 share in almost every f oo d and personal-care
category. Excluding amort ization, Orkla earns an 11.4% operating prof it margin, while most global peers are 20to 700 basis po ints higher. Conso lidated margins eventually could reach the mid- to high teens. A global
consumer-products company might be in the best position to extract these margins f rom Orkla. We wouldn't b
surprised if the company was acquired in the next 12 to 24 months at a substant ial premium. Absent a deal, th
shares are worth at least 70 kroner t hree years f rom now. We are happy to collect t he dividend while we wait.
We recently bought a large stake in BioScrip [BIOS]. In the past f ew years CEO Rick Smith has radically
transf ormed the company f rom its retail and mail-order-pharmacy roo ts into one o f only three national
providers of home-inf usion- therapy services. BioScrip stumbled last year in integrat ing fo ur major acquisition
creating an opportunity for us. Demand for infusion therapy is growing at a mid-teens rate as a result of agin
demographics and a robust pipeline of specialty drugs t hat need to be delivered intravenously. Inf usion therap
traditionally was administered in a hospital, but has shifted to an outpatient setting in the past two decades.
Home therapy is more comfortable f or the patients and much more cost- ef f ective than hospital and in-patien
Schafer: BioScrip operates a network of state-licensed infusion pharmacies and employs nurses to visit
patients, administer treatment, and coordinate care. This is a highly f ragmented market, and 70% of infusion
pharmacies are independent. The large managed-care companies are pushing the industry to conso lidate, to
ensure consistency of care. The other national consolidators are Option Care, which Walgreen [WAG] acquire
in 2007, and Coram, which was purchased by CVS [CVS] in November. Government reimbursement isn't a big
risk for BioScrip. Medicare doesn't cover home infusion, which forces patients to get treatment in the high-co
hospital set ting. Eventually, the government will f ix this issue.
The stock f ell more than 60% last f all, and now t rades at $7.52. Management revised its annual guidance thretimes last year. It now is focused on f inishing the integration, cutt ing corpo rate expenses, and improving gros
prof it margins in the inf usion business. Current margins dramatically understate the earnings power of the
f ranchise. BioScrip could generate $120 million o f Ebitda and 85 cents of f ree cash f low in 2015. We value the
shares at $13. CVS paid 16 t imes Ebitda f or Coram. We wouldn't be surprised if Walgreen, CVS, or another
st rategic acquirer pays nort h of 15 times to buy BioScrip.
What else have you got?
Schafer: One important advantage to being in the stock-picking business for more than 50 years is that you
have a context f or evaluating companies within an industry. I never had big positions in the large pharmaceutic
companies because there was very litt le in their drug pipelines that could move the needle. That wasn't t rue inthe 1980s and '90s f or generic drug companies, especially when they had six months' exclusivity. We did well in
generics. Then two things happened. Big pharma stopped looking down its nose at generics and brought o ut
its own 'branded' generics, doubling the players and reducing prof itability. Also , the number of blockbuster
drugs coming of f patent dwindled. Recently, generics companies have merged, creating giants that have
ett isoned their smaller drugs. This brings me to ANI Pharmaceut icals [ANIP].
What's to like about ANI?
Schafer: The market cap is only $200 million. ANI came public in June via a reverse merger with Biosante
Pharmaceuticals. It makes an estrogen product to treat menopausal symptoms. Until mid-2013, there were two
players in this market, but the competition was f orced to withdraw, leaving ANI alone and allowing it to increasprices. As a result, f irst- quarter sales could double f rom 2013's $5.6 million. To reduce dependence on its key
product, t he company acquired 31 generic products f rom Teva Pharmaceutical Industries [TEVA] for $12.5
million and a percentage of gross profit. Current sales of these generics and the branded versions are about
$500 million. ANI's earnings per share could be well nort h of $1 this year, rising over t ime to $2. The key is to
grow the portfolio from seven drugs to more than 30, and buy additional drugs. The stock is $22.79.
Thanks, Oscar. Felix, you're next.
Zulauf: I have great respect f or China's achievements, but its credit and investment boom, which start ed 10
years ago, is overdone. Many have predicted its demise through t he years, but they were early. Now it is more
obvious that it's in a terminal stage. China became the world's second-largest economy in a short time. It weninto overdrive after the 2008 financial crisis. In-the past five years, total credit outstanding more than doubled
growing by $14 trillion, to $24 trillion. That growth is equivalent to the s ize of the U.S. commercial-banking
secto r. The balance sheet o f China's central bank has expanded more t han any other s ince 2000. This is the
biggest monetary expansion and credit boom in modern histo ry.
With the 10-year Treasury bond yielding about 3%, I want to buy Treasuries. I'm not const ructive on the bond
market af ter 30 years of declining yields, but t he 10-year yield rallied to 3% f rom 1.4%, and could easily f all by
75 to 100 basis points. I'd buy the TLT [the iShares 20+ Year Treasury Bond ETF] at $104.41. The U.S. dollar
will strengthen against mos t o ther currencies, and it is a good t ime to buy gold, which is completely washed
out . It is the most -hated ass et class. If a panic hits, go ld will rally.
Black: In the absence of inf lation, why should gold go up?
Zulauf: Gold can protect you against many things. Inf lation is just one. There will be a panic that brings backsystemic fears. Those who wanted to sell gold have sold it. China last year bought the world's total productio
of physical gold. Western investors, asset-allocators, exchange-traded fund players have all sold their gold.
Hickey: The GLD [ SPDR Gold Trust ] saw f our years of inf lows depart in one year.
Zulauf: It was a dramatic liquidation. Physical gold moved f rom Western to Eastern hands. I haven't
recommended gold stocks for seven or eight years. Now is the time to buy the GDX -- the Market Vectors Go
Miners ETF. I got my f eet wet at t he mid-year Roundtable, recommending a cheap opt ion strategy to buy gold
stocks [see mid-year scorecard at barrons.com].
Jennifer S. Altman for Barron's
Zulauf : "The Hong Kong banking system is heavily exposed to mainland China. When things f inally go bellyup,
there could be a banking crisis in Hong Kong. I recommend shorting the Hong Kong stock market."
In general, risk positions will get reduced by the market. Everybody is short the yen and long Japan's Nikkei
index. The yen could suddenly jump and wipe out t he shorts . The dollar will strengthen t his year, so buy yen
against another currency. It 's bes t to sell Swiss f rancs and buy yen, which were at CHF115.42 [$126.55] Friday
[Jan. 10]. This t rade could work f or six to nine months. I'll have to review it at midyear.
My last recommendation involves a bearish bet on Turkey. In June, I recommended shorting the Turkish lira
against the dollar and euro. A dollar bought TRY1.88 then and TRY2.19 now. Among developing markets, Turke
was one of the main benef iciaries of f oreign capital, No. 2 af ter Mexico. Since 2010, Turkey has received $85
billion of capital. There was a big economic boom. The iPhone cost more than $1,000 in Istanbul. Turkey is the
seventh- largest economy in Europe. It had hyper-inf lation in the 1990s, and ref ormed its currency in 2005,
which encouraged capital inf lows. In the past f ive years, credit grew 2.5 times f aster than GDP. Credit growth
peaked in 2011 at 50% of GDP. It's now down to 20%. Consumer inf lation is 7.4%.
Turkey also has big political problems.
Zulauf: The corporate sector has $125 billion of short-term debt and $32 billion of medium-term debt. At the
same time, the central bank's f oreign-exchange reserves have f allen below $40 billion. This covers less than
two months of import s. Turkey is short U.S. dollars. This makes for an explosive situation.
As if this weren't bad enough, Prime Minister Recep Tayyip Erdogan int roduced more Islamic rules in recent
years, and the most ly secularized people, particularly in Istanbul, became unhappy. There were st reet protests
especially over his plan to close a park in the middle of the city. Erdogan reacted in the worst way poss ible; he
started to f ight the people in the st reet. Then the count ry's president began criticizing him, which split the rulin
party. Erdogan's support is beginning to crumble. The president wants to be prime minister, and Erdogan can't
run again. So he did what Russian President Vladimir Putin would do: He gave the presidency more power
because he wants to run f or president and stay in the game. The pres idential election is in August.
Erdogan reduced the military's power and inf luence. He put 300 o f f icers in jail. Recently, there was a corruptio
scandal. It's a mess. Mos t important , Erdogan to ld the central bank that it can't raise interest rates , which
would spark a recession. Thus, the system gets adjusted through the currency.
What do you expect to happen?
Zulauf: The do llar/lira t rade could go much higher [the number of lira to the do llar could soar]. You can buy
dollars and sell the lira using the one-month forward contract.
Another way to sell the currency short without paying the f orward cost s is t o sell sho rt the do llar-denominateiShares MSCI Turkey [TUR]. It's trading f or $47.23. It has come down a lot, but the low was $18 in 2008. By
selling it short, you sell the currency at the spot rate but also sell the stocks. At some point, the stocks will
benef it f rom a lower currency, but that is a long way of f . In the near term, the currency could go to T RY3, and
