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Jon Markman's Speculations
April 27, 2011, 12:25 p.m. EDT
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By Jon Markman, MarketWatch
SEATTLE (MarketWatch) "” Higher gasoline prices, Japan supply-chain disruptions and fear of the Fed were supposed to bury corporate results and investors in red ink this earnings season, but it hasn't exactly turned out that way. Through Monday, more than 70% of companies that have reported results crushed quarterly estimates by an average of 8.8%.
Yet the gains have not been evenly distributed, as some large companies including Google Inc. /quotes/comstock/15*!goog/quotes/nls/goog GOOG +0.49% and Alcoa Inc. /quotes/comstock/13*!aa/quotes/nls/aa AA +0.11% have seen shares blasted by more than 10% despite decent results, while more obscure, medium-sized companies like grocery chain Supervalu Inc. /quotes/comstock/13*!svu/quotes/nls/svu SVU +0.72% and industrial manufacturer Gardner Denver Machinery Inc. /quotes/comstock/13*!gdi/quotes/nls/gdi GDI -1.51% have gone on a tear.
Gold and the U.S. dollar have moved in opposite directions this year. But over a longer period, the dollar has accounted for only a quarter of gold's moves, says Mark Hulbert.
Why the difference? To answer that burning question, I spoke to Craig Drill, a veteran hedge-fund manager in New York who has been around the block so many times that he not only knows where the bodies are buried "” he also spaded dirt on a few himself. When Drill speaks, which he does not do in public much, you need to pay attention.
Drill says that before you can understand which stocks are likely to advance the most in this cycle, you need to understand who the big buyers are. He observes that people running money at the large funds who drive the market today are survivors of a lost decade; they've watched colleagues who made mistakes dumped on the side of the road and left to bid for jobs as peanut vendors at baseball games.
Today's fund managers aren't going to risk their careers on companies with big names but erratic results. And they do not have time to seek out new ideas and try a small position in unknowns. They are so far behind in their bogeys after 10 years in the wilderness, they are sticking with proven winners that won't embarrass them, and everything else be damned.
Drill noted that the economy is fitfully gaining traction, credit markets are open enough for companies to borrow for responsible projects, government bonds provide no competition for investment dollars, and real estate is plagued with overcapacity.
Accordingly, the door is wide open, he said, for expansion of the price/earnings multiple of the entire U.S. market over the next few years to at least 17x from 13x at present.
That should combine with improved corporate earnings growth to provide annual returns for equities in the high teens for two or three more years "” unless the Fed messes up and constricts credit.
Just so you know what that implies, consider that the Standard & Poor's 500 Index /quotes/comstock/21z!i1:in\x SPX +0.11% started this year at 1,260. A return of 18% would put it at 1,485, which is about 80 points below the record set in 2007. Another 18% year after that would put the benchmark index at 1,753. These are not outrageous goals.
Drill said he believes equities will be the main game in town even if GDP growth slows to around 2% to 3% a year amid a transition from robust recovery to moderate expansion. And not just any equities, but the high-growth attention getters that always seem too expensive.
"With the battered and embarrassed institutional investors only glacially increasing their equity exposures and reluctant retail investors returning slowly to stocks, the more aggressive, absolute-performance-driven hedge funds will set the direction, speed and tenor of the market," he said. "The tail will wag the dog."
To maximize returns, Drill says, funds will gravitate to investments that can demonstrate consistent, top-line "organic'' revenue growth well in excess of their competitors. He forecasts that above-average earnings growth will lead to ever-rising P/Es at favored companies. In contrast, earnings growth that is achieved by mergers, share buybacks, cost cutting, and financial engineering "” hello Google, we're talking about you "” will not be rewarded with higher valuations.
Drill's bottom line: "Investors will favor those countries, sectors, industries, and companies demonstrating the most rapid organic growth. They will become the new global market leaders."
Jon Markman is a money manager and investment adviser in Seattle. For more ideas like these, try a two-week trial to Markman's daily investment newsletter, Strategic Advantage, published in partnership with MarketWatch, or his daily trading newsletter, Trader's Advantage. His Twitter feed is @jdmarkman.
The media, obsessed with the royal wedding in England and the Obama birther issue, shouldn't gloss over a chilling story with genuine news implications: the bombshell that a hacker infiltrated Sony.
11:24 a.m. Today11:24 a.m. April 27, 2011
"Watch historic Bernanke news conference live on MarketWatch 14 tune in now http://on.mktw.net/kW0qBk" 1:08 p.m. EDT, April 27, 2011 from MarketWatch
"MW Radio: Stocks pick up pace in wake of Fed statement http://on.mktw.net/m3TInZ" 1:00 p.m. EDT, April 27, 2011 from MarketWatch
"Amazon shares hit all-time high despite day-ago earnings shortfall http://on.mktw.net/iYtD84" 12:22 p.m. EDT, April 27, 2011 from MarketWatch
"U.S. stocks get modest lift from Fed monetary-policy statement http://on.mktw.net/mCZvU4" 11:52 a.m. EDT, April 27, 2011 from MarketWatch
"Fed leaves benchmark lending rates at historic lows; 'extended period' vow intact http://on.mktw.net/iH5vxF" 11:34 a.m. EDT, April 27, 2011 from MarketWatch
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