Investment Picks and Pans From 7 Portfolio Managers

TEAM on asset strategy, Hennessy on stocks, Oberweis on Growth, MTB on bonds, Hodges on small cap

As the year comes to a close, portfolio managers are positioning assets with a look to 2012—and considering the state of the global economy, they’ve got an upward climb ahead.

The following opinions from a selection of portfolio managers set out their economic views, market predictions and investment strategies, with a view to tradable ideas for other investors.

Here, then, are picks and pans for 2012 from portfolio managers James Dailey of the TEAM Asset Strategy Fund, Neil Hennessy and Brian Peery of Hennessy Funds,  Jim Oberweis and Ralf Scherschmidt of Oberweis Funds, Wilmer Stith of the MTB Intermediate-Term Bond Fund and Eric Marshall of the Hodges Small Cap Fund.

James Dailey, CIO and Portfolio Manager, TEAM Asset Strategy Fund (TEAMX)

James Dailey, CIO and Portfolio Manager, TEAM Asset Strategy FundMany investors appear to remain in denial about the burgeoning global recession, while the sovereign debt issues in Europe and widespread policy intervention by central banks create a very challenging backdrop for investors. We expect the Federal Reserve to launch QE3 and for it to take place for most of 2012. The European situation is likely to end with significant amounts of money printed once Germany decides what role it wants to take.

Significant quantitative easing by most major developed governments in the face of a global recession is our base case forecast, which creates a very challenging environment for investors. Declining economic growth in real terms will be fighting competitive currency devaluations under our base case scenario.

Where to Invest in 2012: Our highest conviction long idea for 2012, which we believe to be very overlooked, is gold and silver mining stocks. The stocks, as a group on average, are trading at a historical extreme discount relative to the metals. Mainstream earnings discount models at large Wall Street firms continue to use out-year forecasts for gold and silver that are well below current prices; they expect gold to be $1,400 or lower in many cases.

We continue to favor the currencies of various countries with strong fiscal standing relative to the United States, members of the eurozone, the U.K. and Japan. A good example of this is the Norwegian kroner, as Norway’s finances are very resilient.

We also continue to favor select large blue chip high quality stocks in the United States, where valuations remain cheap on both a relative and absolute basis. Many also provide an added benefit of paying a significant dividend yield, with many yielding significantly more than long-term Treasury bonds and even the yield on their own corporate debt.

Neil Hennessy (below), CIO and Portfolio Manager, and Brian Peery, Co-Portfolio Manager, Hennessy Funds (HFTFX)

Neil Hennessy, CIO, Hennessy FundsEmotions Are Driving the Market: Before Aug. 4, the Dow Jones industrial average did not have a single day when the index moved up or down more than 300 points. Since then, the Dow has experienced more than 12 of those days. What has fundamentally changed?  Nothing. Investors are reacting to the nonstop barrage of negative headlines.

U.S. Companies Are Doing Well: Corporate profits are at an all-time high. Companies are sitting on mountains of cash—over $2 trillion among the S&P 500 companies alone. While companies are reluctant to hire they are deploying capital in other ways: increasing dividends, buying back stock, building internal infrastructure and making acquisitions.

The Market Is Undervalued: Whether looking at price to earnings, price to sales, price to cash flow or price to book, the market is significantly undervalued versus its five- and 10-year historical averages, and the last five to 10 years haven’t been that great. The market will move on the fundamentals, it is just a matter of time. For those with the guts to jump in, we think today’s equity market presents a huge buying opportunity.

Lower End Consumer Spending: We continue to see opportunities in the lower end consumer discretionary and consumer staples sectors. Look for consumers to continue the trend of “selectively shopping,” which we define as looking for great values on premium brands.

Look for the Bare Necessities:  People are not going to stop using water or electricity or stop heating their homes, and chances are you’re never going to see your electric company have a 20% off sale.

Stock Picks: Wal-Mart (WMT): The company recently announced same-store sales that were up for the fiscal third quarter and it announced that revenues increased during the same period over 8%. Boeing (BA): The company has seven years of commercial plane backlog amounting to over 4,000 planes and its 787 is sold out through 2019. NiSource (NI): NiSource is an example of a stock within the Utilities sector that has very consistent operating income and a dividend yield that is nearly double that of a 10-year U.S. Treasury note.

Jim Oberweis (below), Portfolio Manager, Oberweis Emerging Growth Fund (OBEGX), and Ralf Scherschmidt, Portfolio Manager, Oberweis International Opportunities Fund (OBIOX)

Jim Oberweis, Portfolio Manager, Oberweis Emerging Growth FundWhen you look at the hard, cold data, it doesn’t look like we’re going into recession, but businesses that contain costs in this slow-growth environment will do well. We’re buyers of HMS (HMSY), a Medicaid audit recovery contractor.

Consensus for S&P 500 Earnings for 2012: Expectations are for earnings of $102, which puts the U.S. market at a very reasonable 11.7x 2012 EPS. These estimates do not look overly optimistic given companies earned at a rate of $101 in the third quarter.

We are optimistic about equity returns for 2012 given relatively strong corporate profits and reasonable valuations, although we believe markets are likely to remain volatile until European policy makers act more aggressively to stem the crisis.

Buying Opportunities: We are finding opportunities amongst globally exposed companies that have been marked down to very reasonable valuations due to overestimated exposure to Europe. In particular, we are finding such opportunities amongst select European cyclicals.

China and other emerging market countries, while slowing, are just at the beginning of an easing cycle, and will likely continue to be the engine of global growth. We like mining equipment providers supplying equipment to miners supporting growing resources demand in Asia.

The time to invest in smaller high-growth companies is when risk appetite is low and uncertainty is high. That time is now. The premium that one has to pay for high-growth stocks relative to more conservative low-dividend stocks is much higher than normal. We also like companies along the smartphone value chain that will continue to benefit from the rapid growth in that industry.

Wilmer Stith, Portfolio Manager, MTB Intermediate-Term Bond Fund

Wilmer Stith, Portfolio Manager, MTB Intermediate-Term Bond FundThe Federal Reserve’s commitment to keep short-term rates near 0% until June 2013 should continue to have an over-arching impact on the short to intermediate part of the yield curve, keeping yields low.

MBS a Good Opportunity. We continue to build our mortgage-backed securities (MBS) position in 15-year and 30-year conventional prime mortgages.  With interest rates expected to be range-bound over the next six months, a dampening in interest rate volatility should help the MBS sector. Also, the Fed has started to purchase roughly $25 billion monthly in MBS in its Operation Twist strategy. This, along with the fact that MBS origination is low, should also help mortgages. It is our expectation that if there is a QE3, it will be centered on even more purchases of MBS.  MBS is an opportunity to diversify away from U.S. Treasuries and corporate securities while adding a yield.

Corporate Exposure Counts. We are focused on adding corporate exposure in the 3- to 5-year part of the yield curve.  With the Fed on hold until June 2013, we view the 3- to 5-year portion of the corporate yield curve as offering the most value during these uncertain times, especially as the 10-year U.S. Treasury is yielding roughly 2%.

We also anticipate that the corporate sector will offer investors relative value in 2012 as global investors scramble to find yield. Balance sheet restoration is well underway and stable credit profiles are expected to continue. We especially favor the industrial sector of the corporate bond market, as the economy is expected to plug along and exports have continued to move higher.

We have created a core allocation in the fund in names like Google, Microsoft and Conoco Phillips. We also like companies at the lower end of the investment grade spectrum that have executed a global strategy well, have pricing power and a clean balance sheet and liquidity—YUM, Kraft, DTV—and companies that have high levels of brand equity globally demonstrated over multiple economic cycles—Hanes Brands, Harley Davidson and McCormick Spice. We continue to be overweight healthcare REITS—with names including HCP, HCN and BioMed Healthcare—which have continued to be one of the fastest expanding sectors in the U.S. economy.

Eric Marshall, Co-Portfolio Manager, Hodges Small Cap Fund

Eric Marshall, Co-Portfolio Manager, Hodges Small Cap FundBusinesses have intrinsic values that are not always adequately reflected in the daily swings in stock prices. Although there are plenty of legitimate headwinds to the economy and visibility is lacking in many areas, we believe the trends in corporate earnings remain intact and should provide a favorable backdrop for many stocks in our portfolios as we enter 2012. 

Our view is that domestic equity markets are considerably undervalued compared to the risk-adjusted returns on most other asset classes such as real estate, commodities or bonds.

After four years of net redemptions in domestic equity funds, skepticism among the investing public remains historically high. This is a bullish indicator for stocks for the next 12 to 18 months.

Valuations Are Attractive. The S&P 500 now trading around 12X forward earnings. The inverse of this multiple is an earnings yield of more than 8% compared to the 10-year Treasury yield that is just above 2%.

Some small cap stocks we favor are: Hibbett Sports (HIBB), Alamo Group (ALG) and Kodiak Oil & Gas (KOG)

Read Mike Patton’s blog post Which Are Better: Funds That Stick to Style, or Those That Wander? at AdvisorOne.com.

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