Stock picks from a persistent bull
Markets may be in a turmoil, but hedge fund veteran Leon Cooperman still thinks equities are a buy, and shares some of his best picks.
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| Cooperman believes the market has already priced in the worst economic data. |
NEW YORK (Fortune) -- In the days leading up to the August credit crunch, stock prices fell and prognosticators said the bull market had run its course. But Leon Cooperman wrote in an article for Fortune: "I view this market drop as a long overdue correction rather than the end of the bull market."
Several months have passed, along with rounds of bank write-downs, broken M&A deals and haywire stock prices, but the founder and chairman of Omega Advisors, a hedge fund with $6 billion in assets, still believes equities should move higher. In a follow-up interview, he points out that the S&P has gained more than 4% since his story and gives his four reasons to still like equities, including Alcoa (Charts, Fortune 500) and two beaten down REITs. (See the chart for his stock picks.)
Given all that has happened in the stock markets since August, why are you still bullish on stocks? What trends will drive prices higher?
I'm still constructive on stocks for 2008, for now, holding aside the potential effects of the 2008 presidential election. While there is certainly a fair amount to worry about - subprime and housing issues, bank write offs against capital, a slowing econ and slowing earnings - there are several reasons to be bullish on stocks.
First, market valuations are very attractive relative to government bond yields, and the S&P is priced today akin to previous market trough. The market has already discounted an awful lot of the negative news. Second, I expect the U.S. economy can escape recession in 2008. Housing weakness should be partly offset by more significant inventory build-up, and housing's effect on the U.S. economy should moderate in the second half of 2008. Employment data doesn't foreshadow recession either. Leading indicators of the labor market point to positive growth in monthly payrolls. Before a recession, average monthly payrolls drop about 500,000 a month. We're currently growing monthly payrolls by about 100,000 a month.
Third, core consumer inflation and inflation expectations are tame and within the Federal Reserve's comfort zone. With tame inflation and a dislocated market that is still not functioning properly, this should allow the Fed to cut interest rates and inject liquidity into the system. Fourth, earnings and dividends should increase in 2008. Bear markets in the U.S. are usually preceded by an overheating economy, accelerated inflation, tight money and bad valuations. None of these, in our view, are present today.
Private equity was a major force behind stock price appreciation in 2007. What will happen to the industry going into 2008? What were some of the biggest errors made by private equity firms and corporations?
It comes down to this: What the wise man does in the beginning, the fool does in the end. Private equity capped out this bubble by overpaying for recent deals. Now the LBO boys have lost their advantage in terms of cost of capital. They were getting money from the high yield market on ridiculously easy terms, and that game is over. We'll see more strategic mergers as U.S. and European corporations buy U.S. companies. America is selling on the cheap now. Look at the dollar exchange rate versus the euro and the pound.
What were some of the biggest errors made by investors in 2007?
They didn't understand the significance of the subprime problems and the massive write-offs in capital losses on the part of large financial institutions.
You've been a critic of the stock buyback trend, which also boosted share prices in 2007. Can you talk about that?
Many corporations showed have shown a naiveté when it came to understanding how to value businesses in the market. I think they misspent shareholder cash by buying back overvalued shares. Clearly share buybacks are being embraced more and more, and I would caution companies not to play in that arena unless they have a firm understanding of the business outlook and have concrete reasons to believe that the stock is undervalued. Buybacks should not be a shell game we're playing to support stock prices. 
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