ED HYMAN, CHRIS DAVIS AND TOM PETRIE TRANSCRIPT

January 19, 2007

This week on WealthTrack, three investment stars exclusively for you. Wall Street’s number one ranked economist for 27 years running, ISI Group’s Ed Hyman, and former Morningstar fund manager of the year, Davis Funds’ Chris Davis, and the energy expert Merrill Lynch just brought in house, their new Vice Chairman, Tom Petrie. They’re all on our red carpet next on Consuelo Mack WealthTrack.

CONSUELO MACK: Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. We have an all star cast lined up for you on WealthTrack this week and they have plenty to talk about. The Street’s long time number one ranked economist, ISI Group’s Ed Hyman shared some of his signature charts with us which I will get to in a moment. This week we learned from various Federal Reserve banks around the country that the economy is growing at a modest pace in most regions and even manufacturing is picking up. But inflation does not seem to be a problem. U.S. consumer prices rose at the slowest pace in three years last year and as you can see from this amazing chart showing a composite of consumer prices in 35 countries, global inflation is restrained as well. One development keeping inflation in check has been falling oil prices. Crude oil has fallen by double digits this year alone and down just over one third since hitting its all time record of over $78 a barrel in July. We’ll ask energy expert Tom Petrie to explain that. And the stock market has been full of surprises. We focus on longer term trends around here, but there’s no denying it’s been a rough start to the new year, but not for everything. ISI Group pointed out to clients this week that the mega caps are back. Over the last year the largest 50 companies by market value have outperformed both the S&P 500 and the Russell 2000 after lagging for several years running. Where’s the value to be found in the markets? We’ll ask value investor Chris Davis. What the markets, the economy and energy mean for your portfolio are next on Consuelo Mack WealthTrack.

On WealthTrack this week, we are reviewing the investment climate through the eyes of three guests at the top of the professional game, and all TV exclusives to WealthTrack. You’re not going to see this kind of investment fire power anywhere else. First up, the man institutional investors have voted the number one economist on Wall Street for an unprecedented 27 years in a row, Ed Hyman, co-founder with Nancy Lazar of ISI Group, one of the most highly regarded sources of independent economic research. It is considered a daily must read by many professional investors around the globe, and oversees nearly a billion dollars in bond funds. Great to have you here. And one of the things they track is the energy market, and one of the sector’s savviest experts is also here, Tom Petrie, until recently the head of his own research and investment firm Petrie Parkman, but no more. Merrill Lynch decided to bring Tom’s expertise in house, and last month bought the firm and made Tom Vice Chairman of Merrill Lynch where he will be focusing on investment banking. Is there value to be found in the energy sector or anywhere else for that matter? Our next guest has value in his blood, Chris Davis co- manages three highly rated value funds including selected American shares that has earned Morningstar’s highest rating for over three years, and the equity fund manager of the year in 2005. It is great to have all of these stars with us. So thank you very much for being here. Ed, I want to start with you and have you set the stage for us with the economy. What kind of an economy is it going to be this year for investors?

ED HYMAN: Let me say, it is nice to be on your show, and with Tom and Chris, and thank you so much for having me. I think the economy will slow down a lot this year, and it will be a very good year for the market. Because I think the Fed will ease towards the latter part of the year. But currently the economy is accelerating. Retail is strong. And for the past five years, the economy has picked up early in the year, and it is doing it again. You had more bonus payments, and warm weather, and you have these gift cards, and the economies picked up. There is a tendency for inflation to be bad early in the year. So I’m, frankly, scared for the next, say, two months.

CONSUELO MACK: Scared for the market?

ED HYMAN: I’m scared that the Fed might think about tightening in the next few months, particularly in the next two months. And so I’m trying to get through that. And then we’ll see if my view of the economy will slow is the correct view or not. Right now it is going up, and there is a little inflation coming here in January.

CONSUELO MACK: If the Fed does tighten, is that going to be a problem? Or how much of a problem will it be for the markets and the economy?

ED HYMAN: I think they’ll just tighten until they get the economy to slow down. I see no chance they will stop without succeeding. And if they go back and tighten, I would guess the market would go up about 1% a quarter. The market was going up something like that, 15% a quarter. In ’04, ’05, the first part of ’06, the market was going up about 1% a quarter, because earnings were great, but the Fed was tightening. Right now we’re in 1Q acceleration for the economy, and I’ll let you know in March if it is going to slow.

CONSUELO MACK: We might know even if you don’t let us know. Let’s assume that your forecast is correct, and the first quarter acceleration and you just raised the GEP forecast to 3.5% for this quarter. And then you’re saying it will slow down. What is going to slow it down?

ED HYMAN: These are the factors: there is a lagged impact of the 17 rate hikes, and the yield curve is inverted, and house prices are going down. And consumers were taking a lot of money out of their house.

CONSUELO MACK: Right.

ED HYMAN: And that’s coming down, called MEW- mortgage equity control. And that package, history tells me, will slow the economy. But right now, I’m unable to tell if it is working because these three factors, more bonuses, more people are getting bonus pay, every year, and the gift cards pushed some of the Christmas into the first quarter, and we’ve had warm weather.

CONSUELO MACK: Right.

ED HYMAN: The warm weather works not only for helping housing, but everybody is happy with their energy bill.

TOM PETRIE: It’s in lieu of the interest rate cuts for the moment.

ED HYMAN: So at the moment, the argument for the economy not slowing is pretty good. And I think the bond yields will move up further, say to 5% or higher. And they’ll be worried that the Fed is going to tighten them. At this moment, when we talked to investors, there is now no expectation — the consensus is for no Fed easing.

CONSUELO MACK: Right.

ED HYMAN: Where there was one month ago, there were like three Fed easings, and people were worried about a down-turn in the economy. And that, in four weeks, has changed. And my guess is in four more weeks there will be an even more hawkish concern that the Fed didn’t get the job done.

CONSUELO MACK: That the Fed might tighten.

ED HYMAN: That 5.25 wasn’t enough and they’ve got to go to 5.50 or 6. I don’t think they are. I’m sorry to be on your show with a move here and then a move there, but that’s the way I think it is.

CONSUELO MACK: Which is why investors read your research because you follow exactly what is going on.

ED HYMAN: Beyond this, economy will slow, and the inflation is low, I think, and I think rates will come down, and we’ll have a good year for the market in the same sort of vein that we had in the latter part of last year, starting in August, September, October, November, which was the first phase of what we call a mid-cycle slowdown.

CONSUELO MACK: Let me turn to energy because we did get a big tax cut with oil prices going down. Tom, what’s your outlook for oil?

TOM PETRIE: We’re still within the range I talked about last time, $50 to $70 a barrel 80% of the time, and some smaller percentages below 50 or above 70. But we’re testing it. The key thing right now is geopolitics are driving it. The Saudis have come out and said we don’t need to cut production, which is signaling to the rest of OPEC, either you guys have to come along and do your cuts, we’ve done ours, or else the price is going lower. Or if you want to stabilize somewhere near here. Otherwise I think we will spend a little bit of time with another round of decline seasonally. In the very near term, we’ve got a very warm winter; the warmest winter maybe on record is in the making. And that’s contributing to this. But even if it were a cold winter and we get a snap, and some recovery, there is going to be a seasonal test of the real lows this spring.

CONSUELO MACK: Let me ask you about that. A former WealthTrack guest, Bill Miller, was on here saying he is personally shorting oil. Let me ask you on his behalf, because I talked to him again today, basically he thinks oil is oversold and it might go up to $55, if that, but it is going to fail there and he thinks it is going to go lower. What is your advice to Bill Miller?

TOM PETRIE: That is a pretty logical conclusion. One, we are seeing some weather finally arrive here. And for those who are short and were short at 50 or 65 or 63, you could be short 63 six, eight weeks ago, and they made a lot of money. The way they nail it down is to cover, and that takes prices back up some. But I tend to agree with him, I don’t think it goes very far up before it runs out of steam, and then you have the seasonal effects to deal with. All of this is masking the long-term we talked about the last time. Resource nationalism, in terms of Russia, Venezuela, and others, and resource maturity, in terms of conventional oil development, is still there. And the effect of all this is we’re going to compress the cycles. Some of what Fed is talking about really resonates for me because the cycles are compressing, and we’re having to deal with these things changing much more rapidly than they have historically. If you go back and look at historical cycles for capital investment in this industry and so on, it misleads you as to what the lead times are. And, you know, I think as a result, 2007 is going to be a challenging year.

CONSUELO MACK: Challenging meaning that oil prices are going to go lower?

TOM PETRIE: Oil prices are not your friend, which they have been for the past four years. But I also think we’re a lot near our bottom now than a real plunge into the low 40s or lower. I think the odds of that — they’re not zero, but the odds are very small, single-digit probability.

CHRIS DAVIS: It is also interesting that the oil stocks didn’t seem to be discounting. They certainly weren’t discounting $80 oil, and many of the stocks did a lot less badly than you would have thought with oil going from 80 to the low 50s. The interesting question is what is priced into the equity prices for oil stocks.

CONSUELO MACK: Chris is speaking — you were buying energy positions and the 1990s.

CHRIS DAVIS: Yeah.

CONSUELO MACK: And you’ve got major holdings in Conoco-Phillips, and Oxidental Petroleum, that you’ve held since the late 90s, and you’ve decided to stay with your energy holdings?

CHRIS DAVIS: We have very low turnover, and so we tend to have a very long time horizon. We see it more of a buy on the dips then sell on the strengths, sort of long-term play in energy if you look out ten or — our holding period of ten years. I think they’re discounting oil prices about in the low 50s, and that’s probably at the low end of what might be a reasonable range over the next period of time.

CONSUELO MACK: What is Chris going to go through in the next one, two, or three years?

TOM PETRIE: Well, I don’t think — I think what I’m talking about is literally the first half of ’07. And that’s why I went to the resource nationalism resource maturity. Those two factors have been alive and well post-9/11, and we’re seeing more and more evidence that the development of significant new low- cost oil is not occurring on a global basis. And that really underscores the position, the strategic positioning of the kinds of names Chris was talking about.

CONSUELO MACK: Chris, where else are you finding value in the marketplace? One of the things you were watching you told me earlier, you’re watching this kind of growth versus value type of dynamic.

CHRIS DAVIS: And large versus small. I think Ed’s chart was terrific. This is an amazing number, but that the largest 50 companies in the S&P 500 in March of 2000 traded at, I think, 170% premium in terms of valuation to the next 450 companies. And that bottomed at about 5% discount in the beginning of last year. And sort of maybe set the stage for some recovery. There just doesn’t seem to be any real appetite for these really large companies. All of the hedge funds that are getting huge incomes are skewed towards small and mid-sized companies. You mentioned Bill Miller, and he had a great phrase “we’re in a just in time market.” Nobody wants to be early investing in anything because so much of the money is in funds that are being judged over a quarter basis. A lot of hedge funds can have a bad three months and be put out of business, let alone a bad year or two. There is a lot of money waiting for things to start moving and waiting for catalysts, and it can create a good opportunity if you’re willing to look sort of beyond the dips. I do think the large companies, the high quality, and the global companies, stronger balance sheets, and global positions, maybe less exposure to commodity prices, and the ability to pass on price increases if needed. And it’s amazing they aren’t trading at the premium that they traded on average for 30 years; they’re trading at a discount. It seems to me that’s a fairly good place to hide when risk premiums are very, very tight. In a world where there is no premium — god forbid a terrorist event or some sort of shock in the system, I think you’ll see the quality spreads change in the fixed income markets of course, and also in the equity markets where people will pay up for the lower risk and the higher quality global names.

CONSUELO MACK: Right. Does that work in energy as well?

TOM PETRIE: It probably does. Quality does matter. And this dichotomy between short-term orientation, versus what is the real two, three, four-year outlook, which gets you on the way towards that ten-year horizon that Chris talks about. It is totally different from what the near term focus is of the hedge funds. Really, when you think about what’s been going on, once we knew that things were running very, very warm in terms of this winter, you know —

CONSUELO MACK: The hedge funds got out —

TOM PETRIE: The near-term trade was obvious. And now the real issue is: is China slowing? China’s imports last year were 14.5% above the year before. And that demand growth is one of the fundamental drivers that is not going away.

CONSUELO MACK: And it is interesting that research in China — you’ve got a group that is dedicated to that. What’s the answer to that question?

ED HYMAN: First, I think that the developing economies in general, and China included, are one of the most important dynamics in the world economy. And boy, they are growing. And it’s not just China. All these countries that are being involved in the globalization are doing very nicely.

TOM PETRIE: The greater Pacific rim, and other parts of the world.

ED HYMAN: Latin-America, and Eastern Europe. I mean it’s amazing, and, of course, they’re very big commodity consumers. One thing I would share is the idea that the Fed is in play. And I don’t see any chance they will stop until they have produced a significant slowdown in the economy that will make this inflation worry be put aside. And so if the economy doesn’t slow in the second quarter, as I expect, they’ll come back and tighten again.

CONSUELO MACK: And you expect it will slow —

ED HYMAN: I think it will slow. But if it doesn’t, the Fed will come in and tighten again.

TOM PETRIE: And going back to what you said earlier, you’re worried about the next two months. If it gets cold and the oil prices go up, that would reinforce their inclination.

ED HYMAN: That would reinforce their inclination, but this drop in oil is going to pull the rug out of inflation for six months. It may disguise inflation for six months —

CONSUELO MACK: So that would be a positive, actually?

ED HYMAN: That’s a positive —

CONSUELO MACK: It would hold the Fed back.

ED HYMAN: It would hold the Fed back. But they’re going to be focused more on growth, and if the unemployment rate heads towards 4%, it is currently 4.5%, if it goes to 4.3 or 4.2, they’re going to come back and hit the economy.

CONSUELO MACK: You sound worried, Ed.

ED HYMAN: Actually, I’m not.

CONSUELO MACK: Okay.

ED HYMAN: Because I’m so confident of my forecast.

CONSUELO MACK: Well, that’s why for 27 years you’ve been the number one economist on Wall Street.

ED HYMAN: But if it doesn’t, they’re going to come back and tighten again. One thing on the side is that if this is right, that they are so adamant, and I watched the Bernanke testimony this week to see if the Democratic Congress would be pushing back, and they didn’t. They’ve still saying, you can do your job.

TOM PETRIE: And there were predictions they might.

ED HYMAN: There were predictions they might. The longer term inflation picture looks pretty favorable because the Fed is in good position.

CHRIS DAVIS: And it does seem that the real estate bubble, that really could have had a bigger impact, now is being deflated. That is the one thing I wanted to ask about, this idea that if it seems that adjustment is sort of rolling through or if the market is not clearing yet? I sort of get different reports from different areas.

ED HYMAN: It looks like housing starts, the building of new houses —

CONSUELO MACK: Have picked up a little bit.

ED HYMAN: Have bottomed and picked up a little bit. And we got today the first piece of news I’ve seen that existing house prices, existing market, might be improving. There was a Michigan survey out that showed improvement in plans to buy a house.

CONSUELO MACK: But in your gut, do you think that that is the case, that housing might bottom?

ED HYMAN: Yeah, I do.

CONSUELO MACK: That doesn’t mean it will turn up any time soon?

ED HYMAN: Chris and I were talking earlier about the decade performance of the stock market, which is not very good. People love housing. It still looks like the best thing you could put your money in.

CONSUELO MACK: Okay, we have to go to the one investment for a long-term diversified portfolio which we do at the end of every WealthTrack and Tom Petrie cannot participate because he is now the Vice Chairman of Merrill Lynch in the investment banking department and it is totally separate. So, Ed Hyman, we’ve been talking about this. Your one investment has to do with something you recommended here before, and that was large cap growth stocks?

ED HYMAN: Well, I would — first, my best investment idea would be to invest in Chris’ funds.

CONSUELO MACK: Which one? Like the New York Venture, or…

ED HYMAN: The one he told you about. But I like GE (GE) as a company. I like their global footprint.

CONSUELO MACK: Right.

ED HYMAN: I like the valuation, and I like the way the stock is trading. And so — I’m not a stock picker, but that would be —

CONSUELO MACK: I know you’re not.

ED HYMAN: If we were placing bets tonight for who would win by the end of the year, I would put GE as my interest.

CONSUELO MACK: Are you two in cahoots?

CHRIS DAVIS: I’m so glad to be able to agree with everything Ed said; he has a 27 year record of being right. I agree with every word. I don’t happen to own General Electric (GE), but I just spent a day at their investor day, and I was talking to my father —

CONSUELO MACK: Shelby, who used to run Davis Advisors.

CHRIS DAVIS: And he was saying the same thing. Not necessarily that you would retire rich, this is not Google, but it is enormously high quality, trading at a reasonable valuation, which seems to be a very honorable management team, and much higher quality earnings than they have for the last decade. The earnings are up substantially, and the multiple is down in half or so from the peak, and outside of our own funds or the stocks we own, my father said to me, “why don’t we own GE?” And having heard it from Ed, I think I better get back to work.

CONSUELO MACK: We’ll leave it there. Tom, do you own GE personally?

TOM PETRIE: No, but I might think about it.

CONSUELO MACK: After tonight. Thank you all so much. Ed Hyman, great to have you. And Tom Petrie, Vice Chairman at Merrill Lynch, thanks for being here as well in from Denver, and Chris Davis, great to have you as well.

At the conclusion of every WealthTrack, we give you one suggestion to help you build or protect your wealth. And I am going to follow up on the sentiments of today’s guests that quality counts. As Chris Davis and Ed Hyman said many blue chip American companies are bargains right now, especially compared to their less than stellar competitors. One measure of a company’s financial strength is its ability to generate cash and pay a dividend. Over the past century dividends have contributed more than 40% of the stock market’s returns. So this week’s action point: pay attention to dividends.
Research by past WealthTrack guest Rob Arnott and colleague Clifford Asness found that higher dividends equal higher earnings growth. Over ten year periods, the average rate of earnings growth was nearly four percent greater when companies’ dividends were high than when they were low. Other research by Columbia University professors found that companies that raise their dividends have superior stock returns. One of last year’s best performing strategies was to buy stocks with high dividend yields. The most recent evidence of dividend allure is a recent Merrill Lynch poll which found that a record 53% of fund managers surveyed want cash returned to them via either dividends, share buybacks, or cash acquisitions. 46% believed dividend payout ratios were too low. So as you look for higher returns, pay attention to companies paying dividends and increasing them. They can payoff in both the short and long term.

And that concludes this edition of WealthTrack. Next week we are going to help you avoid some classic investment mistakes in mutual funds, stocks and art with Morningstar’s Christine Benz, Money magazine columnist Jason Zweig and Art and Auction’s Ann Berman.

And don’t forget if you want to see Ed Hyman, Chris Davis and Tom Petrie again, and who doesn’t, just go to our website wealthtrack.com. Starting on Monday you can view this program on a webcast or podcast. And before we leave you we want to welcome a new station to the WealthTrack family, Norfolk, Virginia’s WHRO is airing us Sunday afternoons at 2:00. We are delighted to be there.

Until next time, make the week ahead a profitable and a productive one.


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