PSigma contradicts recession bears

James Abate, manager of the new American Growth fund, favours oil and technology in a fund that has outperformed since launch – and, he says, the market could yet hold surprises.

It’s the new conventional wisdom: America is sliding towards recession, if it isn’t in one already. But America is no longer the engine of the world economy, so as long as you keep your money in the growth parts of the globe, such as Asia, you’ll be safe.

That’s all hogwash, according to James Abate, who runs PSigma’s American Growth fund. PSigma favours Asia and emerging markets, but sees no contradiction in also holding the view that American equities look relatively cheap by historical standards.

Valuation is not the only support for American stocks. Many high-quality American companies will continue to be the chief beneficiaries of emerging markets growth because of their exposure to those markets. And Abate’s fund is stuffed full of them.

His stocks, such as Procter & Gamble and Coca-Cola, are at the heart of the explosion in consumer spending in emerging markets, while companies such as Exxon Mobil are providing the energy that keeps them ticking over. America may catch a cold, but these companies will barely sniffle.

Coca-Cola is trading at a 52-week high of $64 (£32), compared with $45 in April, while Procter & Gamble has had a terrific run since mid-July, jumping to about $75 from $61. Subprime they ain’t. But surely no one wants to be in American equities when the credit crunch appears to be deepening?

Abate is sanguine. “There are distortions in the financial sector, but it’s a global issue, not just the US. The write-offs will occur over a period of time, with the climax in the first quarter as pressure from auditors to force banks to bring vehicles such as Sivs [structured investment vehicles] back on to the balance sheet.”

The losers during this period – apart from the banks themselves – will be smaller and mid-size equities. “The lack of lending will cause a bit of an economic slowdown and affect those companies that are dependent on access to cheap capital to finance growth – such as smaller companies. It will also harm the companies whose share prices are dependent on chatter about LBOs [leveraged buyouts] or who have grown on debt-financed acquisitions.”

What investors can expect, says Abate, is a narrower market of successful stocks at the mega cap end. “This environment will favour the largest and bluest of the blue-chip stocks who can power through this slowdown,” he says.

Financials and consumer cyclical stocks will remain the no-go areas for some time, although Abate says the fund is nonetheless “dabbling” in a few of the stocks and finding some bargains.

This sounds like a credible argument – but isn’t it one that’s already in the price of big-cap stocks? “The top 50 names are trading at about 18 times forward P/E [price/earnings]. That is reasonable. We are looking at the sort of valuations that were common in 2003 and 2004.”

The other persistent worry for sterling-based investors is dollar weakness. Won’t any gains simply be wiped out by a falling greenback?

“Our view is that the dollar is not going to be the same headwind for investing in US equities that it has been.” He’s not forecasting any dramatic recovery in the dollar, but he reckons that the period of relative sterling strength is at an end. From here on out, sterling will be at best stable against the dollar or weakening against it, he says.

One of the more surprising features about this fund is that it is overweight technology – at 26% of his holdings – while massively underweight utilities, which do not feature at all in the fund. It’s an unusual position to be in if you believe the economy is going into a downturn. But Abate’s view is that growth, in the form of hi-tech companies, is going to be at a premium over the next few years.

He’s playing tech through stocks such as Google, Cisco Systems and IBM. Somehow he manages to find a yardstick in which when you measure Google it looks cheap. “If you look at price to revenue, it’s at 15 times, when over the last five years its average has been 16 and the high was 24.”

He’s also overweight in oil, which makes up 17% of the fund. His single largest holding is not something investors are likely to have heard of: Energy Select Sector SPDR. It’s a synthetic creation matching the performance of the big American quoted oil companies.

Abate uses it because he sees a high level of correlation between the oil majors, and you only need to stockpick if you have particularly high conviction.

“The correct call is to hold the sector or not. The correlation between oil stocks is close to 90%,” he says. He believes that the oil price will remain high and at the company level there are also efficiency gains to be had.

The fund is only a few months old, so the early performance figures (it’s outperformed in a falling market) are only the shallowest of guides. But Abate’s pedigree goes back a long way. He runs his own boutique, Centre Asset Management and previously worked with Ian Chimes, the PSigma boss, during his successful stewardship of the Credit Suisse Transatlantic fund from 1995 to 2000.

It’s interesting to ask him what sentiment is like on Wall Street, as he only has to pop his head out of the window. The firm’s offices are on 30 Wall Street, and right now Abate says that the pessimism about subprime-wrecked and credit-crunched America has gone too far. “You see more headlines about subprime in London than you do in New York,” he says.

Investors with the deepest pockets – such as those in the Middle East – are snapping up American assets at what they see as bargain basement prices. Little wonder that Citigroup went to the Gulf with its begging bowl.

“The fundamental picture of the US is a lot better than people perceive,” he says. “The surprise will be just how much the market goes up next year.”