Better Times for Investors -- Soon
Look for the stock market to act poorly a while longer as the subprime mess works its way into the rest of the economy. But the economy should begin to rebound in 12 to 18 months. Because stocks typically start to rally halfway through a recession, it's almost time to buy.
That's the view of Kathleen Gaffney, co-manager of Loomis Sayles Bond -- in my opinion, the best long-term taxable bond fund you can buy. The big-picture economic views of Gaffney and co-manager Dan Fuss are more often right than wrong -- and stock investors can profit from their analyses. As far as stocks go, I'd wager that Gaffney is right: We are getting close to the bottom.
The economy may well have dipped into a recession late last year. "We go through this kind of cycle every so often," Gaffney says. "Everyone gets very negative. But it won't last. The point of maximum fear is when you get the best bargains."
As Gaffney and Fuss slowly turn more aggressive, they're shifting assets from supersafe Treasuries to corporate bonds, especially those with the lowest investment-grade ratings -- that is, just above junk ratings.
What's more, they're investing in risky industries: homebuilders, automakers and financial companies. Among their purchases are bonds issued by Bank of America, Goldman Sachs and Merrill Lynch. "Financials are where we see real opportunity and bargains today," Gaffney says. She and Fuss are also buying telecom and media debt.
Dollar decline is over. Along with some other savvy market observers, Gaffney says she believes the long, steep decline in the dollar against the euro and the British pound is probably over. A stronger dollar would erode returns of U.S.-based investors' overseas holdings.
At the same time, Gaffney says, the downturn in the U.S. will be steeper than in Europe -- which would favor European stocks. If she's right on the dollar, though, the lengthy period during which European stocks have beaten U.S. shares may soon end.
With the Fed slashing rates and the U.S. economy looking like it's already in a recession, why bet on the dollar against the Euro? "Because," Gaffney says, "the Fed is open full throttle; the European Central Bank is still in LaLa Land. It needs to cut rates, too. I see rates converging, and the U.S. is already ahead of the pack."
Gaffney and Fuss remain bullish on emerging markets, especially their currencies. They have 5% of assets in Asia and 6% in Latin America. "The developing world is becoming the driver of the world economy," says Gaffney.
An economic slowdown in the U.S. will affect China, whose gross domestic product has been growing 11% annually. But even if China's growth rate is "cut in half, that's pretty good growth," says Gaffney.
For stock investors, the message is to add emerging-markets stocks and funds even as you consider trimming in developed markets. My favorite emerging markets fund is T. Rowe Price Emerging Markets Stock (symbol PRMSX), a member of the Kiplinger 25.
Although commodity prices may fall this year because of a decelerating global economy, the long-term trend remains up, says Gaffney. Consequently, Loomis Sayles has 12% of its assets in Canada and 5% in New Zealand and Australia, all commodity-rich nations. Gaffney and Fuss expect those countries' currencies to remain strong against the dollar.
Usually Loomis Sayles Bond (LSBRX) keeps 35% of its assets in high-yielding "junk" bonds. But in the past year or so, the fund, a Kiplinger 25 member, has held much less.
Lately, though, as junk yields have moved up to 10%, the managers have begun buying, and high-yield corporate bonds now represent 25% of the portfolio. Still, Gaffney says, junk yields will rise to roughly 13% before they start dropping. "It's a good time to start dipping your toes in the water, but I wouldn't be in a hurry," she says.
It's impossible to predict the length and breadth of the economic downturn. Its severity will depend, in large measure, on just how much subprime garbage is out there -- something no one knows yet. But Gaffney and Fuss have been good at market calls in the past, and I think they'll be right again.
Their views closely echo those of Bill Miller, whose Legg Mason Value (LMVTX) and Legg Mason Opportunity (LMOPX) have both had long dry spells. It may be time to buy Legg Mason Opportunity, a Kiplinger 25 member and the smaller and more nimble of the two funds.
Steven T. Goldberg (bio) is an investment adviser and freelance writer.