Bracing for a Worse Bear Market

Comstock Capital Value Fund's Charles Minter takes a top-down approach to investing -- and he's sure harder times are yet to come

The Comstock Capital Value/A (DRCVX ) isn't a typical mutual fund. Manager Charles Minter operates the portfolio much like a hedge fund -- he can own any kind of domestic or foreign security he thinks will prosper in a given economic and stock market environment. He also uses a variety of tactics to try to take advantage of bear markets for stocks, including selling shares short and owning put options.

Minter, who manages the portfolio with Martin Weiner, starts by analyzing the economy, the stock market, interest rates, and other macroeconomic data to get an idea of what might happen over the long term. Then the managers adjust their portfolio based on short-term and cyclical conditions.

Given their gloomy outlook for the U.S. economy and domestic equities, Minter and Weiner have been favoring Treasuries and shorting stocks, a strategy that has paid off in recent years. Comstock Capital Value returned 42.6% for the 12 months ended in March and an average annualized 26% for the three years ended in March. By comparison, the average domestic equity fund fell 23.7% for the one-year period and lost 31.1% annually over the last three years. Based on return and risk characteristics, Standard & Poor's gives the fund its highest ranking of 5 Stars.

Minter and Weiner also manage a similar fund, Comstock Strategy/A (CPFAX ). Both funds are members of the Gabelli family of funds. Richard Diennor of S&P's Fund Advisor recently spoke with Minter about Comstock Capital Value's strategy. Edited excerpts from their conversation follow:

Q: How do you run the fund?


We start from the top down, looking at economic forces, like inflation and deflation, and interest rates, and try to determine where to go.

Q: You've described it as being very similar to a hedge fund.


If we felt bullish, we'd be buying stocks, and if we're bearish, we sell stocks short and buy puts. If we were bullish, we'd also be buying calls and doing everything to benefit from a huge bull market.

A lot of hedge funds buy stocks long and sell stocks short. What we do, typically, is to try to determine whether to be bullish or bearish.

Q: Are there any limitations on what you can invest in?


We can buy anything we deem appropriate. We can do virtually anything in the fund. We can buy or sell short foreign securities. We can buy Treasury bonds. We can short futures on Treasury bonds.

Q: Do you own any stocks right now?


We're selling short quite a few common stocks. We're short Disney (DIS ). We're short a lot of technology stocks. We're still short Cisco Systems (CSCO ) -- we shorted it around $86. We're short IBM (IBM ), Intel (INTC ), KLA-Tencor (KLAC ), Linear Technology (LLTC ), and Broadcom (BRCM ).

Q: You think the bear market is far from over?


We suspect that we won't start a new bull market until we get to stock valuation levels that established major market bottoms, like in 1932, 1949, 1974, and 1982.

Q: What kind of multiples would get you interested in stocks?


At a minimum, we're not going to get even neutral on the market until it reaches normal valuations of about 15 times earnings. The Standard & Poor's 500 index is trading at around 30 times earnings right now. For 80 years, its price-to-earnings multiple has typically ranged from approximately 10 to 20 times earnings. It's 10 at the end of bear markets and 20 at the end of bull markets.

Q: What kind of returns do you see stocks delivering over the next 5 to 10 years?


I suspect they will be pretty low. They might even be negative. We think the S&P 500 is going to decline below 600, probably below 585.

We suspect it's going to go down fairly sharply, either this year or next. It could possibly decline slowly over a 5- or 10-year period. Then maybe it would reach an attractive level, and from that point, we think we could have a very nice environment for equities.

Q: Convention says the recession has ended. You disagree?


Most people think it ended in November, 2001. But it's hard for us to think the recession ended when we just continue to lose jobs. The only reason it looks like it might be over is the fact that individuals are continuing to buy homes and cars. But that's only because of incentives offered by the automobile companies and the fact that interest rates have come down. That has encouraged people to refinance home mortgages, and that has given them the wherewithal to buy.

We're not really laying a very strong foundation for an economic recovery when it's on the backs of consumers who are either going into debt through refinancing mortgages, or taking equity out of their homes, or whose net worth has been declining with the stock market. Typically, to have a good, sustained recovery you need investment and hiring by corporations.

Q: What's needed to spur corporate spending and investment?


You're probably going to need higher capacity utilization. No matter how low interest rates get, corporations aren't going to spend money on plants and equipment until they feel like there isn't a tremendous amount of overcapacity. There was so much investment during the [tech stock] bubble that their capacity has grown to levels that are so extreme -- it's going to take some time for them to start investing again.

Q: What are your thoughts on the bond market?


We have a fairly significant position in U.S. Treasury bonds. We haven't added to it in the Capital Value Fund, but we have added to it in the Comstock Strategy. We have about a 25% position in 30-year Treasury bonds in that fund and about a 16% position in 10-year Treasury bonds.

We have a positive outlook for certain bonds -- the highest-quality bonds, like government bonds. But we're not positive on junk bonds. We're not positive on municipal bonds because state and local governments are in big trouble.

Q: What's wrong with high-yield bonds?


They act more like common stock. In the difficult financial times that we expect, they default.

Q: If we were in a bull market, what would you do to boost Capital Value's returns?


We would sell all of our puts. We would cover all of our shorts. We would cover the shorts in the S&P 500 futures market and start looking for attractive areas to invest in. We'd be looking for companies with very little debt and good growth prospects -- and whose stocks had good valuations. We expect to find that in the technology arena after the bear market ends.

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