(This is not a legal transcript. Bloomberg LP cannot guarantee its accuracy.)
TOBIAS LEVKOVICH, RESEARCH ANALYST OF CITIGROUP, TALKS ABOUT MARKETS ON BLOOMBERG TV
AUGUST 20, 2010
SPEAKERS: TOBIAS LEVKOVICH, RESEARCH ANALYST, CITIGROUP
TOM KEENE, HOST, 'BLOOMBERG SURVEILLANCE'
KEN PREWITT, HOST, 'BLOOMBERG SURVEILLANCE'
08:07
TOM KEENE, HOST, 'BLOOMBERG SURVEILLANCE': With us, Tobias Levkovich.
Let me get right to it, Tobias. We need math in August. OK? We are 2.48 standard deviations below the mean.
I mean, if you've got these fancy charts here, and you look at how much we've come down, are you saying buy here, as others, including Dennis Gartman, go to cash?
TOBIAS LEVKOVICH, RESEARCH ANALYST, CITIGROUP: What we're saying is on a relative basis, equities look a lot more attractive than bonds do at this point. And I want to buy on weakness. So when the markets pull back, I want to take advantage. I don't want to chase the market given some of the uncertainties in place today. But on a valuation factor, the equity market is factoring already a lot of bad news in the earnings environment.
KEENE: Yes.
KEN PREWITT, HOST, 'BLOOMBERG SURVEILLANCE': So the equity market is wrong?
LEVKOVICH: Not necessarily wrong, but the extent to which the investment community has gotten fearful. And just almost - think about it. Over the past week or two, we've heard about things like death crosses and the technical indicators are the Hindenburg Omen and things like that, and it just gives you a sense of the -
KEENE: Help me here.
Folks, it's a jargon-free planet.
What is a Hindenburg whatever you called it?
LEVKOVICH: Well, I didn't - I haven't created the Hindenburg Omen, but it was a technical -
KEENE: Is this like a Clemente thing?
LEVKOVICH: No. It was a technical indicator created by a mathematician looking at the percentage number of highs in the market and lows in the market. And when they cross over a certain percentage, it causes a Hindenburg moment.
KEENE: It causes the New York Mets to win.
LEVKOVICH: I'm the wrong guy to talk baseball with. But the context here is that only one out of four times does this Hindenburg Omen mean anything in terms of sending a bad signal, yet it was all the rage after an article in "The Wall Street Journal" recently. So it gives you an idea of how these kinds of articles are affecting the mindset in the investors.
PREWITT: Yes. Well, you know, Tom just read some of the numbers. You know, the two-year treasury at .47, the 10-year barely above 2.5. McDonald's goes to Hong Kong and sells three-year bonds at three percent.
I mean, do we reach a point here where people say, come on, I've got to have some return?
LEVKOVICH: Well, you would say the junk bond market is so strong because of that in terms of the yield opportunity. The MLP markets are strong, the REIT market has been strong, anywhere we can get a better yield.
The dividend area is a little bit more complex given the expiration issues of the Bush tax cuts and what's going to happen with that in the future. We don't know the answer. We don't know the answer in general dividends, but in things like REITs and MLPs, that's not an issue.
PREWITT: Right.
LEVKOVICH: So, you know, in the sense that investors do want yield, but they're also fearful of what's going on, so they've been running to bonds. What I'm concerned about in the bond market is not bonds are a bad investment. The extremities of the money flows is what worries me.
So, for example, back in 2000, or late '99, we saw massive amounts of money going into the equity market at just the wrong time. And I feel the same way when I look at all the money going into bonds.
KEENE: I mean, this is a huge debate, Jeremy Siegel of "The Wall Street Journal" versus Paul Krugman right now.
Is there a bond bubble, Tobias?
LEVKOVICH: I don't like the word "bubble."
KEENE: I don't either.
LEVKOVICH: I think bubble is something you define as something you don't personally own. So you kind of categorize it as a bubble because it justifies or rationalizes your view.
I do think that there is an uneven distribution in the way money is flowing into different assets. And right now it's all out of equities and all into bonds. And again, 10 years ago it was the reverse, and we kind of know what happened in the past 10 years in stocks.
KEENE: Are dividends a yield equivalent?
LEVKOVICH: You know, European strategists do a lot of work on this, and the dividend yields in Europe crossed the treasuries, or the equivalent government bonds in Europe in terms of the yields, over a year ago. It hasn't really done much to change the mindset, so I'm not sure it's the fact that you have these crossovers that cause everyone to wake up and smell the coffee beans.
PREWITT: Well, you know, when you look - I mean, there's a reason it's called fixed income. Right?
LEVKOVICH: Yes.
PREWITT: Dividends can - I mean, they can go down, but dividends can also go up.
LEVKOVICH: Well, the truth is our greatest concern in the fixed-income market is if you believe - and you almost have to take extremes. If you believe we're going to get stimulus working globally and we're going to get economic growth, then there will be some inflation down the road, and obviously bonds are risky.
On the other side, if we don't have that, and we potentially go down the deflation route, you're going to have some real big risks in terms of the imbalance between federal revenues and federal expenditures. In other words, deficits will continue to balloon.
And we can say, well, it was Japan, and they went through this. But Japan doesn't source 40 percent of their funding from outside of their own country. We do.
PREWITT: You mentioned the Bush tax cuts, which is all part of the uncertainty argument. We don't know what's going happen. They expire at the end of the year unless Congress does something.
So does that mean everything's going to be on hold until the end of the year?
LEVKOVICH: I'm not sure if it's on hold until the end of the year, but it's certainly going to be watched very carefully as to where we're heading in November.
PREWITT: Oh.
LEVKOVICH: So my sense is in October, we're going to get a much better feel for what the midterm elections outcomes look like. And while I've heard talk around, well, they'll do something in the lame duck session, that will have to be a pretty significant set of compromises, because I don't think - potentially, if the Democrats were to lose a fair amount of seats, that could be a big problem to try to do something in the lame duck.
So I - you know, they're going to be viewed at circumventing the will of the people, and I don't think you want to take that route.
PREWITT: Excuse me, Tom.
If the tax cuts do expire, would that possibly be a plus in the sense that it's not uncertain anymore?
LEVKOVICH: Well, I think anything that removes uncertainty is a positive, but think in these terms. Right now, Citigroup's forecast for GDP next year in the U.S. is about 2.4 percent. If all the tax cuts expire, you can take at least another point out of that GDP number. And if you're in the 1 to 1.5 percent range next year, that's not going to feel good for markets.
KEENE: And with the second quarter markdown that we're looking at here off of inventories and trade balance and such, how do you trail on earnings forecasts from these new normal GDP statistics?
LEVKOVICH: Well, number one, I probably take a little bit of an issue with the term "new normal." One of the things that we've watched really carefully - and this has been talked about for over year - we talk about call it the old normal. You're going to go to what I call conscientious consumption instead of conspicuous consumption.
KEENE: I like that. Very good. I can't spell it, but it's good.
LEVKOVICH: Well, it's not frugality - or frivolity to frugality, as one of my dear friends David Rosenberg suggests. But it's more about people thinking before they buy for a moment, because - I know it's a horrible statistic, everybody hates hearing it - the top 20 percent of American income earners account for 50 percent of discretionary spending, and they own 90 percent of stocks.
So, if stocks go up, they feel wealthier. If the stocks go down, they feel leas wealthy and don't spend. And that's been consistent for years and years and years, and I don't think that's going to change.
KEENE: No.
LEVKOVICH: So I'm not necessarily in the new normal. I just think that people will be a little bit more thoughtful.
KEENE: We're going to come back and have a thoughtful - what did you say, conscientious?
LEVKOVICH: Conscientious.
KEENE: A conscientious discussion with Tobias Levkovich of Citigroup in our next half hour.
8:14
(BREAK)
8:37
KEENE: We continue with Tobias Levkovich, Strategist, CitiGroup. What do you overweight now? I notice here energy you are overweight. A lot of the strategists we talk to are looking at demand and they are little fragile here on oil - $73.42. Why the enthusiasm?
LEVKOVICH: Well, one of the things we - we are very different when we look at our work for the various industry leaders. We look at five factors typically - valuation, earnings revision trends. We look at sentiment factors. We look at fundamental drivers for stock prices.
And this is probably where we really start to move differently from a lot of analysts. I want to know how the market treats information, not how I would like it to be treated. So we actually back test about 330 different economic series to see which one have been the best predictors for individual industry groups. We look at about ten or 15 uniquely correlated to each of industry group and in energy, for instance, it is signaling stocks should go up. The valuation criteria, again, how do markets treat information.
So I think the way you almost positioned the question was a lot of the analysts say the price of oil here, the stocks are going to have some difficulty. We actually say that is interesting if your forecast is right, but if your forecast ends up being inaccurate, then your forecast for the stocks will be inaccurate. I would rather see how markets treat information.
PREWITT: Well, then what do you do with an oil company, Tobias? You look at proven reserves.
LEVKOVICH: Yes.
PREWITT: Divide - figure out how many barrels per share and go from there?
LEVKOVICH: Well, we actually don't get down to the specific only level. We leave that for the energy analysts themselves to do it. As a strategist, I am looking at the broader industry -
PREWITT: Right.
LEVKOVICH: groups. So I - when I look at the energy industry, I am looking at integrated oils, I am looking at refiners, I am looking at oil production companies, I am looking at oil field equipment services companies. So right now the integrateds actually look some of the best on our data.
PREWITT: Oh, they do?
LEVKOVICH: Yes, but it is not trying to say company X has these reserves. It will cost them this much to extract. For one thing, those forecasts also have been proven inaccurate. You find out the reserves are improperly calculated or technological advantages come and you change your extraction class, so that is why when I want to do it that way.
PREWITT: Yes, but I was thinking of a great quote from years and years ago, -
LEVKOVICH: Yes.
PREWITT: - when the oil M&A activity was heating up and it was the cheapest oil in the world was on the floor of the New York Stock Exchange.
KEENE: Tobias, you've got a 30 percent under valuation on S&P 500 on one of your metrics. And then you've got the famous Levkovich panic euphoria model, which is like it is grim now. I mean it is straw hats in winter. How do you pull the trigger on buying that straw hat in January?
LEVKOVICH: I think the issue for us is really looking at - or let me step back. The primary fear in the market in our minds is that we are going to blow our budget deficits apart.
And we will potentially - and I say potentially, I do not think we are going there, - but we could look like Greece. In other words, we are not dealing with a 2.5 percent ten-year bond yield, we are dealing with a 10.5 percent bond yield. And at that point, you are in really, really big trouble.
So I think that is the great fear. And the deficit reduction signals, if you want to call it that, are one, the mid-term elections in November; two, for the President's bipartisan deficit reduction committee or fiscal responsibility committee's report in December; and then the Bush tax expiration in January. So we have some very clear signals here as to where we are heading, and we think those are going to be a very important catalyst for the market.
We will probably start to discount if you like the mid-term election outcomes early in October. In other words, right now it is still two and a half months or so until the election. If it is two and a half weeks, the markets will probably start to filter that information and start pricing it into place.
PREWITT: $3 trillion in corporate bank accounts these days. We are in the middle of a big flurry of merger and activity here. This is - August is shaping up to be the busiest month this year. Does that continue?
LEVKOVICH: I think to some degree. I think we ought to be careful of that $3 trillion number. It includes banks and a lot of those assets tend to be our money that we have deposited in there.
PREWITT: Oh, yes.
LEVKOVICH: So you have to take financials out, but you are still talking in the $1.7 trillion numbers, which are staggering amounts of money in any way you calculate it.
What we have been hearing - and I heard one of the comments from the M&A head at Sylvan Cromble (ph) that you just had on the radio, - that we are clearly seeing the lawyers at the M&A firms seeing preliminary work picking up, but it is nowhere near the surge of activity we were looking at in '06 and '07 when -
KEENE: Right.
LEVKOVICH: - funding costs were easy and we were talking about literally no limitations to the amount of money you could do a deal with and we have Covenant Light and all that kind of stuff. Today the Covenants, for example, on high yield issuance is pretty tight.
KEENE: All right, -
PREWITT: Well, Tobias, we had been talking about all this cash building up and CEOs afraid to do anything with it. Are we going to look back at the Intel deal for McAfee and the BHP Billiton for Potash - are we going to look back at this and say, yes, that was the beginning of more confidence on the part of corporations?
LEVKOVICH: We could have argued this six months ago on -
PREWITT: Yes, true.
LEVKOVICH: - some other transactions that were announced or at least potentially coming to fruition. I think again we are going to have a steady improvement as opposed to just a spike. And I think people are overly interpreting every piece of information.
KEENE: Well, within that, and within cash on balance sheets, is there a new level of cash given the uncertainty out there?
LEVKOVICH: Well, there are two aspects. One is we just went through this horrific liquidity crisis where companies were terrified about where they were going to get money from and I guess they would get money from. So they are sitting on a higher pile of liquidity just a - the memory is lingering on and it is too short term. We have not distanced ourselves enough from March of '09.
On the other side of that, you also have the notion that they are worried about putting some of that money to work because of uncertainty related to regulatory and legislative agendas. And again, I think the mid- term elections may help clear some of that air.
KEENE: Where would you not be right now? I mean I know you are underweight in media, but is there one sector that is particularly difficult?
LEVKOVICH: Retailing is one that looks a little difficult, not because we have a real great concern about the consumer, but the valuation criteria and earnings revisions were way high. Ninety percent of all estimates were to the upside, now they are rolling over.
So it is not necessarily saying, hey, it's going to have a bad Christmas or holiday season, it is more about just the expectations got too far. In the instance - the one area I would still worry about in technology a great deal, is in semi-conductors.
KEENE: And I am glad you're here because I've got an announcement here. Tobias Levkovich, thank you. Being a strategist is a tough business.
8:44
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