Loomis Sayles Divines New Equilibrium in Equities Markets: But Environment Still Favors Small-Cap, Value
March 13, 2006
NEW YORK - Fund companies that might be ramping up for a rush by investors from value to growth would be wise to listen to Warren Koontz, Jr., manager of the Loomis Sayles Large Cap Value Fund.
Koontz, who has been at the helm of the Boston fund firm's flagship value fund since 2000, thinks an equilibrium - where one investing strategy no longer pummels the other for extended periods - is beginning to settle on the markets.
"One will always beat the other," Koontz said during an investment briefing here last week, "but I don't think we'll see the substantial out-performance that we've witnessed over the last 10 years."
The biggest reason for this balanced environment, Koontz said, is the prolonged out-performance of value stocks in recent years. And the Loomis Sayles Value Fund wasn't on the sidelines during that run-up, either. Its average annual total return over the three-year period is 17.91%, nearly 3% better than the S&P 500 and slightly ahead of the Russell 1000 Value Index. One-year numbers, however, are particularly impressive, as the fund has beaten the S&P by nearly 8% and the Russell 1000 by almost 6%. The fund currently has $38 million in assets under management.
But it's that sort of success on the value side that has sent valuations between the two indices to as narrow a margin as they've been in a long time. The impact going forward, Koontz said, is that thematic investing strategies will likely take a back seat to a bottom-up game plan.
"It's a great stock-picker's environment right now," Koontz said. "It's a great environment for picking stocks one at a time, and I don't see that diminishing much."
So what's Koontz picking? His fund has been taking profits off an early bet on the energy spike and is now underweight energy, although Koontz still finds oil services companies attractive as they expand their refining capabilities. Other key stakes include Citigroup, Lehman Bros. Holdings and Burlington Santa Fe, as well as "almost anything telecom."
Commenting on the AT&T/Bell South merger that had been announced just hours earlier, Koontz said the consensus at Loomis Sayles is favorable, and he's optimistic that it will pass regulatory scrutiny.
"We think it makes sense for a lot of reasons, and it should close by year's end," he remarked, adding that the merger would probably fold Bell South and Cingular under the AT&T brand. With "a $160 billion market cap and $132 billion in revenues combined, it will have a very large footprint" on the markets, he said.
Also driving this new equilibrium is a slowdown in revenue-based earnings on the large-cap growth side, added Richard Skaggs, manager of the Loomis Sayles Growth Fund.
Skaggs, who has managed the $293 million fund since 2000, rattled off a litany of blue-chippers that have struggled to meet expectations: "General Electric, growing revenue in the single digits and struggling to put up 15% earnings growth; Microsoft, a single-digit revenue grower; Procter & Gamble, single-digit earnings growth; Johnson & Johnson, great company, but it had negative sales growth in the quarter just reported; Intel, struggling; Wal-Mart, 10% sales growth and steady, but still reflective of a maturing economic cycle.
"The staid blue chips that had their performance glory in the 1990s are certainly still strong companies, but for growth, we have to look elsewhere," said Skaggs, whose fund was off the Russell 1000 Growth Index by 1.13% in 2005, but up by almost 3.5% over the past three years.
Not surprisingly, Skaggs follows his colleagues outside of a thematic investing strategy and into niche companies across all sectors. In financials, banks are out of favor and investment management firms themselves are gaining steam, he said. Firms such as a Moody's Investor Services and the Chicago Mercantile Exchange are two niche picks, while in consumer discretionary, Skaggs' tendency is away from mega-retailers like Wal-Mart and toward specialty companies like Chico's and Coach.
Arguably the hottest growth stock in large-cap, Google remains a key holding, despite recent regulatory troubles and an earnings hiccup in the January quarter. Skaggs, as well as other Loomis Sayles managers, grabbed the search engine out of the gate at $110 a share and as the stock moved to the $450 to $500 range began scaling back. His position has gone from just under 5% as the fund's top holding to about 1.5% of the portfolio.
"The revenue growth is too fast for us to sell to zero," he said. "We think the shares could be attractive at $300 to $350, and that's when we'll dust off every file and take a hard look at it again."
Despite his role as a large-cap manager, Skaggs cautioned against placing too much emphasis too far up the valuation chain. He said the current environment still favors small- to medium-cap funds. Besides, significant out-performance by large-caps over smaller-caps is oftentimes a forecast for recessionary winds.
"Sometimes we have to be careful what we wish for," he remarked. "If large is outperforming small, it's probably because business conditions are under significant pressure, where the large-cap company is benefiting from its extreme financial strength and financial power. So, I'm not expecting small and medium to begin to underperform large anytime soon, unless there is a recession," Skaggs said.
On the fixed-income side of the ledger, veteran bond fund manager Don Fuss, who guides the Loomis Sayles Bond and Loomis Sayles Global Markets funds, said he expects short-term interest rates to reach 5.25% this year. In addition, the 10-year Treasury should clear 5% and reach 5.25%. He characterized the inverted yield curve between short-term and long-term notes as "unusual" and "not likely to continue."
In fact, the risk in bonds, he said, is the nation's current accounts deficit, which is now upwards of $800 billion.
"We're running the ultimate risk of severe inflation," said Fuss, who manages a collective $5.5 billion in assets. "Hopefully that will stop, but right now, it is not."
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