Too Far, Too Fast?
"I definitely think the market has come too far too fast." So says Richard Steinberg, portfolio manager of the Reserve Large-Cap Growth Fund (RLVAX ). He adds: "I wouldn't be surprised if we were flat to down at the end of the year" on the Dow Jones industrial average, because of high valuations and the degree of speculation in the market. Steinberg also notes that the move by portfolio managers into some of the Dow's cyclical stocks may have skewed the average ahead of the underlying fundamentals for the year to come. However, he thinks large-cap stocks offer the most value as the economy turns.
Among the stocks Steinberg likes now are Clear Channel Communications (CCU ), Viacom (VIA ), TJX(the retailer owning TJ Maxx, among other things), and Hewlett-Packard (HPQ ). He says he looks for highly liquid companies that hold first or second place in their markets.
These were some of the points Steinberg made in an investing chat presented Sept. 25 by BusinessWeek Online on America Online, in response to questions from the audience and from of BW Online's Jack Dierdorff and Karyn McCormack. Edited excerpts follow. A full transcript is available on AOL at keyword: BW Talk.
Q: Rich, bad news on durable-goods orders and oil is spooking the market. Do you expect the rally to resume? A:
Q: Rich, bad news on durable-goods orders and oil is spooking the market. Do you expect the rally to resume?
A:I think that this has been an excuse to sell off the market. I think the market is due for a rest and will probably consolidate more.
Q: Why do you think the market was due for a pullback? High valuations? A:
Q: Why do you think the market was due for a pullback? High valuations?
A:Valuations are too high, and there's too much speculation going on.
Q: Where do you see the fourth quarter heading for the Dow Jones? A:
Q: Where do you see the fourth quarter heading for the Dow Jones?
A:I think the Dow is going to have some trouble in the short run. I wouldn't be surprised if we were flat to down at the end of the year. Unfortunately, the Dow has so much volatility because of the concentration of the 30 names, so I would focus more on the S&P than I would on the Dow. A move to heavy cyclical stocks that a lot of portfolio managers have made may have skewed the Dow's returns ahead of the underlying 2004 fundamentals.
Q: What has your strategy been for the Reserve Large-Cap Growth Fund in recent weeks? A:
Q: What has your strategy been for the Reserve Large-Cap Growth Fund in recent weeks?
A:We have been concentrating on watching our reward targets, and we tend, as a stock becomes too large for the portfolio, to take profits on stocks that are reaching rewards and searching for opportunities that [offer] growth at a reasonable price.
Q: You referred to stocks becoming "too large for the portfolio." Do you have a market-cap maximum? A:
Q: You referred to stocks becoming "too large for the portfolio." Do you have a market-cap maximum?
A:When I refer to stocks being too large, it's not a market-cap issue. We have a minimum $2 billion market-cap restraint. It's more percentage of the portfolio. When we get to a full position, it's around 3% (we have 30 names). If a stock becomes around 5% to 6% of the portfolio, we tend to manage greed and take money off the table, and reallocate it to stocks that have more upside.
Q: You mentioned "low beta" names -- can you tell us what you look for in that sense, and name some stocks that fit the bill? A:
Q: You mentioned "low beta" names -- can you tell us what you look for in that sense, and name some stocks that fit the bill?
A:What has happened is that growth managers have been chasing technology -- and, in some cases, where the fundamentals haven't really started yet. But they're looking to add beta, which is volatility. We prefer to look at some of the broadcasting stocks, like Clear Channel Communications (CCU ), Viacom (VIA ), and some of the drug stocks that are temporarily out of favor, which have a lower beta than some of the stocks that are really speculative.
Q: What's the stock that you are looking at most closely now? A:
Q: What's the stock that you are looking at most closely now?
A:Some recent purchases that we've made have been in retail, like TJ Maxx (TJX ), and we found some value recently in Hewlett-Packard (HPQ ). It's an unloved stock right now, with great value and a great franchise that is underowned currently in the market.
Q: What do you think of Bristol-Myers Squibb (BMY )? A:
Q: What do you think of Bristol-Myers Squibb (BMY )?
A:We don't own Bristol-Myers in the fund currently. We do own it at Steinberg Global Asset Management. We have a psychiatrist from the Harvard Medical School on our staff, and he believes that the psychiatric drugs that BMY has in its pipeline will do well for it in the next few years. It screens well on dividend yield, as well as multiple.
Q: Why do you think large caps would perform well? In relation to small and mid caps and their showings? A:
Q: Why do you think large caps would perform well? In relation to small and mid caps and their showings?
A:We think the large-cap arena offers the most value as the economy turns. Companies that have dominant market share...take market share in bad times and drive margins when times get better. That's why we're focusing on highly liquid companies that are either No. 1 or No. 2 market-share leaders. We think the high speculation that has occurred in small and midcap will circulate back into large cap.
Q: You mentioned you're trying to manage greed these days. Do you worry that the market came too far too fast? Do you think the market will fall further? A:
Q: You mentioned you're trying to manage greed these days. Do you worry that the market came too far too fast? Do you think the market will fall further?
A:I definitely think the market has come too far too fast, based on the $58.50 earnings for the S&P for the year. We would view a pullback as a very healthy shakeout for people who may have retrograde amnesia to the speculative bubble that has occurred in the past.
Q: What's your view on Pfizer (PFE )? A:
Q: What's your view on Pfizer (PFE )?
A:We love Pfizer in the long run. We own it in the fund, and although there may be some challenges with a competitor to Viagra, we think it will help grow the market in total, in which Pfizer will hold its own. We think there's 50% upside over the long run.
Q: How important are dividends in selecting a stock? A:
Q: How important are dividends in selecting a stock?
A:It can't be the only reason to own a stock, because you can get a 4% yield but lose 8% on the stock. As we screen them, however, we like to see a nice dividend and view this as a part of the total return. Wells Fargo (WFC ) yields over 2%, and this comes in when we figure our fair value and reward total for our stock.... The other component is looking at stocks that throw off large cash flow and have the ability to raise their dividend with that cash flow. McDonald's (MCD ) is a great example of that. We own it in the fund.
Q: Rich, what are the top holdings in your large-cap fund? A: Q: The fact that GE is a top fund holding partly answers this question: Do you like GE? Can you amplify? A:
Q: Rich, what are the top holdings in your large-cap fund?
A:Let me walk through the largest holdings in the fund: AOL Time Warner (AOL ), McDonald's, Schwab (SCH ), Microsoft (MSFT ), Berkshire Hathaway (BRK ), Home Depot (HD ), Tyco (TYC ), GE (GE ), and Alcoa (AA ). We've been running the fund for the last two or three years, so when people focus on what we've been doing, they should look at the last two years. The first year was kind of a turnaround year.
Q: The fact that GE is a top fund holding partly answers this question: Do you like GE? Can you amplify?
A:It's really a cornerstone of our six-sigma approach to investing in this fund. [New CEO Jeffrey Immelt] is now steering GE in the right area. They're now exiting businesses that they can't be No. 1 or 2 in, and investing in businesses that make strategic sense in the long run. Don't forget, as goes GE, so goes the economy. If the economy doesn't turn, GE will not turn.
Q: Does the dividend increase by McDonald's make it more attractive? A:
Q: Does the dividend increase by McDonald's make it more attractive?
A:The dividend increase does make it more attractive. However, the key is that they're turning their business around. The exciting part is that they're a two-sided story. They're redoing their menu with battered chicken fingers -- which my kids love - and the high-quality salads that they're now producing. This is bringing back customers who couldn't tolerate the food before. There's also a tremendous unearthed value to the real estate component of McDonald's.
Q: Do you think the weak dollar will help the multinationals? A:
Q: Do you think the weak dollar will help the multinationals?
A:I do think the weak dollar will continue to help them, as their goods are made more competitive. However, remember the euro was close to 1.17 earlier and came all the way down, then has rebounded back. Our view is that the Bush Administration really doesn't have a dollar policy -- it's somewhat haphazard.
You need to use the dollar as a component to the investment process. Poorly run multinationals will still not do well, regardless of the dollar's value. You still need to worry about management's ability to execute, and you need to see where their exposure is in various areas and make sure that the geopolitical and macroeconomic issues are conducive to companies doing business in those areas.
Q: Your thoughts on Big Oil? Energy? In the wake of the OPEC cutback news. A:
Q: Your thoughts on Big Oil? Energy? In the wake of the OPEC cutback news.
A:Big Oil and energy is definitely an area that we think is positive over the long run. Currently, the mutual fund is 8% energy, and that's in Exxon Mobil (XOM ) and ChevronTexaco (CVX ). We like the dividend yield components, as well as the fact that oil remains stubbornly above the $25 level, which allows these companies to be stubborn cash machines.
Crude is still over $28 a barrel as we speak, even though it pulled back from the low 30s. Furthermore, as the economy picks up, the demand for energy will pick up and oil will be a beneficiary. We view these as growth-at-a-reasonable-price type of stocks.
Q: What are your growth criteria? A:
Q: What are your growth criteria?
A:What we try to accomplish is finding stocks that are trading below their three- to five-year growth rate at multiples that are favorable to those growth rates, and where we either see a management catalyst, product catalyst, or macroeconomic catalyst that will reward us in the future with a higher multiple to that growth rate. McDonald's is an example of that -- great business, horrible execution. Execution is getting better, performance follows.
Q: Any favorite financials? A:
Q: Any favorite financials?
A:I think American International Group (AIG ) offers great value here -- we own it at the firm. It's probably our single best idea for the large-cap financials. We missed an opportunity with the hurricane to buy some of the reinsurers based in Bermuda, and have tattooed on our brain the need to look to buy into weakness when large storms come and investors panic.
Q: Will the JetBlue (JBLU ) stock price be affected by the recent scandal? A:
Q: Will the JetBlue (JBLU ) stock price be affected by the recent scandal?
A:JetBlue is a fantastically run airline -- I use it at least twice a month. The question will be how they manage their growing pains as they continue to get larger. The key question is, will they be able to maintain the same level of service and commitment to their clients as they roll out into bigger markets? We don't own it at the firm. If we did, we would probably be inclined to take some money off the table. The scandal is an issue -- I'm sure the attorneys will have a day with it -- but I don't believe it will be the demise of JetBlue.
Q: Do you like any of the chip stocks? A:
Q: Do you like any of the chip stocks?
A:We currently own Intel (INTC ) and Texas Instruments (TXN ) and think those stocks offer the best risk/reward in the chip sector for us. We think the chip equipment makers have more risk than these names.
Q: Finally, Rich, what would your advice be for investors at this stage of the market? A:
Q: Finally, Rich, what would your advice be for investors at this stage of the market?
A:In closing, I would say that clients need to focus on the names that they own and what valuations they want to apply to the stocks they own. This is definitely a period to manage greed, and if you've been lucky to catch the high-beta speculative tech stocks, remember it never hurts to get off the bus a little earlier than everybody else.
I think that time in the market remains a critical component to building wealth in the long run, but we must remember that we have to look at stocks as long-term investments and analyze the difference between a good company and a good stock.
Edited by Jack Dierdorff