Stock picks from the expert roundtable
With economic uncertainty near an all-time high, we sought the advice of five of the smartest market watchers we know.
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(Fortune magazine) -- High anxiety unites most investors these days as the U.S. economy struggles, the global economic order shifts, and the emerging "new normal" feels distinctly strange. To get some calming perspective -- and specific advice -- we convened five top-ranked investing pros.
Susan Kempler is a portfolio manager for the giant TIAA -CREF organization, which invests nearly $400 billion of retirement plan assets. Ron Muhlenkamp, who runs his own fund firm, has been a student of investing for 40 years; this is his seventh recession. Barry Ritholtz is chief executive of Fusion IQ, an online quantitative research firm that is constantly screening thousands of stocks. Steve Romick manages the high-performing Crescent fund for First Pacific Advisors. And Jason Trennert, often ranked among Wall Street's top strategists, guides investing strategy at Strategas Research Partners, which advises institutional investors.
When the team sat down recently with Fortune's Geoff Colvin, a few themes emerged clearly: respect for large-cap quality names and disdain for gold mania, among others.
But calmness amid the turmoil? Turns out these denizens of the markets may be every bit as anxious as the rest of us -- they just handle it better. As Muhlenkamp observed, "Investors pay us for our stomachs, not our heads."
Edited excerpts from the discussion:
If I'm an investor, I can think of all kinds of reasons to be worried right now. One, I missed the big rally since March; it's too late for me now. Two, inflation is going to wipe out me and everybody in sight, and I don't know what to do about it. Three, U.S. consumers are traumatized, and the economy may not bounce back for years. So is there any reason not to despair?
MUHLENKAMP: I think "the rally since March" is the wrong phrase. That assumes that March prices had some fundamental meaning, and I think March prices were simply the culmination of forced selling by a lot of people, including hedge funds.
It's hard to get numbers on it, but in late '08 through March '09, there may have been $1 trillion of forced selling by people deleveraging and responding to redemptions.
So if you just throw that out and say that March was the anomaly, you ask, Where are we today? What are prices? Prices look fair today, which means the opportunities are as good as they normally are.
KEMPLER: I think there are a lot of reasons to be encouraged right now. If you look at what the Federal Reserve's been doing -- the Fed is our friend, and it's not going to do anything to tilt the economy in the wrong direction.
We've had several positive signs. Unemployment claims are getting lower week to week. Housing has stabilized. The stimulus is still out there. And President Obama just signed the Worker, Homeownership, and Business Assistance Act of 2009, which allows nearly all companies to use losses to offset profits going back five years instead of two. That's money in companies' pockets. And China is still growing at a decent clip.
We meet with companies all the time, and what we're seeing is that they are for the most part in really good shape. I mean they've been cost cutting, obviously, their way to profitability or as close to profitability as they can get. So if revenues come back, sure, some of those costs will have to come back for hiring people, but companies are a lot more profitable and in better shape than they were quite a while ago.
TRENNERT: To a greater extent than I've seen in my career, I have a different view of the cyclical outlook than I do of the secular one, which is to say that from a shorter-term perspective, I don't want to stand in front of a tsunami of stimulus that is about to befall us. Believe it or not, of the $787 billion in stimulus that we passed earlier this year, only 22% of it has actually been spent. So you have that to look forward to next year.
The Fed has also tripled the size of its balance sheet. Before Bear failed, it was about $800 billion -- 90% of it in Treasuries. Now the Fed's balance sheet is over $2 trillion, and it includes a dog's breakfast in collateral. So it's an unprecedented level of monetary stimulus. The phrase that we've been using, though, is that we're bullish until the bill comes due.
RITHOLTZ: First, it's pretty clear that the Great Recession ended in March, and now we've kind of been muddling along with a fairly typical recession. You still have deflation in most asset classes outside of equities. We're losing a quartermillion jobs a month. Anything that looks like a glimmer of green shoots, to borrow a phrase, pretty much has been juiced by government stimulus.
So the first cash for clunkers was the bailout of Wall Street. The second one was of the automakers. We're still doing it with housing. Wherever you look and see something that's relatively positive, there's some artificial stimulation going on. That makes us look at the data and say this isn't a healthy organic economy.
That said, sometimes the market and the economy go their separate ways. The example we're fond of using is that in the 1990s the Nikkei in Japan had four rallies greater than 50%, and it was still in a recession.
We've gone back and looked at what secular bear markets look like and what sort of rallies you get off the low, and we call this a cyclical bull market rally within a secular bear market. It is fairly typical: 55% over nine months. A little quicker than usual.
But if you look at 1933 or 1973, or even the bounces in '02, '03, by my recollection you tend to get about a 70% move over the course of 18 months, which is followed by the bill coming due -- the Fed actually withdrawing its accommodation. That tends to lead to anywhere from a 20% to 30% correction, and then you enter a trading range for a couple of years.
My favorite comparison is 1966 to 1982. Off the top of my head, the Dow went into '66 at 1000. Sixteen years later it comes out of '82 at 1000. But there were five major rallies and selloffs of 24% to 75% during that time. We're sort of in a similar period now, but times 10. In 1999 to 2000 the Dow is at 10,000. Here it is nine years later -- the Dow is at 10,000. I wouldn't be surprised if four or five years from now the Dow is at 10,000, but it's going to be a roller coaster to get there.
Well, now we've really gotten into it because what you guys have described is actually, it sounds to me, like a challenging environment for investors, particularly individual investors. I'll start with you, Ron. What do you recommend for this environment?
MUHLENKAMP: Well, the public has made a shift from spending to saving. The point is, Wall Street is a very good marketing organization. There's a whole lot of money that the public is no longer spending on houses and cars and Las Vegas, and Wall Street is going to get a piece of it, whether it's the brokers or the banks or the insurers. So we own a bunch of Bank of America (BAC, Fortune 500). We think that Merrill Lynch will prove to be an asset. Also, I recently bought AT&T (T, Fortune 500) for the first time probably ever.
MUHLENKAMP: It has a 10% free cash flow yield [share price divided by free cash flow per share], and 6% of that's in the dividend.
ROMICK: You'd better hope Verizon (VZ, Fortune 500) doesn't get the iPhone.
MUHLENKAMP: Well, you can also buy Verizon. Buy them both if you like. I bought Pfizer (PFE, Fortune 500): 10% free cash flow, 3.5% dividend yield -- which means that they're not blowing all that cash.
TRENNERT: I do agree with Ron about the importance of dividends. Believe it or not, since 1928, dividends have been 51% of the total return of stocks, a not insignificant portion. Dividends should be even more important in a period in which price/earnings multiples are contracting. So finding those companies that can pay back their shareholders in the form of dividends will be key.
Do you have any?
TRENNERT: Well, one that I like is L-3 Communications (LLL, Fortune 500). It's a defense contractor. Unfortunately the world is a more dangerous place, and L3 is cheap relative to its peers. It's trading at about 10 times earnings. It has a 1.8% dividend yield, and it's had a very good record of both increasing dividends and buying back shares.
KEMPLER: We look for stocks with improving fundamental trends, and one of our favorites in the portfolio is Novartis (NVS). Its dividend yield is 3.1% -- not as big as Pfizer's, but it's still pretty good.
It's growing revenue at twice the clip that the pharma group is. It's had 13 drugs approved by the FDA over the last three years, which should drive a significant portion of the estimated 10% top-line growth in the pharmaceutical division. And its revenues are going to accelerate.
It has also hired Jonathan Symonds to take over as CFO next year when the current CFO retires. He comes from AstraZeneca (AZN), where he was very good at cutting costs.
Novartis is actually a relatively bloated organization, and Symonds is going to get in there and cut costs. So you'll have revenues accelerating and costs coming down, and that should translate to good earnings-per-share growth.
Well, if Novartis is one of your favorites, I've got to ask you, What else do you like a lot?
KEMPLER: Halliburton (HAL, Fortune 500). It's been a controversial name because it has kind of a sketchy history. But we actually like the controversy because we think that kept it trading at a discount to a peer like Schlumberger. What we really like, though, is that the management team has been able to transform the business by developing new technology and expanding its product offerings.
Halliburton used to be very concentrated in North America, but recently it has been winning more business overseas. For example, it just got this amazing five-year contract from Saudi Aramco, which proves that it's doing the right things, and it's doing it all with superior returns on capital.
Speaking of Saudi Aramco, are any of you buying oil and gas companies now?
MUHLENKAMP: Energy Transfer Partners (ETP) owns a pipeline, so it benefits from the volume of gas used, not just the price.
ROMICK: We have a large position in Ensco (ESV), a contract driller that works in shallow and deep water. We believe the economics for offshore drillers will be better than for the land drillers. The company has a great balance sheet and a smart and very tax-sensitive management. It recently announced that it will be moving its domicile to the U.K., which could save it 10% to 15% on taxes.
RITHOLTZ: Right now we don't see the energy stocks nearly as aggressively as we did at the end of the 2001-02 recession -- the exception being coal stocks, which are doing really well. We have owned Arch Coal (ACI) for some time. We think it has plenty of room to go from here. In fact, the entire coal group has started to move despite analyst apathy. If Wall Street catches on to the story, that could be a further catalyst.
Let's look beyond energy completely, then. What else is coming up on your screen?
RITHOLTZ: You have to recognize our average holding period is six to 12 months, so whatever I say today, be aware that it may change. We use both fundamental and technical factors when we buy something. We typically are looking for names where earnings are doing pretty well. Not overloved by the Street yet. Very often pretty mediocre buy and sell ratings. Pretty middle-of-the-road. But stocks that are moving in the right direction -- the trend, the momentum, the money flow -- all are positive.
Some of the names that have come up lately have been pretty surprising. We have a position in Gannett News (GCI, Fortune 500) and a position in the New York Times (NYT).
RITHOLTZ: I understand why you would say that's crazy. Why would anyone want to own those names? But when you get that reaction -- pay attention, you're on to something.
MUHLENKAMP: If they don't call you crazy, you won't make any money, right?
RITHOLTZ : Right. Who in America doesn't know that the newspaper business is in deep trouble, that advertising has been very soft, that layoffs and restructurings are coming? Most of that is pretty well reflected in the stock price.
Look at Gannett the past couple of quarters. It's restructured, it's announced improving ad sales. The same with the New York Times. There's going to be a big shakeout in traditional media. I think you could say there will be a handful of survivors. I have to assume the New York Times and Gannett will be among them.
TRENNERT: I wanted to talk about gold, because I would imagine that many of your readers would be interested in it. I think we've all been taught that because it doesn't yield anything, and it costs money to store it, that it's always a bad investment.
And while that's normally true, I believe this may be one of those times when it actually does make sense to own gold. I wonder whether the crisis of confidence in fiat currencies as a result of profligate fiscal policies might make more investors see it as a store of value.
RITHOLTZ: Part of the issue is that the cult of gold has been around for hundreds of years. It's only in the past six or seven years that we've seen a nice run in gold. We own Gold Fields (GFI), a South African mining company. It's done pretty well for us. We're going to keep owning it. We have a $1,350-per-ounce short-term target price for gold we set about six months ago.
But when I start to hear predictions that it will reach $5,000 or $7,500 an ounce, that's when you say, You know, let's walk before we run. It's up 300% to 400%. If you're really looking for another 500% from here, that's a bit aggressive.
ROMICK: You can use gold as insurance against both inflation and a declining U.S. dollar, and there are ways to do it without buying coins or mining stocks. There are less traditional ways to add protection to your portfolio.
For example, you could put on a bull call spread: Sell the July 2011 call tied to the ETF for gold, the SPDR Gold Trust (GLD), with a $2,000 strike price, and at the same time buy a call with a $1,500 strike at the same maturity. You would capture as profit -- less the premium you pay for the calls -- the price movement of gold above $1,500 an ounce with a cap of $2,000. Unlike owning the metal outright, you'd have a small downside -- the price of the calls -- and you could make 19 times your money if gold were to reach $2,000 an ounce.
RITHOLTZ: We look at the ratio between gold and silver, and silver will tend to be dragged along, kicking and screaming, with gold. But lately it's been lagging. So if you want to play gold in a slightly safer way, there's an ETF for silver, the iShares Silver Trust (SLV). You could look at the historical relationship, and buy it when silver is cheap relative to gold.
Speaking of playing it safe, in what ways can investors be defensive next year?
TRENNERT: I think we've moved from an income-statement to a balance-sheet world -- access to and cost of credit is going to be one of the most significant determinants of which stocks outperform. That, plus having access to foreign markets, which are probably going to grow faster than the U.S., are likely to be the most significant competitive advantages for companies over the next decade.
The big quality companies that have very strong balance sheets, access to foreign markets, and recognizable brands should win. Brands are extremely important in the developing world because they convey quality -- they give people confidence. I think the "big uglies," as in U.S. multinationals, are good places to be defensive.
Give us some names.
TRENNERT: As a strategist, I don't recommend individual names, but we have created what we call our Bull Dog Index of companies that have very strong balance sheets as well as great sources of foreign revenue. Companies like Schlumberger (SLB), Coca-Cola (KO, Fortune 500), and Colgate-Palmolive (CL, Fortune 500) are on our list. These stocks are not going to blow anyone away, but they should allow you to sleep well at night.
MUHLENKAMP: You could also add IBM (IBM, Fortune 500) and Hewlett-Packard (HPQ, Fortune 500) to that list. Two-thirds of their business is outside the States. Cash flows are great, and they each sell at 13 times earnings. And they're U.S.-based, so I can trust the accounting.
KEMPLER: I'd like to throw out a couple of names that aren't seen as the typical global competitors, but that are household names, if you think about it a little differently: Discovery Communications (DISCA) and Scripps Networks (SNI). And I'll even include Time Warner (TWX, Fortune 500) [parent of Fortune's publisher].
These stocks are all global competitors, and they're going to benefit from the proliferation of channels internationally. Look at Discovery Networks. It's not a household name, but it has the Discovery Channel, the Learning Channel, Animal Planet. And it's got phenomenal programming -- shows like Meerkat Manor. A soap opera starring meerkats -- how great is that? And how easy is that to export? All you have to do is change the narration.
Scripps Networks has the Food Channel and Home & Garden Television. Time Warner has CNN and a lot of cable networks.
Before we wrap up, anyone want to say anything about bonds?
TRENNERT: The question I have is, Would you want to lend the U.S. government money at 3.4% for the next 10 years? And the answer to me is no. If you think rates are going to move up significantly from here, and I do, I would consider ProShares UltraShort 20+ Year Treasury (TBT). It's an ETF that goes in the opposite direction, by a factor of two, of long-term Treasuries. If long-term Treasury bond prices fall 1%, TBT's share price goes up 2%.
RITHOLTZ: The bonds that I would suggest, because they are kind of interesting and relatively new, are the Build America bonds. The federal government is essentially paying the interest for states that issue bonds to pay for infrastructure projects as part of the stimulus plan -- bridges, roads, thruways. You could put some money in a New Jersey Turnpike bond.
Reporter associates: Katie Benner and Beth Kowitt
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