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What's Hot -- and What's Not

Steven Goldberg

The managers of the top-performing Julius Baer International Equity funds are bullish on the dollar and Eastern Europe and bearish on commodities and U.S. stocks.



You don't top your peers every year for the past dozen years by adhering to conventional thinking. That, at least, is the reasoning of Rudolph-Riad Younes, co-manager of the remarkable Julius Baer International Equity A fund (symbol BJBIX).

Younes (pronounced YOU-ness) has more original ideas -- and they're ideas that run counter to the consensus -- than any other manager I can name. What's equally interesting is the fund's profound conservatism. No matter how strong their conviction, the managers rarely put more than 2% of the fund's assets into a single stock. Nor do they make big currency or sector bets. Instead, they make a lot of small wagers -- they typically own 500 to 600 stocks-most of which have paid off.

Their ideas are intriguing. Start with commodities. Do you think that commodity prices have risen largely because of sizzling economic growth in developing markets, such as China and India? Not so, says Younes, who contends that commodities rise when interest rates are lower than nominal growth in global domestic product -- in other words, when monetary policy is too easy. That encourages companies and individuals to buy and build too much, pushing up demand for commodities. "We've studied the numbers from 1970 through 2006," he says. "The correlation is too good to be true."

With global GDP growth in decline, and interest rates rising, particularly in emerging markets, Younes concludes that the bull market in commodities is complete, or nearly so. He predicts a 30% to 35% tumble in commodity prices -- which would imply a $70- to $80-a-barrel price for oil (compared with $108 on September 2). Consequently, Younes and co-manager Richard Pell now have about 3 percentage points less in commodities than the most popular foreign-stock index -- after holding plus-size stakes in commodities for years. Why such a small wager against commodities? "Nobody's perfect," Younes says.

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Younes is bearish on the U.S. stock market over the next three to five years. He doubts it will move more than 20% in either direction. His reasoning: Profit margins of U.S. companies are unusually large -- a product, Younes says, of accounting gimmicks and too much borrowing. He thinks margins will revert to their long-term mean. In another small bet, Julius Baer International Equity A is 9% to 10% in cash; typically, less than 5% of the fund is in cash.

That fund is closed to new investors, but Julius Baer International Equity II A (JETAX) is open. The only difference between the two funds is that Equity II doesn't own some of the small stocks that the closed fund does. Equity II is a member of the Kiplinger 25.

The long-term record of Equity A (to which I'll refer in the remainder of this column) is superb. While it has lost 19% this year through August 29, trailing the MSCI EAFE index of non-U.S. stocks by two percentage points, it has gained an annualized 13% over the past ten years, putting it in the top 2% among foreign large-company blend funds -- that is, overseas funds that pursue both growth and value stocks. Add the eye-popping consistency, and you have a winner.

As for the dollar? Younes is bullish. The greenback has gotten too cheap against other major currencies on a purchasing-power basis. Plus, falling commodity prices will reduce the U.S. trade deficit. Longer term, Younes warns that the dollar could be in trouble unless the U.S. gets its trade and budget deficits under control. The fund has hedged 5% to 10% of its assets back into the dollar.

But Younes remains bearish on U.S. stocks compared with European shares. "The U.S. economy needs to go through a period of deleveraging, reduced spending and increased saving -- hardly a recipe for growth," he says. On top of that, he argues that U.S. stocks are 30% pricier than European stocks, based on such measures as price-earnings ratios and dividend yields.

Younes is also bearish on emerging markets, including their currencies. The commodity exporters will be hurt by tumbling prices. Meanwhile, countries that heavily export manufactured goods, such as China, and those that are big players in services, such as India, will suffer as tighter monetary policy and slower growth take hold in the developed world. Emerging markets are also beset by inflation, and interest rates will have to rise.

The exception: Eastern Europe. Younes has long been bullish on these countries' economies. He sees the integration of their economies with Western Europe triggering a sustained surge in economic growth.

The fund has about the same proportion of assets invested in financial stocks as the MSCI EAFE index-26%. But Younes says, "We've tried to avoid the Anglo-Saxon banks." As in the U.S., many of these banks are undercapitalized and overleveraged. Healthy banks in other countries are bargains, he argues.

Other than Eastern Europe, Younes finds this a difficult market. "Even the hiding spots aren't working," he says. "The correction is more and more global." Indeed, this is the first year in some time that foreign stocks are lagging U.S. stocks.

To end the credit crunch, Younes says, the U.S. government needs to take over Fannie Mae and Freddie Mac, the huge and troubled mortgage giants. "Nationalization will signal the start of the recovery." In keeping with his contrarian approach, Younes is rooting for the stocks of the two lenders to go to zero. "When Fannie and Freddie rally, it's a negative because it means the government can't force nationalization."

From all of this, you'd be right to conclude that Younes and Pell spend a lot of time thinking strategically about economies and markets. Younes says brainstorming sessions are frequent. But the two managers, along with a half-dozen analysts, also spend a lot of time picking stocks.

A successful investor, Younes says, must have "the discipline both to respect yourself and to respect the market." By that, he means a good investor needs to be willing to make investments that go against the herd but also needs to pay attention when the market turns against him. Thus, the philosophy of many small bets: "Some ideas work, some don't."

Younes was reared in war-ravaged Lebanon, which he believes makes him a better investor. "It helped me, growing up in a chaotic country. After all, the markets are nothing if not chaotic." Of that, there's no doubt.

Steven T. Goldberg (bio) is an investment adviser and freelance writer.




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