Sticking with Large-Cap Stocks for 2011By
Jeremy Grantham, Bill Miller, and Donald Yacktman told mutual-fund investors that 2010 was the year to buy the biggest stocks. They're sticking with the prediction even after getting drubbed by most of their peers.
Stocks of small and midsize companies almost doubled the return of the Standard & Poor's 500-stock index in 2010. Large stocks rose 15 percent, compared with 27 percent for midcap stocks and 27 percent for small stocks, Bloomberg data show. Mutual funds that invest in large stocks returned 14 percent, vs. 23 percent for midcaps and 26 percent for small caps.
Big stocks lagged after Federal Reserve Chairman Ben Bernanke said in late August that the Fed would provide more stimulus. His comments triggered a rally in riskier assets, including smaller stocks. "Small stocks generally do better when you are coming out of a recession," says Michael A. Mullaney, portfolio manager at Fiduciary Trust in Boston, where he helps oversee $9.5 billion.
Still, Yacktman and the others are making the same case for the new year as they did for the last: Big companies—those with market values of roughly $10 billion or more—are undervalued compared with smaller stocks, and their earnings will benefit more from faster economic growth outside the U.S. "In 40 years, I have rarely seen a situation where so many big, profitable international companies are selling at such relatively cheap prices," says Yacktman, who manages his $2 billion Yacktman Focused Fund from Austin, Tex.
On the basis of profit, shares of larger companies are half as expensive as smaller stocks. The S&P 500, which is dominated by large companies, trades at 15.8 times reported income, while the small-cap Russell 2000's multiple is 34.4. Miller, chief investment officer of Legg Mason Capital Management, said in a July newsletter that investors have a "once-in-a-lifetime opportunity" to buy large-cap U.S. stocks at the cheapest prices in almost six decades. Known for beating the S&P 500 a record 15 straight years through 2005 at Legg Mason Capital Management Value Trust (LGVAX), Miller, 60, was behind the index for the next three years. Robert Hagstrom, another Legg Mason portfolio manager, reiterated the case for large stocks in a December report, saying they are attractively valued and have exposure to fast-growing emerging-market economies.
Yacktman, Miller, and Grantham did not fare well in 2010, even compared with other large-cap managers. Yacktman Focused trailed 79 percent of similar funds last year, according to Bloomberg data. Grantham's $14.9 billion GMO Quality Fund gained 5.5 percent, worse than 99 percent of its peers, even though top holding Oracle (ORCL) was up 28 percent. Two of the top five holdings in Yacktman Focused—Microsoft (MSFT) and Pfizer (PFE)—are among its worst performers.
The $4 billion Legg Mason Capital Management Value Trust, which has IBM and Amazon among its top 10 holdings, gained 6.7 percent last year, trailing 98 percent of similarly managed funds, Bloomberg data show. Miller's midcap fund, the $2 billion Legg Mason Capital Management Opportunity Trust (LGOAX), rose 17 percent.
In November, Grantham's firm, Boston-based Grantham, Mayo, Van Otterloo, predicted that the highest-quality stocks will return 5.1 percent a year, adjusted for inflation, over the next seven years, compared with an annual after-inflation loss of 0.8 percent for small stocks. Grantham, the company's chief investment officer, wrote in a newsletter that he believes "high-quality stocks should have an even bigger win over low quality than our GMO numbers suggest."
The bottom line: Three noted money managers are holding to their view that high-quality, large-cap stocks offer the best values in the market.