Ryan Leggio: Hi. I'm Ryan Leggio. I'm a mutual fund analyst at Morningstar. And with me today is Jerry Jordan, manager of the Jordan Opportunity Fund. Jerry has one of the best track records in Morningstar's large growth category over the last three and five years. Jerry, thanks so much for joining us today.
Jerry Jordan: Thanks for having me.
Leggio: I wanted to start off with some of the macro thinking and then, maybe, move down to the portfolio level information. And the biggest issue right now, for a lot of investors with the S&P's strong run, we're at 1190 as we talk today, is what is the valuation of the market? Robert Schiller's cyclically adjusted P/Es around 22, which definitely points at the markets, probably overvalued. You think the market's, maybe, modestly overvalued. Can you tell us why you think that and how you derive your S&P estimate?
Jordan: Sure. It's our belief that earnings this year are going to be somewhere in the $80 range, maybe $82. Next year's probably high $80s, maybe even low $90s. So some could argue, "Oh, well the market's cheap. Put a 12 or 13; put a 15 multiple on that. That gets us to 1,300, 1,400."
Our belief is that part of the issue with putting a big multiple on the market, and 15 times, people talk about being the average, but it's really not the average. It's the higher end of the average. If you put a big multiple on these earnings, we think it's a little bit disingenuous because a lot of the bounce back in earnings has been a function of cyclical companies having a cyclical bounce back.
Therefore, the earning aren't as legitimate, as predictable, as visible. I'm not willing to say that all these companies are going to earn this much money and continue to earn this much money, especially in a growth rate basis going forward, and therefore, you ought to put a lower multiple. Perfect example, companies like DuPont, Ford, Caterpillar.
At the peak of a cycle, they're not going to be trading at 15 times. They're going to trade a six or seven times. Why? Because people don't believe the earnings are sustainable. I think there's a healthy component to that earnings number. Let's say we're talking about an $80 earnings number. Very possibly $30 to $40 of those dollars is cyclical earnings, because we're up from $49 a year ago.
So, is it fair to put a big multiple on that cyclical bounce back in earnings? We don't think it is. We think 1,200 is probably about the right price, 1,100 to 1,200. And honestly, in the environment we foresee, which we can get into, we think the market could very easily be 1,200 two or three years from now.
Leggio: And speaking about the environment, another factor you have a strong opinion on is inflation, and certainly, the market agrees with you on that. The break even rate between the 10-year nominal Treasury and the 10 year TIPS is still very much subdued. Can you talk about why you think we're not going to see inflation with this huge government deficits, and debt, and all the other factors which, historically, have led to higher levels of inflation?
Jordan: Well, one of the things that's important to notice is that they have often led to higher levels of inflation, further down the road. So now, I don't think we've got a real inflation risk the next three to five years because we've still got a pretty wide output gap. We've still got fairly low capacity utilization. I still think we've got too much capacity in, sort of, everything. Oil is not tight right now, but it could get tight. I think grains, food in general, is something that's going to get a lot tighter. But, just about everything else--iron ore, that's pretty tight--but other than that, there's still plenty of capacity in steel. There's plenty of capacity in human beings to do work, whether it's here or overseas.
So I don't think you're going to see a lot of wage growth. I think you're going to see whatever bump you might have been able to get in wages is now going to get spent on healthcare. So, the individual's not going to get that benefit. So, I don't think you're going to see much on the inflation side of things.
I also think the economy is probably finishing up its big run here, and we're going to see slower growth going forward, and that's going to take the edge off of whatever inflation risks there were. And, we still really aren't very far along on the deleveraging aspect. Big corporations did a great job of either paying down debt or, more importantly, refinancing their debt to lower levels.
So, interest payments as a percent of revenues is lower even if the debt levels aren't all that lower. We know the U.S. government has now got a ton of debt. So they aren't de-levering. And if you look at small business and individuals, they haven't de-levered much either.
So that process is going to take a while and that process, historically, has led to slower growth and an inability to really see any inflation. Five, eight years from now when the rubber may start to really meet the road in terms of trying to roll over a lot of this paper, then all bets are off.