Correction? How Three Pros Are Betting Now

By TOM PETRUNO

May 22, 1995 12 AM PT

Wall Street’s bears smell blood, but so far that scent is from a paper cut.

The surprise 81.96-point plunge in the Dow Jones industrials last Thursday gave way to a flat session Friday, with the Dow inching up 0.69 point to 4,341.33.

Though almost everyone agrees stocks are ripe for a 5% to 10% setback after their stunning six-month rally, whether that “correction” can come with so many people expecting it is questionable.

More important to most investors is that the bears’ efforts to declare the end of the 4 1/2-year-old bull market still seem premature.

Bail out of stocks en masse? Not logical, with corporate profits still growing, interest rates apparently under control and the economy finally slowed from 1994’s torrid pace, say many veteran investors.

But even within the context of that optimistic outlook, there’s no getting away from the fact that the market has had a good run. That is causing some portfolio managers to focus more intently on value in individual stocks--the idea being that if you stick with fairly valued or undervalued shares, you should ride any new rally while limiting your losses if there’s a correction.

Here, three money managers who have scored big in this year’s rally tell how they’re playing the market going forward:

* James Gipson, Clipper Fund: The old saying is that nobody rings a bell at bull market peaks, but Beverly Hills-based Gipson thought the bells were ringing pretty clearly in summer, 1987.

“We were heavy sellers of stock at that time, because the market was vastly overvalued compared with bonds, and many stocks were rising above our estimates of their intrinsic value,” Gipson recalls.

His prescience was rewarded: By bailing out of many issues before the October, 1987, crash, his fund ended that year with a 3.4% gain.

Today, Gipson’s $325-million fund remains 90% invested in stocks, and the former Navy officer says he’s content to hold tight to his positions for a simple reason: He still finds them to be compelling values relative to their earnings power and to interest rates.

“I think the situation today is in sharp contrast to 1987,” he says.

Yet Gipson hasn’t made a broad-based bet on the market. His portfolio, up 20.5% so far this year, is concentrated in about 25 stocks, mostly classic consumer growth companies and financial firms.

Why those stocks? Gipson likes to pay low prices for healthy long-term earnings growth or valuable franchises--or both. With his average stock selling for about 13 times estimated 1995 earnings per share, and most of the companies leaders in their fields, Gipson doesn’t believe the stocks reflect the companies’ true value.

His biggest positions include mortgage giants Federal National Mortgage Assn. and Federal Home Loan Mortgage Corp., consumer companies Pepsico, Johnson & Johnson and Philip Morris, and brokerages Morgan Stanley, Bear Stearns and Paine Webber.

The brokerages may best reflect the 52-year-old Gipson’s value orientation. Yes, there will inevitably be another bear market some day, he says. But the stocks’ current prices appear to pay too much attention to market cycles and not enough to franchise value. He says, “They’re still cheap relative to what a rational private buyer would pay for those franchises.”

* Dan Leonard, Invesco Strategic Technology Fund: Technology stocks have led this year’s market surge, but that’s really nothing new. The industry has been red-hot for the past five years as spending on computers and related equipment by corporations and individuals has rocketed.

That has given tech-fund managers like Leonard a powerful tailwind--but also increased the risk of trouble, as speculative fever in the tech sector has surged.

With his Denver-based fund up 15.9% this year--and 431% over the past 10 years (versus 285% for the blue-chip Standard & Poor’s 500-stock index)--Leonard admits he’s growing more cautious.

He’s keeping about 20% of the $454-million portfolio in cash--a cushion that he admits will hurt him if tech stocks keep soaring.

He has sold semiconductor high-fliers Intel and Texas Instruments, while holding niche players like Cypress Semiconductor and Integrated Device Technology.

And he’s focusing more on bigger tech names--like IBM and Honeywell--that he thinks would hold up better if profit-taking hits.

Leonard, 55, still finds good value in some of the tech-service firms. GM’s Electronic Data Systems unit, for example, “is putting on new [corporate computer-servicing] contracts at a tremendous rate, and I don’t think that’s going to change regardless of what the economy does,” he says.

Likewise, he’s bullish on credit-card processing firm First Data Corp. And in the telecommunications area, he’s comfortable holding equipment makers General Instrument and Scientific Atlanta.

As for the market-leading semiconductor makers that he has walked away from as the stocks have zoomed this year, Leonard concedes it wouldn’t take much more than a 10% pullback in those stocks to make him a buyer again.

“I think the strong demand for chips is going to take us through the end of the century,” he says.

* Steven Check, Check Capital Management: In the late 1980s and early 1990s, Check was big booster of consumer growth stocks. But when they fell out of favor in 1992, the Costa Mesa money manager began to take a closer look at some of the old-line industrial firms he had previously ignored.

The more he looked, the more he liked what he saw--specifically, robust earnings growth that seemed to have staying power, despite the historically cyclical nature of many industrial markets.

As a result, Check’s “Quality Growth” portfolio, his 8 1/2-year-old model for the $50 million in private client funds he manages, is filled today with industrial names like PPG Industries, Textron, Parker-Hannifin and Superior Industries.

The portfolio has jumped 19% so far this year, he says.

For Check, 33, an electrical engineer who found his analytical skills could also be applied to investing, the bias toward industrial stocks today is a function of their low price-to-earnings ratios versus estimated earnings growth.

Despite the economy’s slowdown, Check says, Wall Street still expects 15% to 20% earnings gains at many industrial firms this year. Yet the stocks are in many cases selling for less than 13 times their most recent 12-month earnings.

Though he says he’s mindful that Wall Street could be expecting too much, Check notes that analysts have by and large underestimated earnings over the past two years. For now, he’s betting that the stocks have plenty of catching up to do in an economy that appears poised for a soft landing.

“These stocks corrected last year, but their earnings didn’t,” Check says. And with interest rates having slumped this year, he argues that “stocks are a better value now than they were at the beginning of the year.”

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James Gipson

Clipper Fund, Beverly Hills

Assets: $325 million

Major holdings: Federal National Mortgage Assn.; Federal Home Loan Mortgage Corp.; Morgan Stanley; Pepsico; Philip Morris

1994 performance: -2.5%

1995 performance: +20.5%

10-year performance thru March: +264%

Dan Leonard

Invesco Strategic Technology Fund, Denver

Assets: $454 million

Major holdings: IBM; Digital Equipment; General Instrument; GM EDS; First Data