Forbes Investment Roundtable:
On January 31, 2011 Wallace Forbes, CFA, president of Forbes Investors Advisory Institute, hosted a Forbes Investment Roundtable discussion among several leading investment authorities. Each investor’s commentary, along with their interchange with the other participants, will appear individually on Intelligent Investing. Today we highlight the commentary of Vahan Janjigian.
Participants:
Vahan Janjigian, Ph.D, CFA, Chief Investment Officer of Greenwich of Wealth Management and Editor of the Forbes Special Situation Service
David N. Dreman, Founder and President of Dreman Value Management
Barry Ritholtz, CEO and Director of Equity Research of Fusion IQ
Michael Holland, Chairman of Holland Balanced Fund
Vahan Janjigian: As always, there are things that concern me. In the past decade or so, we’ve had a couple of major sell-offs in the stock market. In the 1990s, we had a big bull run and then, starting in 2000 to 2002, we had a huge sell-off in stocks because of the dotcom bubble and bust. In 2008, we had the financial crisis and we had a major sell-off that followed soon after. Then the stock market bottomed in March of 2009 as we saw the Dow go all the way down to 6,500.
Then, of course, stocks recovered. If you look from July’s bottom to the close of the market on Thursday January 27th, we saw that the S&P 500 had rallied 27%, which is a great return for a full year, let alone for six months. We’ve had a great run recently, but my concern is that it’s not really sustainable.
Because we’ve gone through several severe sell-offs in the past decade, I think investors are more wary than usual, and more prepared to sell on a moment’s notice when they see any type of bad news. That’s exactly what happened Friday, January 21st. I don’t know if it was because of the rioting in Egypt, or if it was because the GDP report, which was strong, was not as good as expected, or if it was because Amazon.com gave some disappointing guidance. Whatever the reason, people started selling heavily on the 21st and I think they’re prepared to do so again.
Right now, we have a number of things going on in Egypt. Egypt itself does not have any serious consequences for U.S. most investors. I think investors, for the large part, ignored the Jasmine Revolution that took place in Tunisia prior to Egypt, but they started getting spooked by what was happening in Egypt.
Again, this was not because it has any consequences for them directly. But there is a real fear that what happens in Egypt could spread to other Islamic countries, especially the ones that produce a significant amount of oil. A rise in the price of oil would certainly have consequences for U.S. consumers and U.S. investors. So I think people are on edge right now because of that.
There are other things happening on the international stage that I think also worry U.S. investors. China, India and Brazil all have very strong growth. But recently, we’ve started to see that they all have very high inflation, too. I think that’s something that’s really starting to worry American investors. Portugal, Ireland, Italy, Greece, and Spain — the so-called “PIIGS” of the European Union — are plagued with all kinds of problems, especially high debt and high unemployment. They eventually will probably have to be bailed out. The United Kingdom has implemented austerity measures, and we have seen that their last GDP report showed contraction, not growth. So that’s another concern.
The U.S. has a lot of serious problems, too. We have a tremendous amount of debt on the federal level. The federal government can’t seem to get its spending under control. I think that’s a big concern. State and municipal governments are drowning in pension obligations. In general, there is too much debt, too much unemployment and too many houses available for sale in the U.S. right now. These are concerns that I think will worry investors and cause them to sell at a moment’s notice when really bad news comes out.
For the most part, investors have known about these problems and have chosen to ignore them. They’ve chosen to focus on corporate profits. And corporate profits, of course, have been very good. Profits have been growing on a year-over-year basis, and they have also been coming in ahead of expectations.
As investors say, “The bottom line is the bottom line.” In other words, in the final analysis, what really matters is profits. Investors have been pretty pleased with profits so they have bid up stock prices. To a certain degree, I think they were right to do so. I think a run-up in stocks was certainly justified.
In my opinion, however, the recent rally has gone too far. Corporate profits are strong, but they have been coming primarily from cost cutting. Not that there’s anything wrong with that — generating profits by cutting costs is a good thing. The problem is that it can only go so far. Eventually, businesses reach a point where they can generate more profits only by generating more sales. And I think many businesses have now reached that point. So we’re going to have to see more sales in order to see more profit growth.
Now, of course, all this does not mean that we’re going to see another severe sell-off like we saw in 2000 to 2002, or the one that followed the financial crisis. But it does mean that we could see about a 10% correction in stocks. So I think stocks could fall perhaps 10% and then remain flat for the rest of the year.
In the longer run, in order for the stock market to go significantly higher, I think that the economy has to get much healthier. This means that the government needs to cut spending and it needs to pay down the debt. In other words, we have to have some short-term pain for the sake of long-term gain. I think one good piece of news is that, in the State of the Union address, we heard President Obama move a little bit closer to the center. That is a positive sign. If he’s willing to work with Republicans, then perhaps in the long term we can address the serious problems of Medicaid, Medicare, Social Security, and a much too complex tax system.
Wallace Forbes: Thank you, Vahan. I have a question. You said that you thought the correction might only be 10%. Over what period of time do you think that might evidence itself?
Janjigian: I think we could have a 10% correction fairly suddenly, over the course of just a couple of weeks.
Forbes: Soon?
Janjigian: Soon, yes. I’m not expecting any more than that, because I think it’s difficult to argue that the stock market is overvalued, like it was during the dotcom bubble. I think we could have a rather quick correction and then remain relatively flat for the rest of the year.
Forbes: What does this lead to in the way of suggestions for purchase or sale of stocks?
Janjigian: Well, of course, I’m in the business of picking stocks. Even in what I think might be a weak market, I’m going to continue to identify stocks that I think are special situations that could do well. One stock I like a lot is a very large cap healthcare company, Johnson & Johnson. I think it is tremendously undervalued. It also pays a very good dividend. They’ve had some very severe problems recently with product recalls and the shutdown of a plant in Pennsylvania. Their consumer segment, in particular, has been really hurt by that. But I think production will eventually come back on line. You’ll see Tylenol sales picking up again once it does. I think Johnson & Johnson could be a good long-term investment.
Another one I really like is a company called Corinthian Colleges. This is a very small cap company. They are in the for-profit education business, a business that’s taken tremendous hits recently because politicians are coming down on it. It’s true that many of these kinds of companies have been too aggressive in going after students who were unable to either graduate, did graduate but couldn’t find jobs, or found jobs that did not pay enough to help them pay back their loans. Taxpayers have been left on the hook.
Yet the same can be said for many of the traditional nonprofit educational institutions, too. Corinthian Colleges — like all the other for-profit colleges — will be less profitable in the future, but it will remain profitable. And the stock has been beaten down way too far.
Forbes: Does Corinthian have a physical location? Or is it an online college only? Or both?
Janjigian: It’s primarily online, but they do have a few physical locations as well.
Barry Ritholtz: There was an op-ed, I don’t remember if it was in the Times or the Journal or FT — that’s the problem with consuming a lot of media, it’s a flush — but the article was about the actually very poor graduation rate that most colleges have in the United States. And the for-profits are the bottom of the list.
Part of the discussion was about how a lot of money goes from the Department of Education to various colleges, both for-profit and not-for-profit. Perhaps what would make more sense — in light of Obama saying, “Let’s look at regulations that don’t make sense and get rid of any payments that could be cleaned up” — to focus on the graduation rate not just the enrollment. What does that do? I honestly don’t know. But I thought it was interesting you mentioned for-profit colleges in light of all the bad news. What would a policy change like that do to that sort of investment?
Janjigian: I think you might be referring — I’m not sure — to an op-ed written in The Wall Street Journal by Donald Graham, CEO of The Washington Post. The Washington Post, of course, owns Kaplan.
Ritholtz: Right.
Janjigian: He was defending these for-profit institutions, and arguing that — for the most part — they deliver a high-quality education at a much lower cost than the nonprofits do. There’s a very important place for them.
They’re also not giving the same kind of education that the nonprofits do; they’re really providing training to help people find employment quickly in a healthy economy.
Ritholtz: Would you say these for-profit institutions are vocational?
Janjigian: Yes, it’s primarly vocational It’s more training rather than education. And for the most part, they have done a pretty good job.
But focusing on the graduation rates, I think is important, not just for the for-profits, but also for the nonprofits. In nonprofit institutions these days, a smaller and smaller number of students people are actually graduating within four years. That time is being extended to five years and six years. So that’s a serious problem everywhere.
Ritholtz: So I was ahead of the curve 20 years ago?
Janjigian: That’s right, yeah.
Ritholtz: Five-year plan? Good to know.
Janjigian: I have no objection to the government saying, “We need to examine these schools carefully, because taxpayer money is being used here.” But if you’re going to come down on the for-profits, you need to come down on the nonprofits as well.
Forbes: Vahan, thank you very much.
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