Neil Hennessy, chairman and CIO of Hennessy Funds, which has $995 million in total AUM through 10 mutual funds, sees the economy and markets as being more than half-full, and expects the Dow Industrials to post 8% to 12% gains this year. As was the case in 2001-2002, Hennessy said in an interview with AdvisorOne on Wednesday, he expects that as the economy “comes back, companies will be more profitable.”
Carefully pointing out that he is “not an economist; not an analyst, but I am an economic realist,” Hennessy (left) drew a line between what many investors and market observers perceive to be true, and what is actually the case.
For instance, he said everyone perceives we have a serious unemployment problem, but even with 9% unemployment, “we have 91% of people employed: that’s not so bad.” Everyone perceives that companies are laying off many workers; that’s untrue as well, he says. Another area where he believes the common wisdom is wrong is on the trajectory of the markets. “No one believes this bull market will last,” he said, “but it will.” Furthermore, “there will be no double dip,” he says forcefully.
American companies are hoarding cash still, he admits, but that’s because of continued uncertainty over the final shape of the tax system in the U.S.—pointing out that even the extension of the Bush-era tax cuts only lasts through 2012—and continued frustration with the high level of regulation that nearly every industry faces from Washington regulators. A third major issue is the cost of healthcare, an issue that “Obamacare” just exacerbates for businesses, he argues. “Companies need clarity” on those issues to move forward.
Even if those three big issues were addressed, Hennessy says that the four main options that companies have to use their cash—paying or raising dividends, stock buybacks, investing in infrastructure and making acquisitions—wouldn’t materially affect the unemployment rate.
What would help businesses move forward, he suggests, would be for the Federal government to slash its payroll, and for politicians to “sooner or later do the right thing” and address the federal deficit. Taxes aren’t the answer, he says, but instead believes that tweaking the tax code and Social Security and healthcare—through moves like tort reform, for instance—would be a good place to start. “It’s not the deficit that bothers me,” he said,
“but the debt” of the United States, which he noted now stands at $13 trillion and is projected to rise to $14.2 trillion next year. What “concerns me most,” he says, is that in Washington, politicians use terms like “ ‘invest’ instead of ‘spend,’ and ‘fees’ instead of ‘taxes’ ” when they pontificate over critical issues like the debt.
With 40% of Hennessy Funds’ business coming through intermediary channels, and with his own background as a broker at PaineWebber 30 years ago who recommended stocks to clients, Hennessy knows advisors and appreciates the tough position they are in with clients. Pulling a page from his own stock selection process, particularly with his Hennessy Focus 30 Fund (HFTFX), he says that the “hardest part of an advisor’s business is getting referrals.” You get them, he says, when you have a “consistent, simple business plan that clients can explain to their friends.”
Referring to the Focus 30 Fund, which had $158 million in AUM as of year-end 2010, Hennessy says that the stock-picking process for the mid-cap value fund is “transparent, and we keep it simple. The more moving parts, the more that can go wrong.” Among the key hurdles for a stock to overcome in the HFTFX investing process is having a price to sales (PS) ratio of at least 1.5 to 1, something Hennessy says he’s been “doing for 30 years.” Instead of using the more common price/earnings (PE) ratio, he likes to look at sales because it’s a “truer number than earnings, which can be more easily manipulated.”
Right now, the biggest sector in his Focus 30 portfolio is consumer discretionary stocks. “Consumers have switched their habits,” he argues, “and they won’t go back to their old ways overnight.” Like companies, “everybody’s hoarding their cash,” but when they do spend, consumers are more likely to use discount retailers, for example, or even to do it themselves, whether it’s in the form of knitting a sweater rather than buying one—which would benefit a mid-cap value company in the Focus 30 portfolio like Jo-Ann Stores (JAS)—or doing your own landscaping and gardening work rather than hiring a gardener, which would benefit another company he favors, Tractor Supply Co. (TSCO).