Investors take note: Abby Joseph Cohen is still bullish on the market. “Our research states that the current undervaluation of the S&P 500 is 10%. Share prices will move higher, even noting the recent rally,” declared Cohen confidently in a speech given to HBS students at Burden Auditorium on Wednesday, November 19th.
Cohen is Chair of the Investment Policy Committee at Goldman Sachs and holds primary responsibility for Goldman Sachs’ investment research on U.S. portfolio strategy. She has been at the firm since 1990. She is widely touted as one of Wall Street’s most influential analysts, and has achieved notoriety as the biggest bull on the Street, having maintained a positive outlook on the equity markets throughout its advance in the 1990’s.
In examining the current state of the market, Cohen notes the critical transition of investor mentality from risk aversion to cautious expansion.
“Over 2004, investors will become increasingly willing to extend out time horizons,” says Cohen. She believes that whereas a year ago investors thought in terms of time horizons measured in days and weeks, investors are now again beginning to look forward several quarters and are therefore making less reactive investment decisions. “What matters most is investor confidence.”
This transition in investor mentality is reflected in the equity risk premium.
“Last year the ERP was at 6%, in the 95th percentile of historical risk aversion. In 2004 we are projecting an ERP of 3.5%, moving closer to risk tolerance.” Cohen benchmarks her ERP metrics against a historical average of 2-4%. She also noted that there may have been an intrinsic rise in the risk premium over recent years. “The U.S. tends to be the safe haven when things go wrong elsewhere. We can’t underestimate the impact of terrorist acts on the ERP. However, after the first act, markets don’t become immune, but they are less vulnerable to future acts.”
According to Cohen, stocks will outperform bonds over a 12 to 18 month investment horizon. With investor risk aversion still somewhat above the historical median, she believes that the stock market is still undervalued.
However, she expects economic growth to slow in 2004 from the pop that it has enjoyed in the second half of 2003. “The U.S. economy is going from recovery to expansion,” Cohen summarized.
Cohen then tempered her enthusiasm with the question, “What could go wrong?” Cohen was particularly critical of the accounting and corporate governance scandals that shocked the market over the past two years.
However, she tempered the effects of the accounting issues, pointing out that the write-offs taken in 2002 largely reflected overstatements from previous years rather than a 2002 problem. She also noted that by dollar amount, the write-offs were highly concentrated, with 85% taken by a small number of companies, almost all in telecom and media sectors.
Now she believes that accounting has been cleaned up, and that CEO confidence is improving. “We are finally seeing that CEO’s are feeling good enough to start acting like CEO’s again, rather than hiding.”
Another area Cohen believes is worth monitoring for potential negative impact in 2004 is the U.S. government’s monetary, fiscal and trade policies. “As we reach an election year we must ask ourselves, will there be something that will abruptly slow down the U.S. economy in 2004?”
With the Federal Reserve looking at low inflation, Cohen believes that they are reluctant to raise interest rates now, but she cautioned against a potential “snugging” of interest rates, “when the Fed lowers, lowers, lowers, waits for recovery, and then ‘snugs up,’ taking back the declines.”
During the Q&A section of the presentation, a student asked Cohen to defend her historically bullish investment recommendations in light of the disastrous performance of the markets beginning in early 2000 through 2002. Cohen clarified the facts on her stance, “In March 2000 we advised clients to sell some stock, and to underweight in technology. In retrospect we should have been even more strident.” She went on to defend her work by noting, “The work we were doing in 1999-2000 was based on fictional data. If we had the right numbers, we would have understood that the ERP was negative, which was a dangerous place for the equity markets to be. On the analytical side, we are now much less trusting of the information we get.”
Looking forward over a five to ten year horizon, Cohen believes that North America and Asia will offer the best longer term investment opportunities.
She also cited parts of emerging Europe, but noted that these are not places that could receive large amounts of capital. In general, and not surprisingly, Abby Joseph Cohen remains optimistic about the market. “The bull market is not over because economic expansion is not over.”