Large-Cap Growth Vehicles Favored
December 3, 2007
Doomsayers and recession forecasters aside, two recent studies that advocate investments in large-cap growth equities say U.S. economic problems will be largely confined to the housing sector and some parts of the financial arena.
Fred Alger and UMB Asset Management have just issued bullish reports suggesting that subprime damage will be limited to only a few economic sectors. Both firms recommended that investors concentrate on large-cap growth stocks for the equities portion of their portfolios.
The thesis of both documents is that growth stocks, especially large caps, will perform better in the difficult conditions ushered in due to the subprime mortgage crisis that started in the summer.
Alger doesn't think the subprime debacle will have as broad an effect on U.S. companies as many assume "While the fallout from the subprime market mess will be bad on both the consumer economy and the financial system, it will not trigger a systemic crisis either in the U.S. or globally," the report stated. Entitled "A Time for Growth (Even if it Doesn't Feel Like It)," the Alger take on the economy is more bullish than many fund managers.
Its authors, Fred Alger Chief Executive Officer Daniel C. Chung and Chief Economist Zachary Karabell, argue that U.S. equities in general and growth stocks in particular are poised to make impressive gains. They believe that growth stocks are underappreciated because of concerns about exposure to subprime mortgage problems. U.S. large-cap growth stocks offer investors the chance to take advantage of many of the economic headwinds that are associated with investments abroad, they argue.
Karabell did warn, however, that one of the pillars of growth stocks, the tech sector, may not perform well if the credit crisis leads to cutbacks in Wall Street IT spending.
And despite the shakeout in the residential real estate market, Alger expects that the worst effects of the credit crunch will be confined to the financial sector and the lower ends of the consumer market, in part because of the global environment of untapped pools of liquidity.
In fact, the Alger report tiptoes up to predicting a rescue by foreign wealth funds of U.S. banks.
"It is too soon to forecast foreign wealth funds bailing out U.S. banks, but they could certainly be a key source of funding for future deals."
In light of last week's news that the Abu Dhabi Investment Authority will invest $7.5 billion in Citigroup, offering the nation's largest bank a capital infusion to offset losses from mortgages and other investments, the Alger report was prescient at least in this regard.
The cash from the sovereign investment fund of the Gulf Arab state, which has profited handsomely from this year's hike in oil prices, will be convertible into no more than 4.9% of Citigroup's equity.
William Greiner, the chief investment officer at UMB Asset Management and the author of its report, concurred that there will be a lot of activity by foreign investors looking to buy U.S. assets.
"Our assets are lower in value because of the weakness of the dollar so there will be some shopping," he said.
The Alger report emphasized that U.S.-listed companies are benefiting from many of the same global trends as are their overseas competitors and yet their stocks remain unloved. Growth funds have seen outflows of capital this year. The report points out that with rising prices among nearly all asset classes, U.S. equities have been one of the few asset types that have lagged.
UMB Asset Management evaluated economic indicators and reached many of the same conclusions in their November report that Alger did. As in the Alger report, UMB's Greiner doesn't overlook the impact of the subprime crisis. "We believe the contagion of the subprime issue is deep. The fundamental economic problem which continues to unfold centers on the sustainability of consumer discretionary spending - and the weakness recently displayed in consumers' willingness and ability to spend money," he said.
The UMB report cites the cause of recent market turmoil as uncertainty in the financial markets growing out of the subprime mortgage crisis. It recommends a neutral weighting of equities with an emphasis on large-cap growth holdings.
Even in a scenario in which the markets correct, the UMB report said it doesn't expect the correction to be particularly severe because valuations underpinning most U.S. equities don't look stretched.
Greiner said that his organization began to shift its clients' money into growth stocks about 18 months ago. He noted that when the domestic economy is slowing, growth-oriented stocks tend to be beneficiaries.
"Normally speaking when rates are low and GDP is low, growth will do better than value," he said.
But, in all, Greiner expects the markets to follow earnings; and earnings growth, which was spotty in the third quarter, could resume growth in the last quarter. Aggregate third-quarter profit for companies in the S&P 500 was down 4.4% from the year earlier quarter. This was the first quarterly decline in more than five years, according to Thomson Financial.
Greiner does expect an overall weakness in consumer spending behavior, but predicts it will be partially offset by strength in capital spending. In addition, export growth rates should help offset a weaker-than-normal consumer picture.
One interesting question that money managers will face, according to Greiner, is when to get back into financials. While the subprime crisis has led many managers to sell off holdings in the sector, Greiner said that perhaps six months from now, conditions will have changed enough to make these stocks attractive.
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