How’s this for new-year op­ti­mism: Don’t count the hous­ing mar­ket out

The Washington Post Sunday - - BUSINESS -

2011 strat­egy

“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.

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