Stock Picker’s Market
If the stock market’s struggle this year is foretelling the trend for a long time to come, that would be fine with Diane Jaffee.
In a “stock picker’s market,” she has been picking much better than many of her competitors.
The TCW Galileo Diversified Value fund, which Jaffee manages from New York, posted a total return of 8% in the first nine months. The TCW Galileo Dividend Focused fund, also run by Jaffee, was up 5.8% in the period.
By contrast, the blue-chip Standard & Poor’s 500 index eked out a total return (price change plus dividend income) of 1.5% in the nine months.
The average U.S. stock mutual fund had a tougher time than the S&P;, adding just 1.1% in the nine months, according to fund tracker Morningstar Inc.
After rising modestly in the first half, most major stock fund sectors declined in the third quarter. The average U.S. fund fell 2.8% in the three months -- the first loss since the first quarter of 2003.
Faced with soaring oil prices, slowing corporate earnings growth and the first Federal Reserve interest rate increases in four years, Wall Street has become a much more difficult place to make money this year than in 2003 -- when nearly all stocks zoomed after a three-year bear market.
Some investors are questioning whether this still deserves to be labeled a bull market, with popular indexes such as the Dow Jones industrial average in the red so far this year.
Jaffee says she doesn’t particularly care what people call this market phase. “It’s really about stock selection,” she said. Among the winners in her funds this year: trucking firm CNF Inc., which is up 38%; Boeing Co., up 22%; and paper producer MeadWestvaco Corp., up 7%.
Indeed, the modest changes in major market indexes in 2004 belie dramatic action under the surface -- a wide divergence in performance among stock sectors that has made it possible for some mutual funds to excel while others slump.
Among the key trends in the third quarter ended Sept. 30:
* Funds that focus on stocks of emerging-market economies rose 7.7% on average, according to Morningstar. Latin America-specific funds jumped 15.6%. The renewed interest in those markets suggested growing optimism about the global economy despite concerns about slower U.S. growth.
* Natural resources funds remained red-hot, rising 10.9% on average. Not surprisingly, many of the funds are heavily invested in energy stocks, which rocketed with oil. Rising prices for other raw materials, such as copper, also boosted mining stocks.
Precious-metals funds went along for the ride, rebounding from a plunge in the first half, when the price of gold pulled back after rising sharply in 2002 and 2003. The average precious-metals fund gained 14.7% in the quarter.
* A decline in long-term interest rates -- even as the Federal Reserve began to raise short-term rates -- helped buoy the real estate and utility stock sectors. The high cash dividends typically paid by companies in those sectors became more attractive relative to falling bond yields.
The average real estate fund jumped 7.9% in the quarter; the average utility fund rose 5.9%.
* On the downside, investors fled technology stocks, driving the average tech stock fund down 11.1% in the quarter. The sector had soared 56% last year and was flat in the first half of this year.
* Growth stocks in general fell out of favor in the third quarter. “Growth” is a catch-all term for stocks of companies that are expected to have above-average sales and earnings growth. Technology usually is considered a growth sector, as are industries such as healthcare and many other consumer services.
Investors shunned many of those sectors last quarter, in part reflecting worries about slower consumer spending.
Funds that focus on large-capitalization growth stocks lost 4.6% in the quarter and were down 2.3% in the nine months, on average.
Small-cap growth funds dropped 5.4% in the quarter and 1.5% in the nine months.
As growth stocks faded, many investors turned to “value” stocks -- shares of companies that tend to have slower growth prospects but also may be less expensive relative to underlying earnings. Many classic value stocks also pay hefty cash dividends.
The renewed focus on value played into the hands of fund managers like Jaffee, whose funds are part of Los Angeles-based TCW Group. Her stock-picking strategy is value-oriented and dividend-oriented -- a discipline she says she developed at the outset of her career as a Wall Street analyst in 1982.
That was the year the great bull market of the 1980s began. But it followed a decade of destruction among once highflying growth stocks.
“That gave me a very strong value orientation,” said the 44-year-old Jaffee.
After falling out of favor in the late 1990s, when tech stocks roared, value stocks have led the market since 2000 as investors have turned much more conservative and more fearful of losing money.
Jaffee said she judges a stock’s appeal based on a number of valuation yardsticks, including the share price relative to the cash flow the company is producing. Generous dividend payments are “the ultimate assessment” of cash flow, she said, because a company has to generate cash to pay dividends.
What’s more, if annual stock market gains overall are more likely to be in single digits than double digits in this decade -- a viewpoint that has many adherents on Wall Street -- annualized dividend yields of 2% to 4% will be a much more important element of total returns, Jaffee said.
Some analysts say the only problem with the value sector is that it has been heavily in favor for five years. Investors with a long-term time horizon should consider whether classic growth sectors might be a better buy now, said Russ Kinnel, director of fund analysis at Morningstar in Chicago.
“There aren’t a lot of these kinds of market cycles that go on for much longer than this,” Kinnel said of the value sector’s dominance since 2000.
Jaffee said the issue was less about an overriding endorsement of value versus growth than about finding attractive individual stocks. That’s often easier when the market, on the surface, appears dicey, she said.
“I think it’s more exciting for value investors when it isn’t a bull market,” she said.
Lance James, a Boston-based money manager who directs the Tamarack Enterprise Small Cap stock fund, which was up 6.8% in the first three quarters, agrees with Jaffee. “We actually prefer this kind of market,” he said.
James said he can buy both growth and value stocks for his fund. Although he tilts more toward value, he said, “I think the valuation differences between growth and value stocks are as low as we’ve ever seen.”
In other words, neither broad sector may have an edge in terms of appeal, James said. The challenge for fund managers is to identify the best individual prospects in either sector.
Two of his favorite picks are Movado Group Inc., a manufacturer and retailer of watches; and Carlisle Cos., which produces roofing and other construction materials.
The big risk to both growth and value managers, of course, is that a new -- and sweeping -- bear market could unfold. Pessimistic market pros say that could happen if interest rates rise more sharply next year than many investors anticipate, if corporate earnings slow more than expected, or some combination of the two.
Art Micheletti, investment strategist at money manager Bailard, Biehl & Kaiser in San Mateo, said he thought that 2004 might be more likely to be remembered as “the pause that refreshes” rather than as a prelude to a new bear market.
“I think the market is looking real cheap here,” Micheletti said. The average blue-chip stock sells for about 18 times estimated 2004 earnings per share. With the economy still growing and inflation low, that isn’t a high price to pay for equities, he said.
But Micheletti is emphasizing to clients that portfolio diversification is paramount now, he said -- in terms of large stocks and small stocks, growth and value, and U.S. and foreign.
And within individual sectors, the next few years may provide the most telling test of fund managers’ stock-picking abilities, analysts say: Investors may be about to find out which managers are worth their fees, and which might want to find another career.
