The Bear Market's Not Over Yet

Most of the best managers of the past 20 years focused on picking stocks one by one -- devoting only a small portion of their time to forecasting economic trends. But the ongoing bear market may be discrediting a pure bottom-up approach to managing stock funds.

Certainly, the managers who did the best job of dodging at least some of the current unpleasantness spent a fair amount of time reading the economic tea leaves, trying to predict where trouble would surface.

Count Ralph Shive, manager of 1st Source Monogram Income Equity (symbol FMIEX), among that group of "top-down" investors. A money manager for 33 years, Shive, 55, thinks globally from his base in South Bend, Ind. The slumping Wasatch fund family is taking over the 1st Source funds -- partly, Shive says, to benefit from the top-down views that he and his colleagues offer. "Wasatch thinks some macroeconomic thinking could help on the stock side." The fund's new name will be Wasatch-1st Source Income Equity.

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Shive started worrying about the credit crunch sooner than most: "It's turning out a lot worse than we thought. We're shaking the foundations of our economy."

The recent growth in the financial-services sector is a huge part of the problem. "Almost every company has a financial arm now. Harley Davidson has a financing arm. Financials are like technology was in 2000."

What's next for the market? Shive thinks it will stage a strong rally in the fourth quarter. But with the recession likely to be nasty, he thinks the market may fall below its October lows early next year: "As the global economy deals with the reality of this financial cesspool, there will be weaknesses in earnings. Housing prices won't turn until 2010, at best." Shive sees the eventual bottom by next year at the latest, as the market starts to anticipate an economic recovery.

Shive has 17% of his fund's assets in cash. Why not more, given his pessimism? "I'm supposed to be running a meat-and-potatoes fund," something that is meant to participate relatively closely in the market's moves.

Alas, this year that means his fund has participated in most of the market's moves downward. Year-to-date through October 20, the fund plunged 27%. But that's about six percentage points better than Standard & Poor's 500-stock index. It also puts his fund in the top 10% among its peers -- large-company value funds -- so far this year.

Shive's long-term record is superb. Over the past ten years, the fund ranks in the top 1% of its category. Its annualized return of 10% through September 30 beats the S&P 500 by an average of seven percentage points per year.

Shive says he spends half his time searching for good stocks. But he looks only in certain places. He wants companies that make needed products, are self-financing and generally don't depend on discretionary consumer spending. "The consumer may be in a period of retrenchment for some years," he says. "I think attitudes are going to change about what's important."

In recent years, he's owned few financial stocks. And he's bearish on the dollar. Even though the greenback has bounced back recently, Shive says the U.S. fiscal, household and trade deficits will hurt the dollar over the long term. The government's $700-billion rescue plan, he says, "just adds to the deficit."

Shive has 8% of his fund's assets in foreign stocks. He likes companies, both domestic and foreign, that sell in foreign markets -- particularly emerging markets. He describes emerging markets as "young and hungry, like we were in the 1800s."

Among sectors, he likes energy now that the prices have plunged, and he likes health care-something people don't scrimp on even in hard times.

Shive tends to buy large, dominant companies. His holdings include Johnson & Johnson (JNJ), Novartis (NVS), General Electric (GE) and Intel (INTC). Assuming, as he does, that the economy doesn't improve quickly, shares of these kinds of high-quality companies should do better than most. Shive's fund is probably a better bet yet. Its annual expenses, at 1.13%, are below average.

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