How Sustainable Is the Recovery?

Andrew Gogerty: Hi, I'm Andrew Gogerty with Morningstar, and joining me today is Jerry Senser, co-manager of the Mainstay ICAP International Fund. Jerry, thank you for joining me today.

Jerry Senser: My pleasure.

Gogerty: A lot has been written recently about the resurgence in the U.S. equity market. A lot of large-cap funds are back in the black, or positive returns for this year, and a lot of international, foreign large caps have really followed that lead. Your fund, for example, is back in positive territory this year. What do you think is driving some of that renewed optimism overseas in a lot of non-U.S. holdings?

Senser: I think the markets around the world are recognizing that the economy is probably going to start to recover by the end of the year. The global economy is going to start to recover, and the markets have reflected that fact. There are a number of factors that we look at that would underpin an economic recovery. We've seen an improvement in credit market conditions. Spreads in the credit markets have declined, and you've actually started to see companies being able to access public capital markets, for example for equity. Stress tests have been completed in the United States, an important milestone.

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We've also seen some upturn in some of the near-term data. Purchasing managers' indexes in the Unites States have turned up, as they have in developing countries in Europe, Asia, and China. And we've started to see some stabilization of earnings, which is very important. Companies are not going to expand employment or capital spending if their earnings are in free-fall.

We've started to see more stabilization in the first quarter, which is very important. And then finally monetary policy--unprecedented stimulus for monetary policy. And fiscal policy around the globe is starting to become more stimulative. It's not just the United States, but we see considerable fiscal policy stimulus in countries like China and Japan as well.

Gogerty: You had mentioned the stability of earnings. What other sustainability aspects are you guys looking at to see is this going to be a steady recovery, or may this be just a short-term thing, are we going to reverse. What are you looking at to verify that maybe this is sustainable, maybe it is for real right now.

Senser: Our horizon extends out about 12-18 months. I think as you look at what's out there, the growth can probably be sustained for at least a year once the economies begin to turn up. And we're actually optimistic that growth could surprise people to the upside. Inventory positions are very, very low. Demand appears to have stabilized. And just a stabilization of demand would probably necessitate a reasonably large increase in production to bring inventories back to the more normal levels.

And of course as I mentioned before, monetary and fiscal stimulus is extremely strong, and we do not anticipate that either the Fed or other central banks around the world are going to be very quick to withdraw that stimulus.

So we feel that there is going to be some sustainability to this upturn, and that people may actually be surprised not only how good the economy may be--and we're not anticipating huge gains. But expectations are very low.

But not only how good the economy is going to be, but how good earnings may be. Companies have really cut their operating expenses to the bone, and we've started to see very good operating leverage. Some of the companies that have reported have shown very high incremental margins, and we think that that could surprise people.