Some of the stars of Wall Street, such as Pimco bond fund king Bill Gross and hedge fund manager John Paulson, got it wrong recently. Even the professionals admit that typical investing disciplines don’t fit this unprecedented era in the markets.
Getting it right depends on looking behind a veil of secrecy in China as investors try to figure out whether they can count on emerging markets to propel growth. And it means anticipating political actions that could help or harm the economy in Europe and the U.S.
This is new terrain for fund managers, who are typically evaluating businesses rather than political strategy sessions. And it comes at a time when risks are extraordinary. The U.S. economy is in a malaise, and investors are worried that a failure to solve Europe’s debt issues could infect the financial system and unleash a global recession.
With U.S. corporate leaders voicing caution as they announce recent earnings, I asked two Chicago-based fund managers how they are navigating this difficult environment. Both think politicians will rise to the occasion and that the U.S. will avoid another recession. But they admit their crystal balls are cloudy.
CHRIS SHIPLEY, manager of the Northern Trust Large Cap Fund: Shipley has used the convulsions in the stock market to add solid companies to his portfolio while cutting exposure to weaker ones.
“You need to be cautious how you position,” he said. “I do not expect an easy or quick resolution” to the threats in the economy.
Yet, despite that, he thinks investors have been overly nervous, selling stocks so aggressively that they have become overly cheap. Prices are attractive, he said, assuming that European bank problems do not lead to a credit crisis in Europe that infects U.S. banks and the global economy. He believes the chances of that are remote.
He has been selling weaker financial stocks and deploying money instead in those he considers the strongest: companies with good balance sheets, modest debt and consistent earnings.
Investors can look at how companies reacted in the 2007 and 2008 economic slowdown to identify those where earnings held up best, he said.
The stock market’s recent harshness on both weak and strong companies created an opportunity to add strong financial companies such as JPMorgan and technology companies at good prices, he said. He has not been eager to buy companies that make consumer staples. Necessities are considered a defensive move, one preferred by investors amid nervousness, and Shipley said they are relatively expensive now.
According to Morningstar, the most resilient companies in the third quarter were growth companies, especially those in consumer services and utilities, which declined less than 5 percent. Industrial, energy, and basic material stocks declined more than 16 percent, and financial services dropped 19.3 percent.
Besides financial companies, Shipley noted, energy and industrial companies and those that make basic materials have been hammered, but he has not been anxious to buy those stocks yet.
Those cyclical stocks do well in growing rather than slowing economies. He said it’s still too difficult to forecast how much China will slow. Some have argued that too much speculation there could end badly, and the government has been trying to tame inflation without slowing growth too much.
“My base case is that growth (in the U.S.) will be positive,” about 2 to 2.5 percent in the next 12 months.
u Buy: Technology and energy
u Avoid: Cyclicals and consumer staples
W. GEORGE GREIG, manager of the William Blair International Growth Fund: Greig searches the globe for stocks and prefers European companies, while cutting back on emerging markets, particularly China.
While he expects more angst about Europe and volatility in the markets, he thinks that eventually there will be a solution to the European debt crisis. Americans “have underestimated how pragmatic Europe will be,” he said.
China, on the other hand, shows “the classic signs of maturing following a boom,” Greig said, and he believes the excessive investment there is unsustainable.
“At some point that will become a concern” in the market, he said.
Investors have become leery of China because of questionable financial reporting and ongoing concerns about a real estate bubble. Because those concerns recently “reached a crescendo,” Greig said, investors may shop for bargains among China’s blue-chip stocks.
But he assumes a rally would be relatively short-lived. Though he would consider buying the stocks as a short-term trade, longer term he will remain “lightly exposed” to China because concerns about growth in the country are valid, he said.
He’s not expecting an abrupt change but “slowing in a stable way,” he said. Greig has been buying stocks in Asian countries that depend on China. But all will be vulnerable in the slowdown that is occurring throughout the world, he said.
While some managers tout the potential of millions of consumers in China, he’s been avoiding Chinese consumer stocks.
“They are way overvalued,” he said, because “everyone has wanted to be invest in them.”
Korea and Taiwan have been stable but are very dependent on technology, and, consequently, exports could be hampered by the global slowdown, said Greig. Brazil and India have struggled with inflation but are growing. He is slightly overweighting Brazil investments. South Africa, he said, is benefiting from being less in touch with the global economy.
If there is a big recession, which Greig is not expecting, he said commodity exporters, including Russia, Africa and the Middle East, will suffer. But the prices have already declined amid recession worries, so any future impact may be muted.
Greig is expecting a lot of uncertainty in the next year or two, so he is avoiding companies that are weak financially or growing slowly.
“I really don’t think the U.S. is going into recession,” he said, while noting Europe “is too close to call.”
He says the U.K. is a favorite area now because companies have strong returns, good cash flow and good value. In particular, he likes high-tech, global pharmaceutical companies and insurance. In Europe, he likes financial companies.
u Buy: European financial companies, U.K. multinationals and Chinese blue chips for a temporary trade
u Avoid: High-risk, low-growth, weak companies and emerging markets