Managers Don't See All Gloom and Doom in 2007
September 25, 2006
NEW YORK-Rising interest rates, a sagging housing market, and inscrutable energy prices all blur into a bleak outlook for 2007. But fund managers at Lipper's "Lipper Leaders" symposium last week said there's money to be made for investors. It just won't be easy.
A series of seven fund managers, singled out for consistent and total return performance, each had different ideas about the best bets in an otherwise dreary marketplace-whether large-cap or small-cap, local or overseas-but they all agreed that opportunities exist.
First, and perhaps most importantly, the economic prospect for the upcoming year is not all gloom and doom, said Kurt Spieler, portfolio manager of Tributary Capital Management's First Focus Growth Opportunities Fund.
"Growth is slow and housing is down, but there's still full employment. Disposable income and compensation are going up," he said.
Likewise, companies are more robust than headlines might suggest. The Business Roundtable released a member survey last week that showed while most believe U.S. economic growth will slow in the upcoming months, they foresee it growing at the historical rate of about 3%.
Reuters Estimates Senior Markets Analyst Ashwani Kaul said that 2007 will show double-digit earnings gains across the board for S&P 500 companies. Corporate earnings grew an "impressive" 13.6% in the second quarter, compared to more modest expectations of 7.5%, he noted. The next six quarters suggest more of the same, he predicted.
What companies do with these earnings may bring surprises in certain sectors, he said. For example, cash-laden companies will invest again in their infrastructure, and that may mean a boost for the long-forsaken technology sector. Industrials, which have beaten the S&P for over two years, will underperform, and energy, which, in its heyday reaped gains of 30% or 40%, will correct as geopolitical unrest eases, he said, earning a still-respectable return in the 9% range.
Managers then turned to the age-old debate of large- versus small-cap, most suggesting that bigger is better.
In 2000, small-caps traded at a discount of about 40% compared to large-caps, noted Duncan Richardson, manager of the Eaton Vance Large Cap Growth Fund. Now they trade at a 5% to 10% premium, he noted. Yet, only a tiny fraction of the $107 billion of inflows to the equity market last year went to large-caps. Because they have been neglected by consumers, they offer great value, he argued.
Micheal Embler, manager of Franklin Templeton Investments' Mutual Beacon Fund, focuses on untapped value, rather than company size.
"If someone told me five years ago that we'd be buying Microsoft, I'd tell them they were crazy," he said. But, in fact, he now sees Microsoft as undervalued by as much as 30%, and his fund has recently bought in.
Get ready for pharmaceutical companies to come back into favor, said Paul Alan Davis, manager of the Schwab Health Care Fund. A few years ago, healthcare companies, like technology firms, were growth stocks that had huge runs, but fell out of favor as the economy showed signs of sputtering. But they're ready for a rebound-this time as value stocks.
Thomas Ross, manager of the Allianz RCM Global Small-Cap Fund, argued that there is hope for small-caps, especially since most companies around the world are, in fact, small.
"There are good small-cap companies expanding in the U.S., quietly in Europe, and for the first time in a long time, in Japan," he said.
Ross relies on Allianz's global network of analysts to pick the best small companies in their regions. So when he's looking for titanium, he goes to Japan, while the Ukraine and Romania have high consumer and service-sector growth.
Although Ross is shopping the globe, most managers said they're buying American again. "There is a trend of coming back to the U.S.," said Michael Cuggino, manager of the Permanent Portfolio Fund. With the dollar weakening against other currencies, he said, "the cost of taking risk is getting higher."
When all else fails, Embler said the best way to rein in a company that is not providing the value it should to its investors is to get active, not only in the fund, but in the companies in which it invests. Embler sits on the boards of two companies in which Franklin Templeton collectively controls about 20% of the stock. In fact, Franklin Templeton funds tend to invest in the same companies, collectively controlling significant swaths. Most notably, the Mutual Beacon Fund joined Carl Ichan's battle with Time Warner, and together accomplished much of what he wanted, Embler said. "It's a matter of valuation," he said.
And that was the final message managers left: Investing in 2007 will require patience, but in the end, investors will appreciate long-term benefits. "If we think there's still value, we're not going to sell," Embler said.
(c) 2006 Money Management Executive and SourceMedia, Inc. All Rights Reserved.