On your terrific nightly show, THE KUDLOW REPORT, which I have the privilege of appearing on from time to time, you present regularly a wide array of investment experts who offer advice to your viewers which, in my opinion, is often counterproductive. Of the approximately 7000 publicly traded companies in the U.S. only a small fraction, less than 5%, are interesting investments at any point in time. Yet if one listens to all the experts over a month or so, nearly all industries get a recommendation. Of course, much of the show's dialogue is framed as a debate between opposing points of view, one bullish, the other bearish. By itself, this is an excellent format, but my critique is based on the fact that most of your guests state their views (a) with only a very short-term, trading-oriented perspective, which in this volatile environment often runs a high risk of whipsawing the viewers, and (b) these experts demonstrate insufficient respect for market-based indicators, which I think you and I agree are far more important in interpreting the present and predicting the future than the opinions of "experts" based on essentially static analysis. Those pundits who recommend specific investment actions according to analyses that do not give proper weight to such market-based indicators as currency exchange rates, commodity prices, interest rates, etc., are doing your viewers a disservice. Indeed, all market-based indicators are PRICES, the prices that real people pay in real transactions in the real world. They occur in real time and are never retroactively revised.
For example, in recent months a surge in commodity prices has given strong evidence of a demand recovery in the global economy. Commodity prices and commodity-based currencies have refuted the arguments of those pessimistic experts who became even more bearish just as the economies of the U.S. and elsewhere were bottoming out. They were joined by those investors who capitulated in early March and made the bottom in stock prices. At the beginning of every economic recovery there is invariably a backup in bond yields. This time is no exception. Yet many guests have proclaimed that rising interest rates would provide a headwind for both the economy and the stock market, when in fact these are a sign of recovery.
Much credit must be given to those guests who peered through the fog of credit losses and saw early on merit in bank stocks. They saw the cost of money going down, while the price of credit was rising, i.e. a steepening yield curve, which is enabling this critical industry to recover its earning power and its capital base.
Many of your guests in recent months have ignored your "mustard seeds" of recovery as well as the many government policy initiatives and instead have urged investors to place their bets on such defensive sectors as consumer staples. Their essentially static analyses focus on the strong industrial positions of these companies as well as their diversified product lines and global markets. What these experts have ignored is that most of these companies are mature giants with no pricing power and little opportunity to expand their profit margins and whose stocks are already selling at generous valuations. Not only did these stocks offer little protection during the bear market, but now they have slim prospects of producing profit leverage on the way back up. People tend to overlook the fact that those stocks that outperform the market indexes are nearly always those of companies whose profits are rising more rapidly than their revenues, that is, companies with expanding profit margins. Most of America's great consumer goods companies are engaged in highly competitive businesses, and not only are they impacted negatively by higher commodity costs but, in addition, they have lost their pricing power, as financially stressed consumers trade down to less expensive brands or curb purchases altogether. Great companies are simply not always great stocks. Growth companies must outperform in terms of profit leverage in order to be growth stocks. Cost cutting and other productivity measures, as well as a richer product mix can help leverage profits, but the biggest boost to margins comes from pricing power. Who has more pricing power today - a copper producer or a pharmaceutical company facing patent expirations?
Likewise, several times each week we hear guest experts proclaim that technology stocks are the place to be. All of their arguments focus on strong industrial positions, highly liquid balance sheets, free of debt, but they ignore the generous valuations, the intense price and product competition between firms and the fact that enterprise, service provider and government spending for high tech products is hurt the most by recession and needs both economic recovery and new product cycles to justify increased outlays by these customers.
Other examples of this type of "static" thinking abound, but they continue to attract adherents who mislead investors. The only statistics which are never revised are PRICES, PRICES of currencies, PRICES of commodities, PRICES of credit, both short-term and long-term, PRICES of consumer goods and industrial goods, and the PRICES of equities and bonds. These are the indicators which point long-term investors in the right direction every time. Those who ignore them will inevitably achieve subpar investment returns. Financial companies, energy and commodity producers are the leaders with pricing power for now. In time that may change, but the clue to the next stock market leadership sectors will be found in prices, not in the prognostications of pundits.
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