Jim Barrow has experienced his share of bear markets. As the prime manager of Vanguard Windsor II for 22 years and Vanguard Selected Value for nine years, Barrow has produced an impressive long-term record searching for beaten-down stocks. The 67-year-old manager's funds have historically performed well in rocky times, so it's instructive to check in with him to see how he views the current market tumult.
This isn't to say that Barrow has escaped the carnage unblemished. Windsor II took a hit on Bear Stearns, which agreed to a buyout by JPMorgan Chase at $10 a share, a pittance of the stock's 52-week high of $160. Barrow sold the stock as the brokerage faced massive withdrawals from customers and the likelihood of bankruptcy before the Federal Reserve and JPMorgan engineered the rescue. "What we're going through right now is a credit correction," Barrow says. "If the banking system is not willing to make loans, it's going to affect all kinds of companies."
The economy faces two problems in his view. First, there's the banking system problem, which is known and being addressed. Second, there's a problem with consumer consumption. Except for the taxpayer rebates that are part of the economic stimulus package, not much has been done to deal with a slowdown in consumer spending. "If you see significant job loss, you are going to see even bigger problems with credit cards and with general level of mortgage activity," Barrow says.
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As a result, it will be difficult for U.S. companies to generate earnings growth until the fourth quarter, says Barrow. In this kind of environment, he prefers defensive companies, such as those in the tobacco business. He realizes that many investors avoid tobacco but says these companies are "very profitable businesses."
As of February 29, Carolina Group (symbol CG) and Reynolds American (RAI) were among the ten biggest holdings in Vanguard Selected Value (VASVX), which is a member of the Kiplinger 25 and invests mostly in stocks of midsize companies.
Altria (MO) and Imperial Tobacco (ITY) were the top holdings in Windsor II (VWNFX), which focuses on large companies. (A variety of management firms run both funds. Barrow, who is a founding partner of Barrow, Hanley, Mewhinney & Strauss, and colleague Mark Giambrone manage about 75% of Selected Value's assets; Barrow himself manages about 60% of Windsor II's assets.)
Defense contractors should fare well, too, says Barrow. "There will be a tendency for the government, if we get into a recession, to try to spend money any way it can, and defense is certainly a way it can do that," he says. His funds own General Dynamics (GD), L-3 Communications (LLL) and Northrop Grumman (NOC).
Utilities are a traditional safe haven. Barrow looks for utilities that have extensive power generation capabilities. He thinks such companies will benefit as they renegotiate higher rates for long-term contracts. His funds own Exelon (EXC) and Entergy (ETR), the two largest nuclear plant operators in the U.S., and Xcel Energy (XEL), a power company with operations stretching from Minnesota to Texas.
Not every beaten-down stock is a buy. Barrow is not interested in homebuilders, for example. "Their inventory is too big and it's understated," he says. "Homebuilders can do very well for a while and then fall into an abyss."
And he's skeptical that companies that make consumer products will be saved by strong sales in emerging markets as the U.S. economy slows. "The story has always been that the Chinese are going to buy these products," Barrow says. "But the middle class in China is not nearly as affluent as the middle class in the U.S."
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