Barry Knapp, Head Of U.S. Equity Strategy, Barclay`s Capital

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BARRY KNAPP, HEAD OF U.S. EQUITY STRATEGY AT BARCLAY'S CAPITAL,TALKS ABOUT THE MARKETS ON BLOOMBERG SURVEILLANCE

AUGUST 31, 2010

SPEAKERS: BARRY KNAPP, HEAD OF U.S. EQUITY STRATEGY, BARCLAY'S CAPITAL

TOM KEENE, HOST, BLOOMBERG SURVEILLANCE

KEN PREWITT, HOST, BLOOMBERG SURVEILLANCE

IRA JERSEY, DIRECTOR OF U.S. INTEREST RATE STRATEGY, CREDIT SUISSE

7:37

TOM KEENE, HOST, BLOOMBERG SURVEILLANCE: He bought seven suits last week at Saks Fifth Avenue, we welcome Barry Knapp of Barclay's Capital. Barry, good morning.

BARRY KNAPP, HEAD OF U.S. EQUITY STRATEGY, BARCLAY'S CAPITAL: Good morning.

KEENE: Equity markets, it's run-and-cover here. You've got a portfolio strategy that's I'm going to suggest cautious. When does cautious become, let's go to cash? Are we anywhere near where we really lower the allocation?

KNAPP: Well, you know it's interesting because I wrote a note on Friday and met with a research force yesterday. And I tried to set up a framework for a late-in-the-year rally and went through a number of things that I think if they developed, you know could set the stage for a rally later in the year. Things like the Fed restarting QE, a favorable settlement on Basil III, expectations getting marked down, some positive outcome on the Bush tax cuts and the like. So the sales people immediately asked me, well, what if those things don't happen. You know -

KEENE: I'm shocked.

KNAPP: What if we don't get the Bush tax cuts rolled - and, which there's a good chance we could obviously have a stalemate at least through the elections.

KEENE: Barry, let me translate this - we're jargon-free, it's a jargon-free earth. Let me translate this for those in the world that aren't on Wall Street. What Mr. Knapp was suggesting is the revenue producers at Barclay's Capital were saying, hey strategists, you stupid idiot, what if you get this wrong, we'll lose our paychecks. Okay, continue, Barry.

KNAPP: Well, it's okay. That's a good way to put it, I guess.

KEENE: So tell us about a year-end rally.

KNAPP: I mean, quite frankly, we've been in a negative camp and we've been saying that we thought we would at least test the early July low of 1010 (ph) and that we could potentially go below it. You know if we didn't get some of these developments to come together, then surely we could trade lower still, you know down into the 900 range or so on the S&P. But we do still think there's scope for a year-end rally. I definitely wouldn't put us in the optimistic camp and in fact, we lowered our price target on the S&P from 1210 to 1120. I realize it's a little bit arbitrary reaching those targets, but nonetheless, we thought that 1210 had become a best-case scenario rather than a base-case scenario.

KEENE: Let's bring in Ira Jersey here from Credit Suisse. Ira, say good morning to Barry Knapp.

JERSEY: Good morning, Barry. You know, one of the things that you have in your report is a significantly slower earnings growth next year. Is there any way that that's going to derail the range that we've basically been in for the last year or so?

KNAPP: Well, it's interesting. I have this debate with the traders quite often who tell me that, you know, the bonds of (ph) consensus forecast is 96. And I say, well no one believes that anyway and we're not trading on that kind of a multiple. So you know, the number's already marked down. And my report to them is that when you're actually - you go through the process of marking those numbers down, it can't be a favorable development for the equity market. So, one way of thinking about that is Intel preannounced on Friday in the market rally as if that was the end of the process as opposed to the beginning of the process. We think there'll be a lot more marking down of those forward earnings estimates. You know, 15 percent for next year doesn't make a heck of a lot of sense. Over time, S&P revenue growth tends to converge with nominal GDP growth, right. So GDP plus deflation and you know the first couple quarters coming out of a recession - or for a couple quarters coming out of a recession it can run as much as 5 percent above. But by next year we think it will converge towards that nominal GDP growth level. And margins have already gotten back to within 1 percent of peak during the last cycle, so we don't think there's much scope for further margin expansion.

JERSEY: So does that mean we just go sideways for quite a while?

KNAPP: It could very well. I mean when you look across all the various valuation metrics on the S&P, the metrics that the S&P looks positive against, or it looks cheap against, if you will, are fixed income instruments. You know, it looks cheap against investment grade credit. It looks cheap against treasuries. But against its own history, it doesn't necessarily look cheap. I'm in the camp that when you have significant upticks in economic volatility and I think your strategist at CS has the same point of view on this, that we can trade at significantly lower multiples. So yes, there's a stream of cash flows you could argue the equity market's cheap, but at least until you mitigate or offset that risk of a double-dip, it's hard to see how the equity market would get any real multiple expansion.

KEENE: Ken, dive in.

KEN PREWITT, HOST, BLOOMBERG SURVEILLANCE: Barry, we put some numbers together here at Bloomberg and found out that the percentage of buy recommendations from securities analyst is the lowest it's been since 1997 and yet estimates are for S&P earnings to be up 36 percent and that's the highest since 1988. In other words, earnings are going to be great, but don't buy stocks. So what's that telling you?

KNAPP: You know, I've heard that - I heard your story on that. I was a little confused by it because I've met with almost all of our analyst groups over the last month or so and I did not - just doing an eyeballing all of their recommendations think, and we have, as you know, the number one II (ph) research rated team. And I though there were significantly more buy recommendations by our team than 27 percent, but I think the net message of all this is that the numbers are just - the numbers are just too high. They need to come down.

KEENE: Yes.

KNAPP: So, to some extent that may very well be in the market. But I don't think when those numbers are actually getting cut, that will be a positive catalyst for the stock market.

KEENE: Right. Ira Jersey, jump in here with a question.

IRA JERSEY, DIRECTOR OF U.S. INTEREST RATE STRATEGY, CREDIT SUISSE: Yes, so you have a chart of one of your recent reports about correlations falling of the S&P 500 even though we've had a pullback. Is - what significance does the correlation within the equity market actually have in your analysis of it?

KNAPP: Well, you know I would say the way I think about it can't really anyways. When correlation goes quite high, and clearly, we had unprecedented correlation of cross asset classes during the crisis and for big parts of 2009 including during the heaviest parts of QE when the Fed was buying mortgages like they were going out of style, creating that portfolio rebalancing effect, you know pushing capital out the risk curve. The fact that correlations started to break down now, to me means that this is not really about just risk aversion.

KEENE: Yes.

KNAPP: People just cutting risk. This is really more about starting to discount the forward earnings stream for the S&P 500. What are the economic prospects?

KEENE: Interesting.

KNAPP: And so what I think that means is the defensive sectors will perform well, even when the market rebounds as opposed to just being you know the Fed's in need of outperformers.

KEENE: Barry, thank you so much. Barry Knapp, Barclay's Capital. Say hi to all your revenue producers as well. Tell them you're a good guy. Barry Knapp, Equities Strategist, Head of Equity Strategy, Barclay's Capital.

7:44

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