After success in emerging markets, attention turns to U.S. investments
Doug Rao, manager of theMarsico Flexible Capital fund, calls it a “go anywhere” fund. The fund invests in companies across the globe, across all market capitalizations and in a variety of capital structures. Rao says he simply invests “where we think the greatest opportunities for capital appreciation are.” And in 2010, that was emerging markets. The fund— which had about 30 percent of its holdings in emergingmarket stocks in early 2010— surged 36 percent in 2010, beating the S&P 500 by 21 percent and other large-cap growth funds by 20 percent, according toMorningstar. Where will he head in 2011? Rao says the fund is moving its investments away from emerging markets and back intoU.S. companies. WP: What market and economic themes did you base your investments on in 2010, and howdo you see those playing out in 2011?
The theme in 2010 was that the financial crisis in theWestern world was aWestern-world crisis. The emerging markets, while obviously impacted, simply slowed down. We positioned the fund for a pretty robust recovery in the emerging word. We thought theU.S. would do okay and recover, but we thought the recovery would be slow and muted in nature because of the de-leveraging of the consumer.
However, we were not in the double-dip crowd. If you look at the significant economic contraction that took place post-Lehman, it was a massive fearful response byU.S. consumers, who slashed spending in the area that was easiest to slash spending: durable goods, or big-ticket items. You need some level of confidence to want to acquire them. If you look at housing and automakers, half the jobs we lost were in those two industries. To
replicate that contraction in the economy would be nearly impossible.
That gets us into 2011. We’re feeling much more constructive on theU.S. recovery in 2011 because we are seeing confidence come back. We think the 90 percent of Americans who are and have been employed are going to open their wallets this year, and that will drive GDP in 2011. We’re seeing a fairly significant uptick in cars purchased, although housing is still in the doldrums. WP: What else makes you upbeat about domestic versus emerging-market stocks?
I try to go to China at least two times a year, and I was there six weeks ago. They have been consistently concerned about theU.S. not doing enough to stimulate the recovery and the possibility of a “ lost decade” similar to what happened in Japan.
I think we already had the lost decade in theU.S. The market today is in the same place it was in 1999. We think the S&P can earn close to $100 this year, which means earnings have doubled but the market’s flat.
Meanwhile, we are becoming more concerned about inflation in the emerging world. In part because of quantitative easing, there’s an increase of prices of commodities that puts inflationary pressure on emerging markets, which is compounded by their own loose monetary policy. We think India, China and Brazil will spend the year fighting inflation, which is not the best backdrop for equity investing. I should add that, secularly, we are bullish on emerging markets. We think it’s a wonderful environment forU.S. multinationals, and the number of households who are engaged in capitalism continues to rise every day.
Our portfolio has moved away from emerging markets and more toward economically sensitive stocks in theU.S. Emerging-market stocks have gone from 30 percent of our portfolio in late 2009 to 15 percent now. U.S. stocks have gone from 40 percent in early 2010 to 65 percent today, and cash and fixed income have come down.
I think theU.S. has been doing a good job at restructuring. You have to appreciate the irony— TARP is going to turn out to be a significant positive for theU.S., but neither the Republicans nor the Democrats want any credit for it. The difficult choice turned out to be a right one: They’re going to make money on most, if not all, the investments. WP: So what sectors in the U.S. are appealing to you? Your largest holding as of Nov. 30was U.S. Bancorp.
It appears the recovery in theU.S. is broadening in nature. We’ve been investing over the last six months more aggressively into theU.S. banking system. Everybody has been terrified of financial andWall Street reform legislation. We look at companies in that space and the consolidation that’s taken place, and we thinkU.S. financials are underowned and underloved.
We are also attracted to companies that can create efficiencies for corporate America, and industrials and technology are two sectors that dovetail nicely into that theme.
I’d say we’re avoiding consumer staples without very strong brand profiles. We’re also avoiding health care. We believeWashington will do something about the entitlement deficits, which will require cuts toMedicare andMedicaid. WP: You mentioned you have less fixed income in your portfolio now. Is that momentum of investment in fixed income shifting?
The balance sheets of businesses in theU.S. are extraordinary— they have more than $2 trillion in cash on their balance sheets. I’ll highlight Oracle, one of the stocks we own in another fund, to show you the value of being an owner [of the stock] versus buying the debt. Oracle bought Sun Microsystems, and they paid $5.5 billion for it. They think they can generate $2 billion in operating profit from it. That’s a 30 percent return even without revenue synergies. They issued debt at 3.85 percent to finance that. Who would you rather be— an owner of the equity or a lender of that debt?
People are very fearful of theU.S. market. Everyone is running away from TARP. People are skeptical of the recovery. Outflows from the equity market have been significant, and inflows to fixed income have been strong. We’re hard-pressed to see how you could get a real return on your investment in being too skewed to fixed income. WP: Howdo you decide when to sell an investment?
All of our funds here are driven by forced displacement. If there’s a better idea and we’ve run out of upside on an investment, if it’s hit a price target or the thesis isn’t working out, that’s when an idea gets sold. WP: What do you see as the primary risks to the market/economy in 2011?
If both Republicans and Democrats are going to try to find wins rather than compromise, particularly as it relates to the deficit, that would be a significant negative. It’s a real overhang for the consumer. They have no sense as to what their ultimate tax burden might look like. Some level of certainty is better than whatwe have today.