BOSTON (TheStreet) -- The stock market has fallen for six straight weeks as the economy has cooled, pulling down benchmark interest rates. Yet, prices for food and gas have risen, worrying investors.
All of this has occurred even though
Chairman Ben Bernanke says inflation isn't a problem. During a speech last week in Atlanta, Bernanke argued there is "not much evidence that inflation is becoming broad-based or ingrained in our economy." While he acknowledged commodity prices have been a key driver of inflation, "the recent increase in inflation will prove transitory," the top monetary policy maker said.
Fed Chairman Ben Bernanke
For individual investors at home shelling out $4 for a gallon of gasoline and nearly as much for a gallon of milk, inflation seems to be anything but temporary.
"Meat, dairy and cheese prices are up over 20% year over year. You see energy prices and gas prices up. There's inflation. It's real inflation," says Cliff Remily, manager of the
Thornburg Investment Income Builder Fund
"I don't know how you can realistically say that inflation is not a problem at this point," Remily continues. "Corporate margins are under pressure because of inflation. Is it transitory? I guess it's transitory if we go into another recession. This inflation is a
Remily isn't alone in his concern over Bernanke's view of inflation. Other fund managers, such as Cliff Hoover of
, worry that the Fed chairman believes he can control inflation.
"When you have to pay $100 to fill your tank of gasoline, you should say 'Thanks, Ben,' " Hoover says. "He's trying to prevent the market from clearing so quickly, but at the same time, you have unintended consequences of that economic policy. The unintended consequences are what we're seeing today with inflation."
had choice words for Bernanke during the Q&A portion of his speech in Atlanta. Dimon pointedly asked the Fed chief whether anyone at the central bank studied the cumulative effects of rules and regulations on banks, noting his own fears that they will stifle job creation and a recovery in businesses and credit markets.
But what could the Fed do otherwise? The central bank has pumped liquidity into the system through two rounds of quantitative easing, the second of which is set to expire later this month after the last $60 billion of open market transactions. Some fund managers, like Philip Tasho, co-founder and chief investment officer of TAMRO Capital Partners, applaud Bernanke for his sobering view of the economy and for taking a
off the table for now.
"We've had so many issues out there, ranging from the turmoil in North Africa to the earthquake and tsunami in Japan," Tasho notes. "There were higher food and gas prices. There were weather issues, from tornados to flooding. We hope these are temporary issues that should settle down and we could see a more benign scenario in the back half of the year."
Because of his view that inflation pressures are transitory, Bernanke expects growth to strengthen in the second half of the year. While not everyone may agree with that view, the volatility in the market during the last half of 2011 could become an investor's best friend.
"Bernanke's intention is to monetize our way out of this thing, which is his only choice at this point. We're in a Keynesian mess," says Dreman's Hoover. "But as a stock picker, you use that volatility and play off of it."
spoke with Hoover and other fund managers to get their view on inflation, how the markets will perform in the last half of 2011, and what stock picks play into their investment ideas, which are presented on the following pages.
Philip Tasho, co-founder and chief investment officer of Tamro Capital Partners, says he finds it funny that the Federal Reserve says inflation was relatively benign when stripping out food and energy. Tamro Capital has roughly $1.6 billion in assets under management.
"I always thought that never made sense because nothing affects people's wallets more than food and energy," Tasho says. "They're necessities. These are issues and that's why consumer sentiment has flagged."
Tasho says that energy is a "very attractive sector" due to huge global demand. He argues there are long-term trends that investors should embrace.
One of his top plays in the energy sector is
, which Tasho calls "the premier integrated oil company."
"They've really lagged their peer group over the past year and I think that offers attractive value," Tasho says. "Given the scope of the global economy, you need a company with the expertise and scale to accommodate a global consumer. Given their clout and size, they're really able to find oil and gas in the most unlikely places."
Tasho notes that Exxon has a very large field 7.7 miles long in the Sakhalin Island, which is part of Russia, which he calls "a major discovery for them." Exxon has also announced a deepwater find in the Gulf of Mexico. "With potentially 700 million barrels of oil and gas, it'd be one of the largest fields in probably the last five years," he says. "That's important."
is another energy sector favorite of Tasho because of its potential as a growth company in the natural gas industry.
"They have tremendous potential of increasing their reserve line in natural gas," Tasho says. "They were one of the first to the Marcellus Shale. They have the lowest finding costs per million cubic feet. They're focusing on the most lucrative part of that area, too, which is the wet-gas portion."
Outside of the energy sector, Tasho says he is underweight the consumer discretionary sector as consumers continues to be pressured as the economic recovery stalls. Opportunities are few, Tasho says, with the renaissance of the automobile one of the few bright spots.
But rather than purchasing automaker stocks like
, Tasho is drawn to supply companies, most notably
"This is a very high quality company," he says. "They have been averaging about 15% return on capital and they have a low double-digit top-line and bottom-line growth. They are the low-cost provider here. If you want to run an efficient operation, they are the supplier to choose."
Cliff Hoover of Dreman Value Management has been a believer of the stagflation scenario for a while. Stagflation occurs when inflation picks up while economic growth remains weak.
"I've never believed it would be a V-shaped recovery. The type of bubble created by the 25-year super cycle of credit ending, that's not going to be healed overnight," Hoover says. "So we're wading through that morass."
From a sector perspective, Hoover says investors have to look out a couple years. Because of that, his firm, which was started by legendary value investor David Dreman and has about $6 billion in assets under management, sees several good buys in the market.
Although he says its hard to predict that the stocks will rocket higher from here, Hoover sees opportunities in the financial sector. While short-term traders have been dumping bank stocks this year, Hoover sees some very inexpensive names his firm has been buying.
Among his favorites are
Bank of America
"These companies are trading below book value," Hoover says. "They're building a substantial amount of excess capital. I think they're going to be big dividend payers and growers over the next two to five years. I think we're going to make a lot of money in our financial stocks."
Hoover says that Wells Fargo is worth $40 "easily," and that Bank of America should trade for "north of $25." Those views may be contrarian, but he believes credit metrics have gotten substantially better and that loan growth has turned a corner.
Similarly, Hoover says several big technology companies are also very cheap. For the first time, Dreman funds have owned the Big Three --
, which the firm just began accumulating.
"They've been broad-brushed for a number of reasons," Hoover says of the tech names. "One of the main reasons has been the cloud computing concept and the virtualization of servers. The big three have been thrown into the dustbin, as investors would rather buy
. But F5 is trading at 40 times earnings. Investors need to realize they're paying for this huge forecast that may or may not happen. Those are the perils of a high P/E stock."
Richard Nackenson, manager of the
Neuberger Berman Multi-Cap Opportunities Fund
, knows a little something about finding value. Nackenson worked for famed hedge fund manager David Tepper at Appaloosa Management, "which gave me a lot of deep-value discipline," he says.
Nackenson has been with Neuberger Berman for 11 years, taking a bottoms-up, deeply analytical approach to investing. He looks for companies with good current and future prospects for free cash flow generation.
"If you're using 2012 S&P 500 earnings estimates as a benchmark, the market is at an 8.5% earnings yield," Nackenson says. "I can find companies with free cash flow higher than that, and at growth rates better than the broad market. What are some alternatives out there? A zero-growth 10-year Treasury below 3%."
While the market appears to be choppy with a lot of volatility, he sees "some pretty extraordinary opportunities out there. The underpinnings for the market are quite positive at this time. It comes down to stock picking."
Among Nackenson's favorite picks is
, the largest U.S. hospital operator that went public again earlier this year. Nackenson says he has been familiar with the company over the past decade.
"We participated in HCA on the IPO, which is very rare for us to do," he says. "I'm not a flipper. I participate in an IPO because I like the name. And it has, so far, been a phenomenal absolute and relative performer. I think there is more to go."
Nackenson points to HCA's "very stable earnings stream," noting that the company's earnings are not highly correlated to gross domestic product or commodity prices.
"They're generating cash and they'll continue generating cash. They're very thoughtful about how they use their cash," he says. "They can generate cash to pay down debt and this accretes directly to the equity layer of the company. I look at this as a steady Eddie cash machine that can do well in a slow growth environment. This is one where investors can do well over an 18 month timeframe irrespective of market volatility."
While HCA is a pure play in U.S.-generated cash flow, Nackenson is a fan of offshore oil and gas production company
for its international operations.
Nackenson says the firm previously owned McDermott but sold the stock after a 60% rally that began last year. Now, he is revisiting the stock as he knows the business very well.
"They have a net cash balance sheet and a very experienced management team," Nackenson says. "This is an attractive valuation. You talk about high gas prices and the volatility in the commodity space and the amount of money going into global E&P investments. When commodity prices goes up, more money goes in to find more oil. MDR is a direct recipient of that."
Cliff Remily, manager of the
Thornburg Investment Income Builder Fund
, is macro-aware but not macro-driven. Instead, his investment strategy is to find companies with steady income streams in the forms of dividends.
Dividend-paying equities have even been on the radar of famed bond investor Bill Gross of Pimco, the home of the world's largest bond fund. The highly respected bond guru is saying that dividend-paying stocks are an asset class people should be going into.
"When you have someone who is a bond manager saying it, people should listen," Remily says. "That's where our view is as well. It's the place where you should be in."
That strategy had the fund underweight materials and consumer discretionary, which were among the best performers of the past year. Instead, Remily says he has been overweight telecom and consumer staples, which still helped the fund outperform last year but made it slightly more difficult.
During the most recent quarter, Remily says that dividend paying stocks "have begun to percolate. People have begun seeking yield from alternative places as short-term rates are as low as they are. People have finally looked at dividend paying stocks, and that has been working for us."
It's no wonder. Last year saw such a good rebound that people are now very cautious and skeptical, Remily says. Unemployment is still high. Corporate earnings are slowing down. Margins are under pressure. All of this has Remily a little wary of the market.
"I'm perpetually concerned about things," he jokes, adding that he "should've been a bond manager because I'm so cautious. I'm always looking for the downside. I figure that if you can protect yourself from the downside, the upside takes care of itself."
As such, Remily currently has a defensive portfolio with a 17% weight in consumer staples, which is starting to do well. In addition, the fund it weighted 18% in telecom, compared to 4% for the market.
"One of the places you want to be invested in during times of inflation is branded consumer staples," Remily says. He singles out
"It's interesting that they haven't been working until just recently," Remily says. "We like those companies with good brands. We're overweight those names. They can basically pass their prices on to consumers."
Remily says that both Coke and McDonald's are hidden in plain sight. "Here are some obvious, well-known companies but they're not doing completely well," he says. "I would lend money to McDonald's at a lower rate than the U.S. government at this point. McDonald's has a better balance sheet and a better business model than the U.S. government right now."
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-- Written by Robert Holmes in Boston
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