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Few analysts know Wall Street like Tobias Levkovich, the veteran chief US strategist at Citi. The analyst is one of the most widely-followed and articulate strategists on the US stock market. Unusually in industry now dominated by more bearish strategists, Mr Levkovich has often argued a more bullish line on the market - a call that worked out well over the last four years as Wall Street has pushed higher into new record territory.
Mr Levkovich joined Citi in 1988 and took on his current role in 2001. Before that he covered the engineering, construction, and machinery industries for 13 years. Mr Levkovich is responsible for assessing equity market direction, sector allocation, and the firm’s recommended List. He is also a member of the firms Investment Policy Committee.
Mr Levkovich answers your questions on how long the current market rally will last, what impact private equity activity is having on current valuations, the best sectors to invest in and the outlook for the US economy.
Despite recent equity markets outperform Nasdaq remains substantially bellow its record high. Do you see the Nasdaq comp setting a new record high soon?
D Mokas, Athens, Greece
Tobias Levkovich: It seems very doubtful that it will happen soon. It took the S&P 500 seven years to get back to its old high and about five years to double off of its lows. The Nasdaq got up to valuations of better than 100 times earnings (and some crazy multiples of sales) back in late 1999/ early 2000 due to the New Economy bubble. I’m not sure where that kind of excitement will cause that again.
Assuming that world demand re-balances (with greater demand from Europe and the Far East and less from the US), will we see a de-synchronising in the movements of the world’s stock markets? If so, which region holds the most promise?
G Coathup, UK
Tobias Levkovich: I have strong doubts about that kind of economic and equity market de-linking story that has become pretty prevalent in Europe. The US is still needed to consume the goods that everyone else wants to export.
If Asia and Europe shift their mercantilist economic systems to a consumption society, then I become more of a believer, but such a shift would be disruptive if it came quickly and more than likely will take many years.
What is the position with the US property market? Are the fears overdone or is what we have seen just the beginning of an continuing correction? What is the likely impact of higher interest rates? What states are likely to be worse affected?
Robin Christie, London, UK
Tobias Levkovich: The US property market is a fairly wide asset class. Commercial or residential? The residential market is getting hurt particularly in areas that got overheated like Las Vegas, Phoenix and southern Florida along the coastline. The commercial property market is booming with M&A transactions and some developers are suggesting it is cheaper to build than buy now. It looks like the residential construction trends may stabilise soon as there is a base demand level needed and interest rates are still low enough for affordability indices in many markets.
If rates were to shoot higher, the property markets could become more unstable, but it appears as if the market has weathered the sub-prime shocks well. Things are not great but they are not dire either and that may reflect the vast size of the market and the geographic/economic disparity in the US.
When the tech bubble burs in early 2000, San Francisco property markets slumped but rebounded after a 20 per cent decline. Orange County got hurt hard in the early 1990s due to the ”peace dividend” and the layoff of thousands of defence industry workers who were forced to sell their homes and find employment elsewhere. So the idea of regional booms and busts are well founded.
The Midwest is benefiting from higher agricultural commodity prices while many energy dependent states are doing well also as are financial services-based cities (New York). In such markets, real estate is in pretty fine shape, though not booming either.
I am using the current rule of thumb for my share/fund portfolio: I stay liquid for 1/3 and sell gains after >10 per cent rises. My idea is to buy back after every >10 per cent drop. But I am aware that this strategy does not take market situation into account. Is partial liquidity an answer to rising share prices? If so, is there a rule of thumb as to the percentage of one’s total portfolio in the current market? And what are the signals / what is the timing to step back in
Hugo van den Broek, Odijk, Netherlands
Tobias Levkovich: We have different philosophies - very good portfolio managers will tell you that they do not sell their winner stocks unless they have a better idea to buy. Since markets typically go up over time (roughly 70 per cent of history), sitting on winners is not a bad strategy.
Setting downside protection limits may not be a bad tactic though. In terms of overall market exposure, diversification tends to be the key but make sure that your assets are not correlated, otherwise the benefits of diversification disappear.
Where do you see US, European and Japanese markets in the next 12 months? And how about interest rates and the direction of the dollar?
Tobias Levkovich: I am a US equity strategist so can only comment on domestic markets. We are looking for the Dow Jones Industrial average to hit 15,500 (4,400 by year-end 2007) by mid-2008 and the S&P 500 to achieve 1,725 over the same time period (1,600 by year-end 2007).
In what we’ve seen thus far with the DJI, what in your opinion may have more of an influence in a slowdown in the exchange - the markdown in the Asian markets, or possible regulation of the hedge fund industry?
Jewelz, Manhattan, NY
Tobias Levkovich: I’m not sure either one. The alleged China cause to market weakness in late February was way too simplistic. That same day saw Greenspan say a recession was possible, poor durable goods orders, big sub-prime fears and a Case-Schiller report claiming home prices fell.
Thus, it was a cumulative hit on February 27. A sharp fall in aggregate emerging markets might signal a major shift in risk tolerance so I would be watchful for that. Hedge fund regulation means what? Greater disclosure? Limits on what they can trade? Seems like you are grasping at straws. The big issue will be earnings and we have some profound concerns about margins for second half 2008, so we are being vigilant on the earnings front.
What would you say are the fundamentals that exist in the medium term, if any, to explain the superior attraction of US equities over international equities both for a dollar based and for a non-dollar based long term investor?
Stephan Collins, Geneva, Switzerland
Tobias Levkovich: Lots of questions in there. International needs to be split between developed and emerging markets. The US and many developed international markets like Japan and Europe look attractive, though one can argue that the more flexible US economy and market is more interesting now.
Emerging markets, on the other hand, look risky to us as too many investors have flooded into these markets with the equivalent of a New Economy endless opportunity mindset. I do not make currency forecasts which clearly matters to that positioning for dollar-based on non-dollar-based portfolios, but it seems like everyone thinks the dollar will weaken over time to solve the current account imbalance.
The problem is that the dollar is down more than 50 per cent against the euro in the past five years and the US bilateral traded deficit with Europe has doubled! It has not declined as Americans still seem to like their Swiss chocolate, Italian clothes, French wines and German cars. Dollar weakness against the renminbi is needed.
What indicators do you rely on to predict certainty in the American stock market? And do you feel 10 per cent, 50 per cent, 80 per cent, or 100 per cent, confident in your predictions? What is your standard rule?
Chad Harrington, Dallas, US
Tobias Levkovich: We have developed a series of proprietary indicators that encompass more than one factor when we consider valuation, sentiment and implied earnings expectations. For instance, we track nine factors in one of our sentiment models so that any single piece of data cannot, on its own, bias the outcome. It is typical for an investor to decide if they are bullish first and then find confirming evidence - our process starts with the data and then we arrive at a decision.
The three most statistically oriented models we use generate better than 90% per cent predictive power on the back test, since one cannot model every development.
How long do you think this can last if, as many are saying, the current bull market is driven by monetary inflation rather than real productivity gains?
Chris Fulker, Nantou, Taiwan
Tobias Levkovich: We typically look a year out in our work and the analysis is still bullish for the next year but I have deep reservations about the second half of 2008 for a variety of reasons including margin pressure and the US presidential elections.
Apart from reporting requirements, what is the difference between private equity funds 2007 and the old-style conglomerates like ITT in 1970?
Tobias Levkovich: Interesting question. There is an inordinate amount of professionalism at the private equity/LBO firms. The people working there are very smart, very educated and have great incentives to make their deals work. A number of the major firms now have a few individuals worth billions running them and thus they do not have to ”prove” themselves any more but they have huge pride in what they are doing. These are the ones pointing out that some of the deals are getting too expensive and they are walking way from deals if they do no make sense.
Plus, with the financing benefiting dealmakers now, the going is good. But, keep in mind that so-called ”strategic buyers” (corporations) account for three times as many deals as private equity buyers.
It has often been observed that the recent years’ rally across many asset classes has been driven by ”excess liquidity”. Does this term mean anything else than official interest rate are relatively low - and is this poorly defined concept helpful for explaining the rally in your view?
Michel Engman, Luxemburg
Tobias Levkovich: I think it is poorly described. Alan Greenspan once defined liquidity as being a function of confidence. One may have liquid cash in the bank but chooses not to lend it out at almost any price (or interest rate) or invest in at any promised return due to the fear of losing the principal.
Buying oil at higher prices to drive our cars does give energy exporters more money with which to invest and they may act differently than you and I who might have used that cash to buy things or go on holiday, so the concept of some excess liquidity being available to investment actors who are willing to take more risk exists, but it may be overstated. Our thoughts revolve around earnings, valuation and sentiment and all are supportive of further equity market gains.
Does the current bull market in the setting of a slowing economy demand caution or should one be fully invested until it becomes ”expensive”?
Sumant Rawat, Pueblo Colorado US
Tobias Levkovich: We are still looking for low-teen like gains for the S&P 500 over the next 12 months so we think that staying invested is appropriate, but there may very well be some bumps along the way as we experienced in late February/early March.
Is this rally for real because economy is doing good, or people are buying stocks because they have no other options to make use of their liquid cash?
Manish Dalal, New York, US
Tobias Levkovich: Liquidity benefits many assets including real estate, commodities and stocks, so liquid cash driving just stock prices seems unjustified. Corporate earnings have been very good and the investment community has doubted that all along. For example, in early 2007, first quarter EPS trends were expected to be up 8.5 per cent y/y according to consensus forecasts; by early April, this was trimmed to a mere 3.2 per cent - the numbers look like they’re coming in better than 10 per cent.
US GDP suffered in the first quarter from weaker residential construction, imports and inventory cleanup, but corporates did well through cost containment, international growth and some help from a weaker dollar. Thus, it looks pretty real to me.
Is it safe to assume that the sovereign wealth funds will continue to bid up assets to overly optimistic valuations? These pools of money have been around for years. Why the sudden praise of the forever bid? This is really nothing new. With housing in the US not yet at bottom (affordability is key) and rates headed higher, is the market rally more of a Zimbabwe-esque type rally due to inflationary concerns.
Tobias Levkovich: I’m not exactly sure by what you mean by sovereign wealth funds - if it is the national wealth accumulation in places like China, Dubai, Russia and Saudi Arabia, their wealth has been growing dramatically over the past few years. There are estimates that the Opec countries alone have generated half a trillion of new cash in the past four years. If you mean private equity firms, their ability to buy up assets is a function of the financing spread between operating cash flow of corporations and junk bond yields and that gap is the best it has been for acquirers since the latter 1980s.
We’ve had a 25 year bull market in disinflation/benign deflation. Credible monetary policy, the end of the iron curtain and the supply shock that ensued, the internet, globalisation, deregulation have been contributory factors. As the world economy is bursting at the seams, companies flex their pricing power and labour begins to be tight. What are the chances of inflation in the coming years and with it much higher nominal and real rates and the end of asset inflation and economic growth? Inflation has been declared permanently dead by bulls and bears alike.
Alvaro Martinez, Madrid, Spain
Tobias Levkovich: I don’t make permanent predictions; things are far too dynamic nowadays. If we go down a path towards protectionism and economic nationalism (as may be the case in the US, in Europe and in Asia now), we will throw out 25 years of the benefits of globalisation on labour costs (which has held down inflation since labour compensation is the primary issue for developed economies, not energy prices).
Globalisation clearly has hurt some members of Western society (who feel great angst and want legislative retribution) but it has benefited hundreds of millions more. That is one of my greatest fears now.
Up to what point do you think the Dow Jones is going to rise before it sees strong resistance?
Mihir Goradia, Limerick, Ireland
Tobias Levkovich: Hard to tell - I am not a technical analyst, I am a fundamental analyst, so I do not think in terms of support or resistance. Traditional economic indicators have proven unreliable in predicting a bullish stock market.
In a world awash with liquidity and asset prices rising at well over 20 per cent per year - witness the stock market, London property, the arts market, etc. - are we being fooled by an official CPI of around 2 per cent? Is cash not losing its value relative to almost all other asset classes much more rapidly, with the consequence that one must be invested in assets in order not to loose out? Or can you foresee a massive devaluation of assets relative to cash in the not-too-distant future so that hoarding cash could make sense after all?
Max Cartellieri, London, UK
Tobias Levkovich: The debate about the CPI truly measuring inflation is a pretty large and contentious one. Keep in mind that the CPI is a basket of goods weighed heavily by owner’s equivalent rent (which reflects housing’s costs but not the actual cost of a home since the financing cost is very important too to the carrying cost). Nonetheless, the notion of purchasing power parity is being addressed in your question which is more intriguing.
Yes, copper, gold, art, stocks and property are all more expensive today but the real issue is relative value. Should one own US stocks vs. European equities vs. Russian bonds vs. Shanghai real estate? Diversification tends to be one of the best ways to ”hedge” portfolios and cash is one asset class in that diversification effort.
Admittedly, we have concerns about emerging markets, metals and even small cap stocks as they have become correlated assets and thus no longer provide quite the diversification benefit that many purport they can. Shocks can hurt asset values as seen when LTCM collapsed in 1998 and cash would have been the preferred asset going into that tumble. We do not forecast such shocks, they are by definition surprises and unpredictable.
What are the three most important drivers of market valuation in the US today? Which driver is likely to be the first to wane?
James Wilbur, New York
Tobias Levkovich: Earnings trends, favourable credit conditions and sceptical investor sentiment - poor sentiment may wane first as stock prices climb higher and converts the doubters into chasing performance.