Optimists Look to Growth Investing
After Recession, Next Boom Could be Promising
April 21, 2008
NEW YORK - While the majority of economists now believe the U.S. is in a recession, market optimists are already looking ahead to the rebound.
"Wall Street has been preparing for a hurricane, but we may just be headed for bad weather," said David Kelly, chief market strategist for JPMorgan Funds in a press briefing last week. "If we do have a recession, it still looks like it will be relatively short and mild."
On Wednesday, JPMorgan Chase & Co. cut its first-quarter net income by 50%, marking down $2.6 billion in leveraged lending and mortgages and expanding its credit-loss provision four-fold. Its posted net income of $2.37 billion was down from $4.79 billion last year. Revenue fell 11% to $16.89 billion.
While a 50% loss is nothing to cheer about, it was better than analysts had forecasted, and many traders were hopeful the news signaled that the worst is almost over. Indeed, Wall Street was delighted by the news Wednesday, with all the major markets posting gains of more than 2%.
On Thursday, Merrill Lynch & Co. posted its third consecutive quarterly loss, dropping $1.96 billion in the first quarter of the year. Merrill also announced it would cut 4,000 jobs in response to a large number of write-downs on risky mortgages, and CEO John Thain called the quarter "as difficult as I've seen in my 30 years on Wall Street."
Nonetheless, the stock defied gravity, rising 4.05%, or $1.82, in Thursday trading, closing at $46.71.
Others were not so convinced that financials are currently, or by the third or fourth quarters could be, a good play.
"Some of us feel like we're still waiting for the next shoe to drop," Joe Saluzzi, co-founder and co-head of equity trading at Themis Trading LLC and a frequent guest on CNBC, told MME.
JPMorgan Chairman and CEO Jamie Dimon cited market conditions and a challenging credit environment for the quarter's downward slide, and said weak economic development could continue to negatively impact credit losses, business losses and earnings "possibly through the remainder of the year, or longer."
But Dimon remained optimistic, adding, "We are prepared to manage through this down part of the economic cycle, given the strength of our liquidity, credit reserves, capital and operating margins, and to successfully position our company well for the future." He stressed that JPMorgan raised a net $4.2 billion of excess capital in 2007.
Nonetheless, Dimon again hedged that statement: "I always discount it when CEOs say they're toward the end of a crisis," he said. "They have to be careful with the words they use."
Financials were bracing for the news from JPMorgan, Merrill and from Intel, but investors "shouldn't get giddy" and think that the worst is over, Saluzzi said.
"The bottom crawlers come out every time there's a rally, and people who were lower could use this as an opportunity to sell," he said.
"Nobody really knows when it will end," he added. "There is a bottom, and we may not be there yet. I would like to see more proof, more numbers."
If the economy is headed for a rebound, growth funds could skyrocket, and portfolio managers are nearly en masse talking up beaten-down technology and financial stocks.
The year "2007, on a rolling five-year basis, eliminated the underperformance of growth stocks" to value stocks, said Christopher Jones, managing director and chief investment officer of U.S. Equity - Growth & Small Cap for JPMorgan. "Was 2007 an aberration, or a shift in market leadership?"
Five-year trailing returns for growth stocks in small-cap funds through Dec. 31, 2006, averaged just 39.80%, compared to the 104.39% rolling cumulative returns of value stocks between 2002 and 2006, but growth stocks erased this trend in 2007 when they posted average returns of 114.60% in small-cap funds, compared to 108.23% for value stocks over a five-year period ending Dec. 31, 2007, according to data from JPMorgan. Growth stocks also showed strong gains in mid- and large-cap funds from 2006 to 2007.
Standby: Seismic Shift
"There is a compression of multiples in the growth universe," Jones said, but how long this trend can continue is anyone's guess. "When shifts change, they tend to change very rapidly," he said. Most investors need to maintain a balance in their exposure to growth and value, and any reaction to market trends tends to be too late.
"Most investors lose 20% of returns by attempts at market timing," Jones said.
A strong sense of anxiety is hanging over the economy, and everyone is looking to the sectors that can lead the country out of a recession, he said. More than 25% of the assets large-cap value funds are invested in financials, while more than 25% of large-cap growth funds' money is in technology, Jones said.
"Market leadership in 2007 was driven by the shift in growth in profitability," Jones said.