How’s this for new-year optimism: Don’t count the housing market out
“Can you hear me now?” might be one of Jerome Dodson’s favorite questions. His fund, the Parnassus Small Cap fund, grew 37 percent in 2010, according toMorningstar, thanks in a big way to telecom stocks. Dodson bet that cellphone service providers would be eager to beef up networks to prevent dropped calls, dead zones and slow data— and he was right. The fund outpaced the S&P 500 by 22 percent and itsMorningstar category of small-blend funds by 11 percent, benefiting from both its telecom wins and investments in what Dodson calls “misunderstood, undervalued companies.” WP: Can you talk about your sector allocations going into 2010, and how those will shift in 2011?
One of the areas that did the best for us in 2010 was telecom. Do you have a cellphone? WP: Yes.
Do you have problems with dropped calls and connection problems? WP: Nearly every call I make frommy iPhone in New York City is dropped.
You are not alone! My thinking was that telecom stocks were pretty depressed. And yet, the networks will have to make investments to get rid of those dead zones, and they’re going to have to do something fairly soon. We’re anticipating that’s going to happen sometime in 2011, although as a cellphone user it probably won’t benefit you until 2012. Telecom companies Finisar, Ciena and Ceragon were the three that
did the best for us last year. WP: Do you plan to stay invested in telecoms in 2011, given their price appreciation last year?
Even though telecom ran up a lot in 2010, I’m holding on to those three stocks. I think they have more room to run and that people will be surprised by how much service providers have to invest to get their networks going. WP: I noticed that home builder Toll Brothers was among your 10 largest holdings in the fund as of Nov. 30. New-home sales are still tepid, and housing inventories are still high. Do you plan to continue investing in home builders in 2011?
Housing stocks haven’t done that well in 2010, but I think that by the end of the year, housing will be much improved. I’msticking with it, and it’s one of the sectors I’memphasizing for 2011.
I’mexpecting employment to pick up. The economy is growing again. What happens is businesses try to work current employees very hard and wait until the very last minute to hire new people. At some point, though, they have to hire more people, and I see that happening in 2011. When people start working, they can buy houses.
Housing inventory is why the stocks [of home builders] are so low. Investors think people will not be building new homes, but I think that some new homes will be constructed. Some of those foreclosed homes are in bad condition. A lot of people would rather buy a new home than worry about fixing up damaged goods. I think inventory will be greatly reduced by the end of 2011, employment will pick up and housing will pick up late in the year. But the market is a discounting mechanism, so we’re investing now.
If I do well next year, I think home builders will contribute to it.
WP: What’s your investment strategy for the fund? How do you pick stocks?
There are three essential elements. We look for undervalued companies. If current price is below 65 percent of its intrinsic value, it’s a candidate. Number two, we look for companies that have unique characteristics. Every company has competition— you can’t pick many monopolies. But there are companies that have a moat, or what we call “unique characteristics,” something that gives them a competitive edge. The third thing we do is look at companies we think are good corporate citizens. We look at workplaces, charitable contributions, whether the product has a positive impact. WP: There was a significant amount of monetary stimulus in 2010. Do you expect that to continue, and how does it affect your outlook?
I think the Federal Reserve will keep stimulus going until the rate of increase in employment picks up substantially. Right now, we’re creating maybe 100,000 jobs a month— that’s still not very much. I think you really need 250,000 or 300,000 — or preferably 400,000— new jobs a month before you bring down the unemployment rate. As long as job growth is low, they’ll keep quantitative easing going. But if they see a few months of 300,000 new jobs created each month, they would ease up [on stimulus] for fear of inflation. WP: Do you think the consensus about the economy for 2011 is too pessimistic or too optimistic, and how does this impact your strategy?
If you asked me six months ago, I would have said it was too pessimistic. Now everybody’s become more bullish, but I’mstill in the bullish category. The American economy is strong. We have entrepreneurs, an open society, a rule of law. It’s a great place to do business.
But while I’mstill very optimistic about the economy, I’mnot finding the undervalued stocks I did six months ago. WP: How do you deal with that?
I don’t move to cash. I’ve had huge inflows into the fund, but I’mnervous about letting the cash build up, because if the stock market runs and I’m sitting in cash, I underperform. That happened five years ago. I’mtrying to keep fully invested. One thing I do is add to current positions. The other thing I do is I have to relax somewhat the undervalued standards. I have 88 to 89 percent of the fund invested. [ The rest is in cash.] I would like to be up into the mid-90s, but it’s hard to do when you have so much coming in. WP: How much money came into the fund in 2010?
We started 2010 with $115 million. Now the fund is almost $450 million. Part of that is appreciation of stocks in the fund, and some is the $200 million-plus of fund inflows we had in 2010. WP: What do you see as the primary risks to the market and economy in 2011?
Oh boy. Here’s what I worry about the most. Number one is employment. If employment grows slowly, which to me means less than 100,000 new jobs a month, that hurtsmy homebuilder thesis. Even if interest rates and home prices are low, if you don’t have people working, they’re not going to buy homes. I don’t look at unemployment rates so much as I do the number of jobs created. Every month when those newjobs figures come out, those are the most important numbers.