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Barron’s: What awaits investors in the second half of the year?

Mario Gabelli: The markets over the balance of the year will be shaped by four Ts. The first is tariffs. The global economy is $86 trillion. U.S. GDP is just over 20% of that. Europe is about 20%, and China and Japan are 22%. The U.S. has about $20 trillion of GDP, and a trade deficit of approximately $500 billion, including $350 billion with China. That means we are delivering money to China, and knocking 2.5% off our GDP. The tariff spat is creating cost inflation at the industrial companies we own. But it is also creating investment opportunities among U.S. companies that serve the domestic market.

My next T relates to the 10-year Treasury bond. The yield was 2.44%-2.73% in January. It rose to 3.11% and then fell back to 2.86%. Is the market’s current multiple of Ebitda [earnings before interest, taxes, depreciation, and amortization] sustainable? I don’t think so, as I expect inflation to pick up, sending the 10-year yield back up to 3%, the level I talked about in January, by year end, and higher next year.

What is your third T?

Taxes. We have moved to a territorial tax system from a global system for corporations, which is good. Corporate tax of 21% is a magnet for business to locate here. The write-off of capital expenditures provides strong demand. The fourth T is technology. It is attracting a lot of attention in the stock market, and will continue to do so. The tariff situation has been a surprise, but it doesn’t bother me that much. Trump is an arm wrestler and there will be a lot of give and take. Some of it is good. It creates volatility – the old normal in markets. That allows you to buy things a little cheaper if you are patient, and makes you look less dumb for not owning the momentum stocks.

What do your Ts tell you more broadly about the economy and the markets?

The consumer is 70% of the U.S. economy. Jobs are plentiful, wages are rising, and the net worth of the consumer is at an all-time high. Gasoline prices have been rising, but Trump is jawboning the Saudis to get oil prices down. He wants a reasonably strong economy in September-October, ahead of the midterm elections. Arm-wrestling with the Chinese over tariffs should cool off by then, as well.

If the Republicans can hold on to the House and Senate, it is possible the tax act will be tweaked again. Trump could try to get rid of the 3.8% surcharge on capital gains and dividends, among other things. Infrastructure spending should pick up in 2019, providing a cushion for the economy, and if oil prices stay above $60 a barrel, domestic drilling is likely to accelerate. There are logistical issues with getting oil out of the Permian basis, which could keep prices up for a while.

I said in January that the market would be up zero to 5% for the year from the Standard & Poor’s 500 level of 2740 at the time of the January Roundtable. I still think so. But over the next 10 years, you could see a 6% to 8% annual return in an S&P 500 index fund. That’s lower than in the past, as multiples are on the high side now and rising interest rates provide a headwind.

Mario Gabelli Jeremy Liebman

Let’s move on to your favorite stocks.

CNH Industrial [CNHI] the former Case-New Holland, is something old; I recommended it in January. The stock, at $10.25, has come down since the start of the year due to concerns about tariffs on agriculture and currency issues in Europe. Case makes farming and construction equipment, and commercial trucks. Sergio Marchionne, chairman of CNH and CEO of Fiat Chrysler Automobiles [FCAU], created value by spinning Ferrari [RACE] out of Fiat/Chrysler. Before he retires, we believe he is going to merge Iveco, a truck brand owned by CNH, with DAF trucks, owned by Paccar [PCAR]. Both make European medium and heavy-duty commercial trucks. It is a logical combination.

On the agriculture side, farmers are doing okay. We expect CNH to earn $1.10 a share in 2020. As investors begin to anticipate this, the stock will double.

You recommended Paccar in January, too. Do you still like it?

Yes. The stock has dropped from the low $70s to the low $60s. Paccar builds Kenworth and Peterbilt trucks. Demand for trucks has surged beyond my estimates, but traders think it will fall in 2019 and I agree. We have Paccar earning $6 to $7 a share for the next two or three years. If the company doesn’t make any acquisitions and sticks with a $1.20 to $1.30 annual dividend – it is $1.12 now – Paccar could have $9 billion in net cash in three or four years. That’s $30 a share of cash.

I recommended Madison Square Garden [MSG] in January. The news that the board is exploring a spinoff of the sports franchises is in the stock, which has done well. I’m holding it incrementally. I still like Liberty Braves Group [BATRA] a tracking stock representing Liberty Media’s ownership interest in the Atlanta Braves. There are about 60 million shares. The stock is around $26. The team is doing better on the field than I ever anticipated. They have a great farm system with ownership of their Triple A, Double A, and Single A teams, and a new stadium, and land, but more important, they have John Malone, who controls Liberty Media. He loves baseball but is going to sell the Braves.

Mario Gabelli’s Report Card

He loves good deals, too.

The Braves sold their TV broadcasting rights until 2027. They are trying to negotiate them back. Getting them back could give the stock extra tailwind, including a purchase of RSNs [regional sports networks] in Atlanta. Betting on sports is another plus.

Next, a lovefest is going on involving Walt Disney [DIS] and Comcast [CMCSA] and 21st Century Fox [FOXA]. [Disney and Comcast have both bid on Fox’s studio assets.] That brings me to Sony [SNE]. The stock is selling for $49. There are three businesses. The company makes robots and sensors for autonomous vehicles and iPhones. Then there’s the entertainment side. Columbia Pictures is a magnet for M&A discussion. Sony also has a music business, which owns rights to artists’ songs. As the music-streaming business grows, that will become more valuable. And it makes the Sony PlayStation.

Do you expect a deal involving Columbia Pictures?

Everyone in media and entertainment is talking about how to scale up and go direct to the consumer as Netflix [NFLX] has done. They’re talking about the globalization of the market. Sony has an attractive valuation. The stock is selling for 6.2 times enterprise value to Ebitda. It would be logical for Columbia Pictures to merge with Viacom’s [VIA.B] Paramount Pictures.

Where would that leave CBS [CBS], which shares common ownership with Viacom?

In the eyes of Verizon Communications [VZ]. CBS is trading at $58 and could be worth $80-$90 in a sale. Viacom is $30 and could go to $50 by 2020. CBS and Viacom should either combine or be part of another organization.

Going back to Malone, all eyes are on the growing Latin American market. Millicom International Cellular [MIICF], which I have recommended in the past, operates cable TV properties in Central and South America. There are 101 million shares, and roughy 38% of the company is owned by Kinnevik [KINV-B.Sweden], which is controlled by Cristina Stenbeck. I speculate that Millicom will merge with LiLAC Group (LILAK), another Malone-controlled company. Millicom is trading for $61 a share. It could be worth close to $100 in two years.

Lastly, I started following Garlock, a maker of sealing products, 40 years ago. It came out of bankruptcy protection in 2017 due to an asbestos issue. It is part of EnPro Industries [NPO]. EnPro’s stock is $72 and there are 20 million shares. EnPro’s industrial-products business could be attractive to a range of companies. The stock might hit an air pocket when the company reports second-quarter earnings, but independent of that, could hit $105 in two years. We expect the company to scale up.

Thanks, Mario.

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