Finally, a growth manager who admits he gave up on tech but is nibbling now.
Manager : Larry Fuller |
| Fund: (MAFGX Quote - Cramer on MAFGX - Stock Picks)Merrill Lynch Fundamental Growth |
Managed Since:
Oct. 21, 1994 [inception] |
| Assets: $5.5 billion |
| 1-Year Return/Ranking: - 32.9%/Beats 72% of peers |
| 3-Year Annualized Return/Ranking: 8.4%/Beats 82% of peers |
| 5-Year Annualized Return/Ranking: 16.2%/Beats 88% of peers |
| Sales Charge/Annual Expenses: 5.25%/0.76%* |
Top-Three Holdings:
General Electric(GE Quote - Cramer on GE - Stock Picks)
Pfizer(PFE Quote - Cramer on PFE - Stock Picks)
America Online Time Warner(AOL Quote - Cramer on AOL - Stock Picks) |
*Using Class A shares as an example.
Source: Merrill Lynch and Morningstar. Returns and rankings through March 23. |
You might not know Larry Fuller's name, but his track record and recent moves merit some attention. Like most growth managers he loaded up on tech stocks last year until they made up nearly half of the broker-sold
(MAFGX Quote - Cramer on MAFGX - Stock Picks)Merrill Lynch Fundamental Growth fund's portfolio. But he threw in the towel when a slowing economy started eating into tech shops' earnings and puncturing their lofty valuations. At the end of February he had less than 3% of the fund's money in tech, and though he's taken a beating with his peers, he hasn't fallen as far and beats them over the past five years.
In the past two weeks he has started to slowly buy shares of tech companies again, but only selectively. What's he buying and why is he starting to buy now? Read on.
1. Examining this ugly market, how did we get here and where do you think we're going? Fuller: The way we got here was the U.S.
Federal Reserve and other central banks tightened money policy going back to late June 1999. If you tighten money policy for six to nine months, then you start to have a really meaningful effect on real economic activity, which means you start to have a negative effect upon corporate profitability and profits. Eventually it gets through to the stock market and they go down. The U.S. Fed did not start to ease until Jan. 3, 2001. If you look back at the consumer confidence levels or minimum consumer spending, [they] flattened out as soon as the Fed started tightening in 1999. And they've just gradually rolled over. And by the time you get into the first quarter 2000, you were starting to see some meaningful downside momentum in consumer spending.
While technology was primarily peaking in the
Nasdaq, in March of 2000, a lot of investment funds were flowing into financials, banks, insurance, electric utilities and health care. The really smart money out there recognized that things were really going to slow down materially.
At that point in time, we had a substantial weighting in technology -- like 40% to 50%. And we had started to build that up in June 1999, based on what we saw happening to orders and spending expectations for communication infrastructure, primarily Internet infrastructure. We were under 10% as of the end of June 1999.
The business momentum across the board was very strong in the first quarter and going into the second quarter of last year. We stayed with a big exposure in technology and then moved into the direction of what would essentially be stocks that would benefit in a major, protracted slowdown in the economy, which would eventually hit capital spending, as it has.
Take a look at our top holdings from Jan. 31, 2000. It was
Cisco Systems(CSCO Quote - Cramer on CSCO - Stock Picks) at 5.3% and
GE(GE Quote - Cramer on GE - Stock Picks) at 3.6. The other holdings were
Texas Instruments(TXN Quote - Cramer on TXN - Stock Picks),
Sun Micro(SUNW Quote - Cramer on SUNW - Stock Picks),
EMC(EMC Quote - Cramer on EMC - Stock Picks),
JDS Uniphase(JDSU Quote - Cramer on JDSU - Stock Picks),
Citigroup(C Quote - Cramer on C - Stock Picks),
Nortel Networks(NT Quote - Cramer on NT - Stock Picks) and
Enron(ENE Quote - Cramer on ENE - Stock Picks). We were doing extremely well relatively, in not a very aggressive portfolio.
Historically, every time you had a downturn in consumer, durable goods spending, the Fed would back off, stop tightening and eventually start to ease. On the basis of the numbers that came out for May 2000, they should have eased in June. And then by October, you had auto sales round the world starting to fall down; I think Germany was down 11% for the month of October, and they still weren't easing, so I basically started to throw the towel on aggressive technology weighting mid-June, and then really started to throw the towel in aggressively the last week of August, going into September. And by the end of September, we had less than half the weighting of what we had in mid-August.
Tech Buckling
Tech stocks had a stunning run but have since folded
and are taking most growth funds down, too |
 |
| Source: Morningstar. Returns through March 23. |
2. You recognized, unlike most, that demand for tech products was going to drop a bit and so you ratcheted down your exposure. A lot of individual investors are trying to do just that now. But it's easier said than done. Could you walk through how you discerned what to keep and what to sell, what are the fundamentals you used? Fuller: What we look at principally is: What's the environment? What's happening to the revenue momentum, the earnings momentum, the backlogs from individual companies from a bottom-up standpoint?
Almost 100% of the time, investment analysts' research doesn't help you recognize that the momentum is changing. We've just never had research come out that gave me any kind of heads-up on that. It's really a matter of listening to the management.
3. Are there values in tech right now? This is a really hotly debated issue. Have you raised your tech exposure this year? Fuller: We just started to [Monday, March 19]. Our tech weighting at the end of February was 2.7% of net assets. (Laughs.)
Wow! (Laughs) That's about one-tenth of the S&P, right? Fuller: Yeah, that's like one-tenth of the S&P. Supposedly, the S&P at the end of February was 18.7%. We're 2.7%.
What happened was this: Earlier this month,
AT&T Wireless(AWE Quote - Cramer on AWE - Stock Picks) started to advertise this new full service -- 3G wireless service, access to the Internet, streaming video, audio, the whole bit. They pointed out that what this was is this
NTT DoCoMo I-Mode service, that it used this wide-band CDMA [code division multiple access] chipsets from
Qualcomm(QCOM Quote - Cramer on QCOM - Stock Picks). Then I saw the announcement that
Verizon(VZ Quote - Cramer on VZ - Stock Picks) was giving
Lucent(LU Quote - Cramer on LU - Stock Picks) a $5 billion contract to build out the infrastructure for this service. When we started to build up our exposure to communications-equipment business in late-December 1996, it was on the same basis. Contracts, after like an 18-24 month period, in December of 1996 were being led by the wireless companies to build out the PCS digital-wireless spectrum.
[Last week,] we made the first meaningful uptick in our exposure in technology in some time. We bought an investment position in Lucent, and we bought an investment position in Qualcomm. I mean, $5 billion is a huge contract, and it's more likely to be front-end loaded than back-end loaded because AT&T Wireless is offering this service. I'm sure they're using Lucent and Qualcomm components in this thing.
4. There are a lot of folks pointing to an economic recovery in the second half of the year or the fourth quarter and saying that will turn things around for the tech sector, potentially. Are you in that camp? Fuller: I think that the overall rate of real economic growth is going to pick up in the second half of the year, principally because of the Fed moves. This is sort of like having the wind at your back. My concern now, ever since the Fed started to ease is: Don't be underinvested. Now the second issue is, you know, where do you invest? And are we about ready to go back to 20% technology? Not soon.
You get cutbacks in investment spending, and technology can go into mothballs for a period of time. I mean one of the economic concerns that people have analytically out there, in terms of the whole communication business is: Is it too much capacity?
If you have autos sitting on a dealer's lot, you can count 'em, you can see the inventory problem. If you've got too much optical-communication bandwidth out there, you can't see it. And all you have to do is make a software upgrade and you can increase the amount of capacity you've got by some enormous amount. So it's a much different issue, and I don't know, we haven't talked with anybody or heard anybody articulate what this situation is with any clarity.
But I think the second half of the year, real growth will pick up, the overall economy will be better, people will spend more on apparel, they'll spend more on entertainment and other services. Will they spend more to upgrade a cellular phone? They probably will; they're more likely to do that than they will be to buy a new car.
Riding It Out
Fuller's fund is hurting like its peers, but he has managed to stay ahead of them |
 |
| Source: Morningstar. Returns through March 23. |
5. I noticed at the end of last year, retail got a significant amount of attention in your portfolio. Is that still the case, and what do you do with that sector this year? Fuller: Oh, yes. As we were coming out of technology, we were going into pharmaceuticals, insurance, selectively into some of the U.S. banks that are not investment-bank oriented, deal oriented, and retailing.
Once people begin to believe how serious the slowdown is, they see how bad the retail numbers are comparatively, they begin to anticipate that there's something going to happen in terms of both Fed easing, reliquification of consumer balance sheets and a tax cut. We started putting money into
Wal-Mart(WMT Quote - Cramer on WMT - Stock Picks) and
Home Depot(HD Quote - Cramer on HD - Stock Picks) back in October. We also started building up exposure in
CVS(CVS Quote - Cramer on CVS - Stock Picks) and
Walgreen(WAG Quote - Cramer on WAG - Stock Picks). I shouldn't say this, I'll jinx it -- One of the most likely supported-by-everybody type programs is going to be a pharmacy-benefit program. There are something like 40 million people out there that may need health care coverage, and this should benefit not just the pharmaceutical companies, but it should also benefit the principal intermediaries, which are CVS and Walgreen and
Merck(MRK Quote - Cramer on MRK - Stock Picks), which owns the largest pharmacy-benefit management company in the industry.
So we're building up CVS and Walgreen. We added
Ahold(AHO Quote - Cramer on AHO - Stock Picks), which is a major food merchandiser to the portfolio. We've not yet worked ourselves down the food chain to things like office supply chains and apparel retailers.
I think that to the extent that we have higher inflation, that passes through in terms of pricing of things like food. It's going to help, certainly, food retailers. But this is a difficult time period, because a lot of companies have been hurt by tight service-sector labor markets and union-negotiation activity. Our assumption is that energy costs aren't going to go away as a problem.
6. It doesn't look like energy prices are going to come down in the foreseeable future -- some people are saying 12 or 18 months, at least, when we talk about natural gas prices. Are you building up your holdings in the energy area, and if so, what companies stand out to you? Fuller: We started building up energy exposure a year ago, and the oil services industry exposure we have is significant. It's almost 10% of the portfolio. And that's without owning
Schlumberger(SLB Quote - Cramer on SLB - Stock Picks), which was sold out when they announced they were going to go into the information technology business by acquiring a French information technology company.
If you go back to the fourth quarter of 1998, when essentially you had recession and depression in Asia, and oil prices were very low, up until maybe about a year ago, it was just a major liquidation of both personnel, equipment and capacity in the oil services business, as the major integrated oil companies around the world cut back in exploration spending.
You just create a very tight excess-demand situation, both for exploration and development services, as well as in terms of demand for energy products.
It gets worse for consumers and better for investors. Fuller: Right. And so we also had a meaningful exposure in integrated-energy companies, which we liquidated late last year.
We don't have exposure to integrated companies any more. We have services exposure.
Baker Hughes(BHI Quote - Cramer on BHI - Stock Picks) and
Halliburton(HAL Quote - Cramer on HAL - Stock Picks) are the two major positions. In what you might call energy marketing,
Enron(ENE Quote - Cramer on ENE - Stock Picks) is a major position.
We also have a big position -- not in the top 10, but big --in
El Paso Energy(EPN Quote - Cramer on EPN - Stock Picks).
7. Beyond Lucent and Qualcomm, what are two or three companies that you think are oversold? Fuller: Well, I think
Cisco -- which was a No.1 and No. 2 investment position for us, for, it's got to be three or four years -- is oversold.
Am I willing to reinvest in it at this point? Not yet. But it's a cheap stock. If you look at the growth potential over the next five years, if you look at the current price-to-earnings
ratio, it's in a trading range of a couple of points around where it's trading right now.
But Japan and Asia are big markets for them. With what's going on in Japan right now, I think the 100% growth they've seen up until just recently in Japan is going to go down.
And the same thing in Europe. Not only do you have cutbacks in spending on the part of telecom customers, corporate customers, you've got this other negative stuff in the backdrop. It's probably not going to make a big difference in terms of how much the stock goes down from there; it's not going to go up.
I think the same thing is true of Sun Microsystems, EMC. The two-three-year time horizon outlook is: Very solid growth, very high quality, prominent companies in their businesses, and these stocks are cheap.
Right. Or cheaper. Fuller: It's like
Commerce One (CMRC Quote - Cramer on CMRC - Stock Picks), which is another one we have in the portfolio. It's a cheap stock. You've got market caps
to estimated revenues of no more than two or three times, and they're cheap. But, when are they going to start to appreciate again? You're going to have to have a whole new upturn start, to take place in terms of corporate investment in Web hosting, in Internet site management and Internet software applications.
You take a look at someone like
Oracle(ORCL Quote - Cramer on ORCL - Stock Picks). They have the biggest database company in the whole world, and then [the] big disappointment is the lack of growth in applications in software sales and licensing in the Internet application area. When's it going to turn? You know, [Oracle CEO] Larry Ellison doesn't know. [Cisco CEO] John Chambers doesn't know. So how can I know?
But what you can do is you can listen to them, and when things start to turn, get involved and get active. I think there are a lot of high-quality technology companies that are cheap. If the business fundamentals and momentum are looking like [they were] starting to pick up, the rates of growth are going to accelerate and profitability is going to go up in ensuing quarters, we'd be in there big time, but it's not happened yet. And the only thing where something is happening, at least from our perspective right now, is that you're starting to get the capital spending on this third-generation wireless Internet infrastructure, and this is a big deal.
And, is it going to be big enough that you ought to go down the screen and invest in Texas Instruments, which is the largest producer of digital single processors in the world? Not yet. Because it's too early. There's not enough of an upturn; there's so many other areas of the communication business in terms of wire line infrastructure and Internet infrastructure and whatever, where things are going the wrong way and so net, net, you don't have a robust overall situation for investing.
8. What sectors and companies do you see having a hard road in front of them from here? What sort of traps that you see on your radar screen? Fuller: I think the strength of the U.S. dollar over the last three to four years has created a tremendous burden for consumer commercial product companies that have a major base of manufacturing in the U.S.
You have to really analyze the company, but I think that the manufacturing sector in the U.S. is going to be hard-pressed. I think that the chemical industry, given my view of the extent to which we're going to have persistent, excess demand for both natural gas and I think even oil product, is going to be under cost-pressure, but they're not going to be able to offset [it] easily by pricing. So I think chemical is going to have a problem.
You take a look at the aluminum industry -- and that's a very high energy consumption business -- it's no wonder that the administration backed off on these carbon dioxide emission constraints because it would raise the cost of electric power to the aluminum industry by a staggering amount and they would be very negatively impacted, and so would Mr. O'Neill, the Treasury secretary, who still owns a lot of stock.
9. What's the biggest mistake an investor could make in this market? Fuller: I think one big mistake is, at this point, is liquidating stocks and going to bonds or cash. I think that'd be a big mistake.
From the standpoint of looking at overall equity markets, certainly the U.S. equity market, it's cheap, it's undervalued. The Fed is moving in the right direction. At the federal level, there's aggressive politicking and movement and discussion toward tax relief for individuals. And I say, it's got to be upfront, and this is all positive, and this is the kind of thing where someone says, oh my gosh, I've lost 25%-30% of my assets in the last year, I'd just rather get out, put it into bonds or put it into a money market.
This is where people are. I think there's more capitulation and anger at the individual investor level than there is yet at the professional portfolio manager level.
In larger, high-quality companies you hold the positions and you wait, because things will turn up again. The problem is, you don't know when, how long it's going to take. But if you can afford to hold on, that's what you should do, because but I think the worst thing people can do is just capitulate.
10. If you had to pick stocks of three companies to buy today and you had to hang onto for five years, what would they be and why? Fuller: The top three in my portfolio, GE,
Pfizer(PFE Quote - Cramer on PFE - Stock Picks) and
AOL Time Warner(AOL Quote - Cramer on AOL - Stock Picks).
With GE, 25% of the profits comes from making and servicing these large, electric power plants around the world. Another area is aerospace. And we've got old planes; we've got planes that don't leave the ground and have to be repaired. Another 25% of their profits comes from producing jet engines for commercial aircraft, and if they are able to consummate the acquisition of
Honeywell, they bring in very high valued-added avionics part of that. There's a huge after market, as well as a new equipment market, in the avionics electronics area.
And in my opinion, they're also the most successful commercial financial-services company in the world.
It's one of the most successful industrial conglomerates in the world. At an estimated P/E of 28 times, vs. 22 times to the S&P, I just think it's a very attractive company. And it's got tremendous ability to consistently produce the earnings and the rates of return.
I think Pfizer is the most successful pharmaceutical company in the world, in terms of existing portfolio of products, as well as what they've got in the pipeline. I think that the acquisition of
Warner-Lambert creates an opportunity for them to manage earnings going forward. The numbers look good: a growth estimate of 25 or 30 times and P/E of less than 22 times; they spend $7 billion on R&D and new products; they've been very successful in the past.
And, you have the demographic argument, at least in the developed markets, that as the population gets older, the rate of growth and consumption of pharmaceuticals, just very basic things, whether it's osteoporosis, whether it's high blood pressure or cholesterol reduction, whatever, it just, you know, keeps growing at a faster rate. In the U.S. market, you've got this incremental growth coming from the federal government putting in a program that's going to provide, should provide, benefits and products for tens of millions of people.
In the case of America Online, I wish they had not made the Time-Warner acquisition. Looking at the Internet, this is the company I think has been most successful at building an online information, entertainment retail business. They've certainly done it in the U.S. They've basically put everyone else out of business.
Ian McDonald
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