It's All About Earnings, Hugh Johnson Says

Podcast on Apple Podcasts, SoundCloud, and Bloomberg dot Com. At a time when the stock market seems to be making new highs every day, eking out a little bit more in terms of gains without going crazy, a lot of investors are seeing stocks is a good place to be over the next three years. Among those Hugh Johnson, Chairman and Chief investment Officer at Hugh Johnson Advisers, which overseas more than a billion dollars and is based in Albany, New York. Hugh, thank you so much for joining us.

First of all, I just want to get your main points that you laid out when you came up with forecasts for this year, next year, and the year after. The main thing is is earnings. You know, I think everybody that talks to me has the same question, and that is, how can you make the case for stocks having done what they've done, and even going even higher given all the problems in Washington, some of the international geopolitical concerns, concerns about getting healthcare through concerns about the

tax tax cut, the Trump tax cut. How can you make the case for higher pricedents. Well, the answer to that question is this is all about earnings, and in a cold hearted way, we're looking at very positive growth and earnings both for two thousand and eighteen and two

thousand and nineteen. And if you crunch the numbers, taking any consideration the earnings that I think lie ahead, you can make the case for higher stock prices four and a half percent between now in the end of two thousand and eighteen, and maybe as much as eleven percent ten point eight percent between now and the end of two thousand nineteen. So higher stock prices, and that might even be helped a little bit if we get a Trump tax cut, a lot, but some. So it's really

all about earnings. You. I wonder if we could take a look from the investor perspective, because let's say you're already long stocks, or you have a portfolio that that favorite stocks. If you were to get out, if you were to sell, chances are you might have a gain, you'd have to pay the tax on it, and then you'd be faced with the question, what do you do with the cash? Correct, You certainly would be faced to that, and it would be not an easy not an easy challenge,

to be honest with you. I mean, you know that interest rates are very low. You know that if you take that cash and you invested in the bond market at a time when the fellow reserve is uh interesting, increasing interest rates not only one more time perhaps in two seventeen, but three times in two thousand eighteen, you're likely to suffer a loss on that fixte income portfolio. So it's it's really a challenge, I mean a big challenge.

I think the returns from the fixed income markets for two thousand eighteen two thousand nineteen are going to be close to zero. You'll get some money from the coupon, you'll lose money on the principle of the fixed income. So it is a challenge for sure. You know, I'm struck by the fact that your forecasts for next year in the year after don't include any sort of downturn. You see wages increasing, albeit not a lot, but steadily, uh, and you see just a general kind of continuation of

what we've been seeing over the past year. I'm wondering what could make you change your mind, and why are you so confident that we won't see some sort of economic downturn where you're you never you never releast, you never that confident. I say these things, I forecast these things, you know, quite frankly, with my fingers tightly crossed. And you know, I assume you know we're at a low level of interest rates. Yes, the Federals there's gonna be

raising interest rates. Yes, interest rates are going to be going higher. But I don't think we're at a level right now that really threatens the economic expansion. So making the forecast that the economy is going to continue to span through two eighteen nineteen is a little bit easier. The second thing is, I don't expect that we're going

to have a move towards uh fiscal restraint. If anything, we're gonna have a move towards an easier fiscal policy, more generous fiscal policy in the form of tax cuts and spending increases. So it'd be really from the policy point of view, you'd say, gee, it's just it's just too early to say this, this thing is going to end. Uh,

it looks like it's going to go further. But but talk to me at the end of well, at the middle of two thousand nineteen, when we have interest rate higher and we start to get much more nervous about federal budget deficits, and I think those are in the cars when we start to get that nervous, and then we're gonna move a shift in the in the different direction, and then you're gonna start to see it show up in the markets, and things are going to get a lot more a lot more dicey, and prospects for a

turn down in the stock market and the economy will start to get certainly higher, if not real high. Alright, so he let's say your forecast is accurate, and things will kind of grind a law a little bit higher all the time over the next two and a half years. I'm wondering what's the best way for investors to allocate to markets. Is it by you know, passive funds that look to broad state look to capture gains and broad swaths of UH specific stock markets. Is it active managers?

What are you advising clients? What's your approach that is a really great question, because you and I both know that that the passive investing has worked a lot better than active investing up until really this year, and this year we're starting to see a little bit of a shift and active managers have been doing a lot better. Whether you lose exchange traded funds for passive investing or you start to look at active managers, I'm not sure

how what the outcome is going to be. The Only thing I can say with a lot of confidences, especially given my forecast, is that you need to have a meaningful allocation, whether it's passive or active, meaningful allocation to equities, in other words, don't go in the bunkers right now. For example, if your target of fifty equities and you've got a range of say thirty to sixt of toleration range, you might be up and around and I wouldn't change

that whether it's active or passive. But your question, should it be active, should it be passive? Great question. We're all grappling with that question, and we're starting to see active managers outperform indexes or passive management. You have you ever had a customer or a client who pulled their account because the performance was let's say, two hundred basis points less than some benchmark. Does that really happen on a regular basis, Well, we've been lucky, we've been fortunate.

We don't take of the levels of risk that they're going to give us that two hundred basis points below benchmark. If we did, I wouldn't be at all surprised if if investors did pull their poll stakes and and go to another another manager, because that's not what we promised them. We've promised them that we're going to be a roughly fifty basis points below fifty basis points above. We've had really good luck or fortune because we picked some really good stocks in the last couple of years, so we've

been well above benchmark. I don't think we're for any long extended period of time, we'll be honestly going to depart very significantly from benchmark, and that means no downside and therefore no loss of customers on Our customers are quite frankly like us, are kind of risk averse. They really want you to do okay in an up market, but what they want more than anything is is really to preserve capital in the down market, because that's the

secret long term performance. You real quick, how are you creating that insurance building it into the portfolio. You do it in a lot of different ways. There's a meaningful, you know, balanced portfolio. The second thing is you reduced risk by having high quality names in the portfolio. But much more importantly is to have a relative balance among things in the portfolio, so you don't make a significant

bet when it comes to sector allocation. Sector allocation, you can certainly be overweight technology, maybe a little bit underweight analogy, but you have to have us. You have to have allocation to all my view, all eleven sectors in the market. You can't can significantly overweight small cap stucks. Have a meaningful allocation to large, mid, and small, but not so significantly different from the benchmark. In other words, don't take a lot of sector or capitalization risk. That's just simply

a mistake, Thank you very much. Hugh Johnson, Chairman, chief investment Officer, Hugh Johnson Advisors. Well, let's say get more information about a group of companies that will be reporting their results. We're gonna get Eli, Lily and Biogen they'll come out with their results tomorrow. Plus we've got am Jen and Gilliad Sciences. This week, Bristol Myers, Squib, Murky, LII, Lily and for that we've got Sam Fizzelli. He's the

director of research for Bloomberg Intelligence in London. Knows weything about these companies. Sam, thank you very much for spending time with us. Where do you want Where do you want to begin? What's the most important results or what should we be looking for this week? Because we've got a variety of companies, right, I'm going to begin with just talking about the large farmer companies because that's where I spend most of my time looking at things I

want to do. Glaxo Smith Klein, we can, but you have to admit that I think the star of the show this week and frankly for the third quarter will be Eli Lily. Okay, so that's tomorrow. That's tomorrow. They've

got some decent sales growth expected about six percent. But really what's going on in Lily is not only you're getting new drugs and some existing key drugs such as Trilicity and Jardians driving the top line and they're both for diabetes and we know what a big problem that is, but it's really the margin story and Lily that's quite attractive and exciting and in that the company is working has got a long way to come and meet and beginning where near some of the others others peers obviously

other other peers, therefore giving it an opportunity to give us almost three times its sales growth in EPs growth expectations for this quarter. So that that's really what's driving the excitement on that one. Can you give us a sense of what's driving that? Is that that they can price their drugs at a higher spot is because they're cutting staff. I mean, where are the where are the

margins coming from? Well, I mean again, Lily has been one of those companies that, putting beer aside, has been at the low end of operating margins among all of its what we call the thirteen large farmer peers if you still want to call beer a large beyer a

large farmer company. So there's a lot of room for for the performance there, and a lot of it that comes from basically a lot um operational leverage that they're getting and also more consolidating its sales and and and different aspects of their business, which the new CEO is particularly focused on in terms of delivering, although it has been a target for the past couple of years at least to get that margin the one they look at, which is R and D plus scn A expenses as

a percentage of sales to below and they're doing a pretty good job of getting that. So it's not just about drug pricing. In fact, if I may, Lily has been one of those that's not been uh particularly aggressive in its price rises, especially in the insulin area where there's been a lot of attention recently diabetes, where if you look at the net price of the insulin products on the market, they've been flat for past three four five years, so no real net increasing prices. It's volume

that's driving that well. And I just want to get your thoughts and if you can look just a one more about ELI Lily having to do with patent litigation and patent interpretation, how's that can affect the company? Well, I mean, you know, they have they're they're affected by patent experience that they're like everybody else. They haven't anything

particularly um different to trying to protect their patents. And they've got one that's coming up with a Limita, which is a cancer drug a billion I have two billion dollars of sales in total and that is going through the motions. It was challenged by IPRs and it's one some of those who has been challenged in the UK and it won those So but eventually the molecule will go off patterns and there's nothing you can do about that.

You're you know, this is a formulation pattern that they've been protecting and it seems to have the test of time so far, but eventually it will come. Other than that, there's nothing really in there that they're not doing any special moves or if if you're referring to, for instance, doing a deal with whether they with a tribe or anything like that, nothing like, nothing like that has happened there.

I'd love to just get a quick overview of what to expect from Mark because it seems like they have a less rosy expectation with respect to margins and how much their sales could right right right, Yeah, So America is in a very cut throat business at the moment, in the cop throat business of emmano oncology in cancer trying to get and it's working immune system, the patient's

immune system to attack their own cancer. So they are they lead along with Bristol Myers, who had the first drug on the market in this mechanism, in this in this arena called the year Boy a few years back. But basically it's so cutthro So you've got Astroseneca, Rush, Bristol Myers and Mark all competing to get the biggest, broadest indications and the largest number of combinations worked out for treating cancer, which costs money and it needs marketing.

So what Mark has been very open with is we are getting some sales potentially in the system. I mean, the sales are expected to be about flat in three Q versus last year because they've got generic expiries, but don't expect margin evolution there. Because we've a twine, we're going to have to invest in the business. W'd be pretty open about this, which of course is a bit tough when you really only have one drug that's growing,

We're gonna have to leave it there, unfortunately. Thank you so much for joining us, Sam Fazzelli, director of research for Bloomberg Intelligence, coming to us from London. Well, Haliburton reported earnings this morning, Schlumberge last week, and here to tell us what the highlights are. Liam Denning Bloomberg Gatflight columnists covering energy. So what stood out from you with respect to Haliburton's earnings. It shares are down slightly, although

not as down as schlumber Jay's. Yes, So the biggest thing here is just the different messages coming out of these two companies. So um, the key differences between Schlumberjo and haliber and his halib And is much more North America focused, like six revenue slamba, it's round a third. So Haliburton whenever there's a big uptick in US activity, particularly in the shale basins, Haliburton is the usual beneficiary.

And so when Slumberge reported on Friday, North America was kind of the only bright spot in their earnings, which made it very likely that Haliburton was going to step up and beat earnings. And and that's exactly what it did on on Monday morning. Well, I just just explained why North America is doing so much better than everywhere

else for them. So a big reason is it's really a timing thing, and it's this is actually kind of the crux of the difference between the two companies, and it kind of reflects a big difference in the global or market what we're seeing at the moment is in the old days, what would happen is the all price would collapse and then everyone would stop investing, and then the all price would rise, But then it would take several years for everyone to you know, find new wells

of fine new prospects, drill wells, bring the oil into production, and so you have a fairly long cycle. What shale has done is it's kind of short cirkuted that what happens is the old price has come down, but then as soon as the old price gets back above fifty bucks or so, and particularly a year out, which is when MP companies are hedging their future production, they all kind of get back to work, which then caps the rally. And so that's a big difference we've seen in schlimber

Jan Haliburton's outlook. Schlimberja is saying things are slowing down in North America. All prices are gonna rise. We're going to see a big uptick in international drilling coming through. Haliburton less certain about that, all right, Leo, let me just go to a couple of sort of points here, right because a crude or right now trading on the NIMEX seventy six cents for a barrel. That's West Texas. Let's go through margins when it comes to Haliburton, good margins, right,

they have very good margins. They kind of took a hit earlier this year. You may remember they issued a profit warning the first quarter and that, But wasn't that to take some some of their capacity out of the market and to then prepare air for what they thought was going to and has happened, which is this extensive tracking. Yeah, and they were actually talking. What they did was actually they put more capacity into the market, so they had to take a big post up front to redeploy that stuff.

And it's it's paid off because there their incremental margins since then have been have been up quite sharply. What about efficiency gains, because they're pointing to the fact, and you've written about this that it's that they are focused on the fact that it's going to cost a lot less money in the future to get whatever you want out of the ground, whether it's the shale oil or regular oil. That's right. One of the one of the points actually made on the coolest morning was they said,

look you look at the rig count. It's it's way down on what it was. But the fact is people are drilling alonger wells. They said, actually foot for foot, we're actually drilling as much this year as we did when all was at a hundred bucks. So maybe you can get rid of the Baker hughes like weakly, you know, up, down, sideways, you know which way it moves. Because tech this is as much a technology story. Well yeah, makesure week, But

I mean is this true though that? I mean it really there has become a technology story when you're talking about energy markets. Absolutely. I mean this has been a theme for at least the past year. You know, Halibut and struck, this alliance with Microsoft. We're seeing these kind of alliances being struggled over the sector. So there was sort of an implication there when you're talking about how Schlumberge seems confident that prices are going to rise and

Haliburton seems less sure of that. It's part of that, first of all, that Schlumberja needs prices to rise in order to hit its projections, and how high does it have to see prices rise? And what's Haliburton seeing as far as a projected crude value in the future. Well, let's Let's let's note first that they're both talking their own book, right, so of course, but this is important

to see how they're talking there. I would say it's less it's less a price level, and it's more to do with something that Haliburton raised on the call, which I think was very interesting. So if you go back to that point I made about the short cycle kind of nature of shale, with shale drillers, all they need to see is the al price to get appreciably above fifty bucks a barrel over the next twelve months for an international project. And this is the point Haliberta made.

If you're going to drill a deep water field somewhere in Africa, you not only need to see that price rise above fifty bucks or whatever level it is that you need for the next twelve months, you've got to think it's going to hold that for at least three to four years, because otherwise, why would you drill a well that isn't going to start producing the two to

three four years. And I think that's the key challenge. Well, that's also the challenge for investors, right because of whether your long term depends how much money you're going to put in the ground to get out what's going to pay you back? Right, And that's why we've seen, particularly with the international companies. You know, even though this is apparently a historic opportunity to invest well, prices of rigs

and that sort of thing are low. You'll notice all their investors are basically saying, pay us dividends because we don't want you putting it in the ground. Thanks very much for joining us and always appreciate your column. So he's our Gadfly columnist when it comes to energy, mining and commodities, Liam Denning, and you can follow him on Twitter at Liam Denning. It's time to pay up. Well, Friday is the time to pay up, and next week might be the time to pay up if you happen

to be the Venezuelan nationally owned the oil company. Here to tell us more about the debt situation and Venezuela is Jamine Patel, our senior credit analyst for Bloomberg Intelligence, and Jamine, thanks very much for being with us. Appreciate it. Maybe just set out for people exactly how much does PETA vesa, oh will it be able to pay? And then maybe just describe the relationship that it has with ros Neft and how that might sort of play into

all of this. Sure, First of all, thank you for having me um to to your first question, how much how much? Instead of oh, we really have to look at both Peta Vesta and and the Venezuela sovereign jet because you know, it's sort of hard to to differentiate between the two. The two are are really quite integrated. And to the extent that at investor doesn't have funds to make its bond payments, then um, I think you

have to you have to turn to the sovereign. So the total they're if you're looking at the at the total bonds is about sixty seven billion, but you have to add to that somewhere around fifty billion of loans primarily from from China, Russia and UH, you know through potentially through Rosneft as well, so that number could be

as highs undred and twenty billion. Now, what's coming to do this week and next week is UH is an amatizing amatization payment on a on a secured bond that's about eighty four eight d forty million, and then there is about one a little over a billion dollars on a on a regular on secure bond coming due in November the second. Yeah, but jaymen, let's just take a

step back for for a moment. So Venezuela is obviously deeply troubled from a political point of view, and literally, uh people are starving in the country, with an average weight loss of I think twenty pounds in the past year or two among the population. I mean, there's been

a huge shortage of food. There have been longlines for the most basic supplies, a lot of tension rising, and there is a question about whether a default on the nation's sovereign debt would force the current leader, Maduro UH to exit, right, I mean so, so the question is, is Venezuela about default given that they have more than two billion dollars coming due in the next two weeks with limited resources to cover that. Well, Um, you know that that that's the big question at this point, and

it really has come down to crunch times of these guys. Um, it's entirely possible that they will make the payments. Um. The history here has been every time a maturity has come to you, they have somehow come up with the funds, either by securing SITCO or borrowing from from outside sources. Uh. To to to make the payments, cutting capex, cutting their imports um in order to fill that cash flow gap.

So um, it appears that they are working on a deal with Rosine to enter into either some mapter tales or jvs which potentially will come up with enough consideration to make these payments. Total payments are somewhere between three and three and a half billion, because the two billion or so and and some interest payments. Okay, that's a

two weeks about three and a half bills. Well, actually over the next week or so, there's one on Friday, and then there's one on November the TEWOD, so October twenty seven and November the SEWOD, So they really cannot afford it to fall. I mean, I think I think a default would be would be almost unthinkable just given uh that petty best accounts for something like their effects flows.

So if petty Vest were to stop functioning as it does right now, which would potentially happen in default, I think things would go from bad to verse for for the people UH as as well as obviously the government. So I think even the opposition really doesn't want to want to see a default here. Jaman, how did they sell the stuff to begin with. I mean, it's not as if the situation in Venezuela is that new. No, No, it isn't. It's it's it's been going on for a while.

But you know, when oil prices are at a hundred dollars of barrel or higher, Uh, it's much easier to manage your your your balances um at forty dollars forty five dollars um, particularly when you don't have a rainy day fund, when you haven't prepared for it, things urry very quickly. Uh. Now, the government just to answer you know earlier question if if there is a default, I think I think there's a good chance that uh President Muduro it would have to uh potentially leave this post,

potentially even leave the country. UM. So I think I think they will do everything they can to to make this particular payment. Uh and then don't forget there at election coming due a presidential election in uh towards the end of next year, November of next year, at which point Venezuela has some some fairly heavy majorities coming to

you that they have to make. So can we just get a sense of why Russia and China are continuing to lend to Venezuela when Venezuela doesn't seem to be getting more credit worthy uh and is igniting ire among other big economies like the US. Well, I think I think China to me seems to be pretty much maxed out at this point. I don't think they're going to be putting a lot more um uh in terms of investment in the country. H. Russia has has a potentially

different agenda. Much of it may be political Venezuela's ties to Cuba some of the other Caribbean nations UM. But it's also a way for them to ensure that they have a steady supply of oil UM going forward. Not that Russia itself doesn't uh, it is not a heavy oil producer, but uh, this this just gives them that one additional avenue and and then a lot of it is political as well, political influence, political economic ties. The

two countries have been tied for a long time. There have been significant arms sales from from Venezuela to excuse me, from Russia to Venezuela, So I think it will sort of ties in with that. Just quickly, jamine if if you got a call from an investor who recently had purchased some of this Venezuelan Petave said that what would you be explaining to them that they may they may not know. I mean, they might know about the risks of of repayment, but what about the potential for unexpected activity,

whether it's from Russia, China or indeed even the Venezuelan regime. Well, I think you really have to differentiate between the long term and the short term bond holders, the the the immediate bonds that are coming to the ones that I talked about on Friday and and next week. UM. You know, at this point it really depends upon whether they this Russian deal comes through. Um. And and that's not even getting into the technical side of of of things, because

there is no great sperod on these payments. So if they don't make them, the bond holes could there they could call it default. UM. For the long term bondholders, UM, it's it's you've got a country here which has got in oil reserves, so it's not a solvency issue. It

really has a liquidity issue. UM. And if if there is a regime change, and that's really what what the bond holders will be looking for in the long run, UM, then that would open up all sorts of avenues for additional aid, because then they could reengage with the IMF, big agreen age with the us UH. Some of the sanctions we lifted and so on. We're gonna have to leave it there. Thank you so much for joining us. Jaman Patel, Senior credit strategist for Bloomberg Intelligence, talking about

Venezuela debt coming do. Thanks for listening to the Bloomberg P and L podcast. You can subscribe and listen to interviews at Apple Podcasts, SoundCloud, or whatever podcast platform you prefer. I'm pim Fox. I'm on Twitter at pim Fox. I'm on Twitter at Lisa Abramo. It's one before the podcast. You can always catch us worldwide on Bloomberg Radio