Mutual-Fund Managers Sour on the Economy

The economy is rebounding but not as strongly as most people think, say two mutual-fund managers.
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NEW YORK (TheStreet) -- Muhlenkamp Fund (MUHLX) - Get Report and Jordan Opportunity Fund (JORDX) share much in common. Both mutual funds are run by their namesakes. And both Ron Muhlenkamp and Jerry Jordan are outspoken economic forecasters. They make predictions and then buy clusters of stocks that stand to benefit from economic trends.

Now, both managers worry that the recovery will be slower than many economists expect. Their mutual funds are buying stocks that can prosper in a period of high unemployment and sluggish consumer sales.

The economy grew at a 3.2% annual rate in the first quarter, the government said today, following a 5.6% pace in the previous three months. That was the fastest back-to-back expansion since 2003.

Ron Muhlenkamp frets that Congress is raising taxes and increasing government regulation. "Employers will be slow to hire because they are being penalized by our politicians," he says.

Faced with insecure employment, consumers are saving more and spending less, says Muhlenkamp. Consumers now save about 4% of their income, up from around 1% two years ago. Cash is moving into bank certificates of deposit, or CDs, and away from purchases of cars and homes. That will result in slow gross domestic product growth.

During economic rebounds that occurred after earlier recessions, Muhlenkamp bought stocks of discretionary-consumer companies, including

Harley-Davidson

(HOG) - Get Report

and

Winnebago

(WGO) - Get Report

, the maker of mobile homes. He figured that sales of such luxuries would spike as the economy recovered.

But in the current cycle, Muhlenkamp is staying away from discretionary goods because he fears that this time consumers will be slow to resume spending. "I don't expect Harley-Davidson's earnings to fully recover for a long time," he says.

Instead of consumer stocks, Muhlenkamp is buying insurers. Those are attracting investments from individual savers. Muhlenkamp's holdings include

Principal Financial Group

(PFG) - Get Report

and

Hartford Financial Services

(HIG) - Get Report

. Both companies sell annuities, which are savings vehicles that come with guarantees. "After everything that has happened in the last couple years, annuities with guaranteed returns have amazing appeal for the general public," he says.

Muhlenkamp's forecasts have generally been on target. During the past 15 years, his fund has returned 10.1% annually, outpacing the

S&P 500 Index

by 2 percentage points and surpassing 97% of his large-value competitors.

Muhlenkamp likes very profitable companies that sell at discounts. His portfolio has a lower price-to-earnings ratio than the S&P 500 and a higher return on equity, a measure of profitability.

As the recession began in 2001, Muhlenkamp started buying homebuilders and financial stocks because they seemed likely to rebound as the economy recovered. The move helped the fund outpace the S&P 500 for five years in a row. But Muhlenkamp held on too long and was clobbered as the credit crisis unfolded.

In 2009, he resumed his winning ways, holding technology stocks, including

Cisco

(CSCO) - Get Report

and

Hewlett-Packard

(HPQ) - Get Report

. Muhlenkamp had shunned technology in the 1990s when the stocks were too expensive for his taste. But now the P/E ratios have come into his territory. He says technology sales will remain strong in a sluggish economy. Instead of hiring expensive workers, companies will invest in systems that can enhance productivity.

Like Muhlenkamp, Jerry Jordan figures that high unemployment rates will persist. He says the stock market overreacted in early 2009, pricing stocks as if the economy was headed for a depression. Now investors have gotten unduly optimistic, Jordan says. "We are not going to see great growth rates in the second half of the year," he warns.

Prime beneficiaries of the sluggish economy will be discount retailers, including

Family Dollar

(FDO)

and

Dollar Tree

(DLTR) - Get Report

, he says. Consumers who once shopped at

Sears

(SHLD)

and

Target

(TGT) - Get Report

have begun seeking lower prices at discounters. Those buying patterns aren't going to change any time soon. "As the economy improves, traffic is not going to dry up at the discounters," he says.

Searching for trends that are likely to produce outsized gains, Jordan sometimes takes contrarian positions. As the economy slipped in 2008, he began buying steel companies. He figured that sales would rebound as demand recovered in China and other markets. That proved to be a winning move. Such successful calls have enabled the mutual fund to return 8.3% annually during the past five years, outdoing 95% of large-growth peers.

Lately, Jordan has been buying media companies. Holdings include

Walt Disney

(DIS) - Get Report

and

Viacom

(VIA.B)

. The shares fell out of favor as investors worried about declining advertising revenue. Jordan says ad revenue will revive as the economy improves. In addition, companies are starting to charge more for their content. "The premier media companies have solid cash flows and content that cannot be reproduced by anybody else," he says. "Those businesses should sell at premium multiples."

Stan Luxenberg is a freelance writer who specializes in mutual funds and investing. He was formerly executive editor of Individual Investor magazine.