The Daily Interview: Banking on a Recovery
Because the financial services sector is typically one of the first to improve following an economic downturn, we decided to ask the portfolio manager of a leading financial services mutual fund for his opinion on the economy and how it will affect the companies he covers.
Burnham Financial Services
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Anton Schutz oversees (BURKX)Burnham Financial Services, the best-performing financial services mutual fund so far this year and over the trailing 12 months. His fund has returned 26.8% this year and 52.4% in all of 2000.
Schutz believes the economy will improve by the first or second quarter and that the markets should begin improving six months ahead of that, which would mean stocks could begin to rebound by the end of the year. In anticipation of this, Schutz has begun moving some of his holdings away from regional banks and thrifts, and into leading money center and brokerage stocks.
TSC: Financial companies are said to be one of the sectors that lead the economy out of a downturn. Given that this is your specialty, do you have any sense of when things might improve?
Schutz: It's very difficult to see earnings visibility. I think earnings are going to be awful for the broker dealers this quarter. The underwriting business couldn't be any worse. But I think we are getting closer to the bottom. As far as the timing of the recovery, I'm looking towards the first quarter, maybe second quarter [of next year]. But the market will actually lead well before we see the recovery, typically by six months. So the market's improvement could be right around the corner here.
One of the issues with the entire financial services sector is that it's such a broad sector that different companies zig when others zag. The thrifts were the ones that zigged. They really had some terrific performance. But those stocks will not be the ones that will do well when the economy improves.
The stocks that will lead the way out will be the broker dealers and the big money center banks -- companies like J.P. Morgan (JPM), Lehman Brothers (LEH), Merrill Lynch (MER) and Goldman Sachs (GS). Those are the types of companies that will lead a recovery because the underwriting business will improve, and a lot of those stocks are trading at 52-week lows.I've begun shifting the portfolio to move away from the savings and loans and thrifts to the market-sensitive ones. I think you can make an awful lot of money in owning some of these more sensitive names, like a J.P. Morgan or Fleet (FBF) or Mellon (MEL). But I can't throw both feet into them yet because it's too early to time the market recovery. I can anticipate it, but I can't quite see it. TSC: Why did you decide to invest so heavily in thrifts? Schutz: One of the reasons I've done well is I chose to go there, sensing the interest-rate cuts and the mortgage market, and actually looking to protect myself from a credit-quality standpoint. Thrifts were a terrific place to be, particularly the large ones, companies like Washington Mutual (WM), Dime Bancorp (DME) and Astoria Financial (ASFC). We made tremendous amounts of money owning them. They do very well when interest rates come down because they get to reprice their certificates of deposit. Also, most of them rely on the mortgage market, and with bonds having rallied as much as they have, business has been booming for them. Thirdly, we haven't seen credit problems there yet. There haven't been any syndicated loan or credit card issues. Those guys are very clean from a credit quality standpoint and they are benefiting from a drop in rates. I like a number of small-cap savings and loans. I still have a number as core positions, names like Astoria, New York Community Bancorp (NYCB) and Bay View Capital (BVC). TSC: How difficult is it for you to research some of these smaller regional banks? Schutz: It's actually really interesting because I look at some of these smaller firms as good opportunities because they are underfollowed. It means speaking to management, visiting them and understanding the geographies they serve. This gives you a sense for their market price and who the buyers of these companies might be, as well. And with 10,000 regional banks and thrifts out there, I think consolidation is going to be a major theme of this sector. It's a little bit more work than looking at someone's research report, because in some cases, they don't exist or are very dated. TSC: Have the rate cuts had the effect on all financial stocks that you expected them to have? If you look back at historical charts of rate cuts and the financial stocks that have done well, it's always been broker dealers. And this go-round, we've actually seen them fall after the rate cuts. They haven't done well because the appetite for IPOs, mergers and risk has fallen. That is the group that is going to lead us out, but clearly the Fed medicine hasn't quite cured the ills yet. If you look at the lag between interest-rate decreases and performance, it's clear that the medicine is going to take some time to work its way through. But there are some positive signs. I think manufacturing, excluding technology, is close to working its way out of the inventory issues. The real question continues to hinge on the consumer. I would continue to avoid the credit card stocks. They're also very sensitive but I think they could come under some very critical issues if the consumer gets into trouble.
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