Finally Time for Some Mean Reversion?
Why US large-cap might be ready to shine.
BY Caroline Cakebread | February 25, 2011
(Bloomberg) Michel Moreno, the 42-year-old chief executive officer of the Moreno Group, an oil-services company, has been investing the cash he set aside during the financial crisis in the most well-known U.S. companies.
“If I’m going to have market exposure, I want to focus on the area I’m personally more comfortable with, which is large- cap stocks,” he said.
Investors like Moreno are buying shares of the biggest U.S. companies again as the market returns to levels not reached since 2008 and the municipal bond market has become more volatile. GenSpring Family Offices, whose average account size is about $30 million, has moved about $1.5 billion, or nearly 10 percent of clients’ assets, into stocks of large dividend-paying companies during the past three months.
“Wealthier folks are beginning to look at this as a market that they can be opportunistic buyers in,” said George Walper, Jr., president of Chicago-based Spectrem Group, a consulting firm that tracks attitudes among millionaires. “They’re still much more cautious than they were in 2005 and 2006, but it’s starting to turn around,” he said.
More than half of investors with $5 million to $25 million in investable assets said they will probably buy stocks in 2011, according to a Feb. 22 survey by Spectrem.
Investors put $5.2 billion into mutual funds that invest in the largest U.S. companies in January, the biggest monthly inflow since April 2009 and a reversal from the $13 billion in outflows in December, according to data from Morningstar Inc. In all of 2010, investors withdrew $77 billion from large company funds, said Morningstar, a Chicago-based research firm.
Overdue for Gains
Shares of U.S. companies such as Coca-Cola Co. and Johnson & Johnson are overdue for gains and represent the most attractive part of the market, according to Jeremy Grantham, chief investment strategist for Boston-based Grantham, Mayo, Van Otterloo & Co., which manages $107 billion on behalf of institutions. Johnson & Johnson returned 4.4 percent and Coca- Cola returned 17 percent in the six months through Feb. 23.
“These stocks are not just a little cheap, they are almost as cheap as they ever get, relative to the rest of the market,” said Grantham, who accurately predicted the 2009 market bottom.
The largest U.S. companies, as measured by the Standard & Poor’s 100 Index, returned 13 percent in 2010 compared with 27 percent returns for small U.S. stocks in the Russell 2000 Index. The S&P 100 had a price-earnings ratio of 14 compared with a ratio of 31 for the Russell 2000 on Feb. 23. Price-earnings ratios represent the price investors pay for each dollar in annual earnings-per-share. A low ratio may indicate a stock is undervalued.
One risk of investing in large dividend-paying companies is that they could continue to lag behind the stocks of smaller companies and highly leveraged companies, meaning ones with high debt levels, said GMO’s Grantham.
“We don’t expect these quality income equities will keep up with the broad market if we get a market that’s up 20 percent this year,” said Atlanta-based Rex Macey, chief investment officer for Wilmington Trust Corp., the Wilmington, Delaware- based bank that is merging with M&T Bank Corp. Leverage can improve certain performance measures such as return on equity because it allows companies to operate with less equity. Wilmington manages $27 billion on behalf of wealthy families.
Investors have been moving from money-market funds back into mutual funds. On Feb. 16 there was $2.8 trillion in money- market funds, down $83 billion from early December, according to the Investment Company Institute, a mutual fund trade group. Investors put $23 billion into stock mutual funds in January, the biggest monthly inflow since February 2007, Morningstar said.
Bel Air Investment Advisors, which manages Moreno’s investments, has increased clients’ stakes in stocks and other growth investments by 10 percent to 20 percent over the past several months, said Todd Morgan, senior managing director. Los Angeles-based Bel Air clients have $20 million or more in assets and its founders have a combined 57 years of experience with Goldman Sachs Group Inc.
Moreno, who lives in Houston, said he likes the safety and growth potential of companies such as United Parcel Service Inc. that have good balance sheets and predictable dividend streams.
Companies with low debt levels and significant sales in emerging markets, such as 3M Co., offer attractive prospects, said Gary Flam, a portfolio manager for Bel Air, which has $5 billion in assets under management. Shares of 3M returned 13 percent and UPS returned 14 percent over the past six months.
“The strong balance sheets, large cash balances, dividend payouts, multinational revenue streams and relatively cheaper valuations make these ‘blue-chip’ stocks attractive,” said Brent Fykes, senior investment partner for GenSpring, the largest U.S. registered investment adviser, based in Palm Beach Gardens, Florida.
Several clients have sold half of their bond portfolios over the last two months and invested the proceeds in large-cap dividend-paying U.S. stocks, said Larry Palmer, a managing director for Morgan Stanley Smith Barney Private Wealth Management. Palmer’s clients have an average account size of about $8 million and his team manages more than $1 billion.
“There’s a margin of safety they have, emotionally, in those high-quality blue-chip names,” said Palmer, who’s based in Los Angeles. “All the advisers here are having the same dialogue with their clients,” he said.
Income investors may prefer shares of companies such as Abbott Laboratories to government bonds, said Alan Zafran, co- founder of Los Angeles-based Luminous Capital. Abbott shares yield 3.8 percent compared with the 10-year Treasury yield of 3.5 percent. Luminous manages about $4 billion for about 250 families.
Shares of the largest companies typically lose less than other stocks in market downturns, according to Grantham. From the market peak of October 2007 through its low of March 2009 the S&P 100 lost 54 percent, compared with the Russell 2000 Index’s loss of 59 percent.
Municipal bonds may hold more appeal for contrarian investors than large-cap stocks, according to David Carter, chief investment officer of New York-based Lenox Advisors, which manages $1.5 billion. Investors withdrew $974 million from municipal bond funds in the week ended Feb. 16, the 14th- straight week of withdrawals, according to Lipper. January outflows for muni funds totaled $13 billion, according to Morningstar. The S&P 100 is up 4.3 percent since the beginning of 2011 compared with a 0.3 percent return for the Bank of America Merrill Lynch Municipal Master Index, which tracks investment-grade bonds.
‘Trading Like Junk’
“Munis are trading like junk bonds, but they’re not junk bonds,” said Lew Altfest, chief executive officer of New York- based Altfest Personal Wealth Management, with $700 million in assets under management. Altfest, who advises clients with assets of $1 million or more, has been purchasing individual munis such as revenue and general obligation bonds as mutual funds have had to “disgorge” their holdings to cope with outflows, he said.
Investors’ newfound enthusiasm for large-cap stocks could become worrisome if shares continue to gain momentum, said Jonathan Satovsky, founder of New York-based Satovsky Asset Management, which manages $380 million for about 200 families. “The fund flows are perpetually wrong,” he said.
The current market cycle likely has six or more months to run before investors need to become concerned about a reversal, Satovsky said.
“I should be going all in,” he said. “But I would rather lean into the wind.”