Will 2011 Bring Record Earnings for the S&P 500?

Schwartz: Thanks to you for asking us.

Sáenz de Cenzano: Marvin and Henry come from Neuberger Berman, the independent US Asset Management company. They are both personal managers of the fund UBAM Neuberger Berman US Equity Value, which is a pretty big fund, €1 billion at the moment. Marvin has around 50 years of experience, Henry around 20, so not bad. So, we are very glad to have them here today.

The first question would be on, I know you've got a positive view on US equities in general, so we would like to know your rationale for that view. What are the main reasons you've got for that, what are the main risks that you think there are in the US equity market and in the US economy in general? Do you have any concerns in terms of a potential double-dip recession in the US?

Schwartz: Okay. First-off, I think that too many investors do not appreciate the fact that in 2011 the Standard & Poor's 500 common stock index and the Dow Jones' industrial averages are going to achieve all-time record high earnings. This seems hard to believe for some people, because of the extent of the economic weakness that was experienced in 2008, 2009. But there has been a remarkable resiliency and resurgence in US corporate profits. For example, the all time peak earnings year for the S&P 500 was in 2006 when the index earned $87.72 a share. We expect that index to earn between $85 and $86 a share this year, and then next year we expect it to earn somewhere in the area of $90 to $92 a share, even though the consensus is $95. So we're looking at record earnings.

Of equal importance, the price earnings multiple of the market today is approximately 12.5 times next year's earnings. That compares to 20 times earnings for the S&P index for the last 20 years. We also have a situation where the amount of leverage that's used by US companies has come down substantially over the last two to three years, so it suggests that if leverage is down, quality of earnings is up, and a 12.5 multiple of next year's earnings just seems to be too low.

Ramallo: I would like to add the amount of cash that are on balance sheets that's going to be able to be used to do M&A or to do stock buyback, increase dividends or further pay down debt levels, is true, is available for use. And the other thing is that our portfolio is trading at a discount to the S&P 500 by about two multiple points lower. Our portfolio is trading with 33 positions. It is trading at roughly a 10.5 times next year's earnings.

Schwartz: I think you should understand that a 10-multiple, I mean it is the equivalent of a 10% return. Now it's true, you are not getting it in your pocket, but a 10% return in an environment where a 10-year US Treasury yields 2.5%, is a very attractive return for common equity investors.

Sáenz de Cenzano: And the largest sector in the portfolio is the energy sector, it's been historically, and it is now around 35% of the portfolio. I would like to know what's your overall view on that sector, obviously it's positive, but why it is so positive? And also, what areas within that sector are more positive to you, because obviously it's a quite broader, wide sector, so probably there are some areas that are a little more interesting than others. Could you give us a broad overview on the energy sector?

Ramallo: Yeah. The energy sector represents about 33% or 34%. I don't mean to correct you, but of that it's made up of roughly 26% to 27% in independent energy and oil and gas companies and about the delta, the difference, is in deepwater drilling stocks, three stocks in particular, Seadrill, Pride and Ensco. The IEA claims that 85% of the world's oil that is yet to be discovered is going to be in deepwater, so that's why we have the exposure there. And when it comes to our exposure in the energy, the E&P space, we don't invest in the Exxon, the Total's or Eni’s of the world. We don't think there is anything wrong with those companies, but those companies are having more and more problems to increase their reserve basin, because oil is becoming more and more difficult to find in the world.

We have the independent E&P companies, because they've been more successful of replenishing their reserve basin and we have an overall belief that the cheap oil in the world has been found and there is demand, record demand, coming on according to the IEA of 88.2 million barrels would be record demand for 2011. Record in the past was in 2007 of 87.2 million barrels a day. The emerging markets and the Middle East, their own internal demand is growing dramatically.

So, with the overall demand outlook and the fact that the resource is there, and you have depletion running at about 8% a year, which means that if you're going to use 88.5 million barrels, that means you need to find roughly 7 million barrels of oil just one in place, where you also have to make up for growth, and growth runs at about 1.5%. So, I mean you need to bring about 8.5 million barrels to market to make up for depletion and growth and it's getting very difficult to do. So we think the overall trend in the market is for higher energy prices, and this is how we want to protect people's money.

Schwartz: There is a growing gap between world consumption of oil and world discoveries of oil. The last time that oil was discovered at a rate close to consumption was 1988. We also believe, as does Goldman Sachs and Nomura Securities, that the average price of oil next year will be $95 a barrel followed by $110 a barrel in 2012. You should also keep in mind that all of the oil and gas companies that we invest in are primarily based in either North America or their reserves are in politically secure areas. We have a belief that many countries in the world are going to expropriate in some shape or form the natural resources that exist in their countries. We want to make sure that we don’t wake up one day and find out that another Venezuela has occurred, and it won’t with the investment that we have.

In addition, there is a substantial discount between the market price and the net asset value of every company that we invest in. One of our major holdings is Occidental Petroleum, the stock sells at $80, and we and others believe that the net asset value is a minimum of $120 a share. Another holding is Anadarko Petroleum, the stock sells at $56. We and other analysts believe that the minimum net asset value per share is somewhere between $90 and $100 a share.

Sáenz de Cenzano: So the companies in the portfolio are all of them US or most of them US based, but there are some exposure to emerging markets and I am asserting that a lot of investors have a lot of interest in. What’s your take on that, do you think you are playing in that emerging market back through some of your energy stocks?

Ramallo: Absolutely, for example, Anadarko, has some major discoveries and participating in some of the fields in the Brazil basin. Seadrill, as I mentioned, is also operating some of their rigs down in Brazil. Without a doubt that’s the way we’re playing it. Do we have any direct investment in Petrobras and other companies? The answer is no, we don’t feel it’s necessary. We also do have some limitations on how much direct foreign investment we could have in the fund because it is supposed to be primarily US based, but we have found a way, and our companies, I should really say have found a way to play the emerging markets, especially the Brazilian basin.

Schwartz: Most importantly, the future price of oil will be determined by the quantity of growing demand coming out of emerging markets. So even though we don’t invest in those markets directly in the oil space, the future success of our investments in oil will be determined by the continued growth of Brazil, and China, and Russia, and India, and so forth.

Ramallo: Just to make one example on China, Chinese car demand year-over-year is growing at a faster rate than the United States. This will be the second year that Chinese vehicle demand will surpass that of the United States. Last year was about 12 million, 12.5 million vehicles, this year it looks like it’s going to be 14 million or 15 million vehicles, and I have a report on my desk that believes that by the year 2015, China demand for vehicles is going to be in the 22 million to 24 million cars a year. Those cars are still all running on gasoline for the most part, so it just shows the never ending demand. And the other thing to keep in mind that oil roughly two-third of every barrel is used in the form of transportation, whether it be the gasoline or diesel for automobiles, bunker fuel for ships or jet fuel for aviation. So if that doesn’t change, the demand for oil as a refined product is only going to continue to go up.

Sáenz de Cenzano: And what about alternative energies, do you see like a lot of pressure coming from that in terms of the oil companies?

Ramallo: Not from the oil companies, it really, in the United States the best way to change the overall demand, for let’s say hybrid cars or electric cars, is the price of gasoline was actually higher. If we had a higher let’s say gas tax like you do throughout Europe, our federal tax is only $0.22 per gallon, you know, in your average countries and throughout Europe it’s $4 to $5 in some countries higher per gallon. So we are not imposing a will to force consumers into what you want to call alternative vehicle type of cars, whether it be a hybrid or whether it be a battery car, but at the same time the technology is really not there to overwhelm the consumer like a battery operated car, it’s a phenomenal thing for example the Nissan Leaf is coming out later this year. It’s a car that’s about $30,000 to $32,000, but it only gets you about 100 miles on every charge. And if you had to start charging them on a regular basis, and right now the entire US fleet is around 270 million vehicles on the road, let’s just say over a short period you are able to get 20% between hybrid or an electric car or let’s say the overall majority being electric cars. I am not sure that our grid is setup to start dealing with the energy demand for all these vehicles we are going to plug in. So it adds another problem, another complexity. So I am not too concerned that those types of technology changes are going to occur quickly in the next five or 10 years in the United States.