The word I encounter most among fund managers today is: “survivor”. The hunt is on for the stocks that will see their profits collapse, that will cut their dividends, slash jobs and close plants – but that will survive what is turning into a ghastly downturn and emerge into a landscape from which many of their competitors have disappeared.
In searching for tomorrow’s survivors, fund managers are looking above all for one characteristic: low debt levels. That is what Garrett Fish, the manager of JP Morgan’s American investment trust, has among his top priorities when deciding what stocks to include in his portfolio as he goes … well, bottom-fishing.
Fish reckons there are already signs (admittedly faint) of green shoots appearing in California. He is not exactly expecting an upturn, just evidence that the bad news is not getting any worse. In recent months he has decided to start increasing the level of risk in the trust’s portfolio. He has moved the gearing up to 11%, compared with a 3% net cash position at the end of 2007.
The recession in America, he says, started in December 2007. We are already 15-16 months into it. America has had only two 16-month recessions since the second world war. This one is likely to exceed both and will be the deepest since the Great Depression.
“Everybody knows the negative story,” says Fish. “We are in a long, deep recession. By the end of 2007 I was in my highest-ever net cash position. But I’ve changed that now. From the last quarter of 2008 I started to buy. OK, I was early, but I’m not looking for absolute precision.”
Fish is going bravely where no man has been before – well, certainly for a rather long time: American retail.
“Retailers have looked cheap for some time, but the fall in earnings was not factored into the price,” he says. “We have seen tons of bankruptcies in the US. It’s not about thriving, it’s about surviving.”
He points to the example of Circuit City. It is – or, more correctly, was – the second-largest electrical retailer in America. During the consumer boom it had 567 stores shifting millions of flat-panel televisions. But now it is no more – it filed for bankruptcy late last year.
Over the past few months the company dumped its $1.7 billion (£1.2 billion) inventory of electricals on to the market in a rapid winding-down process. What that did to margins at its biggest competitor, Best Buy, was pretty nasty. But if Best Buy survives, its margins will fatten when American consumers start spending again.
Fish reckons that a similar process is going on at Staples, an office superstore. “People are saying to me I must be mad. Who wants to buy an office supply company when everybody is trying to cut back on their spending? But its two other competitors are mismanaged and have tons of debt.”
Staples’ shares collapsed in price from $26 in September last year to $13 in November. It was around that point that Fish started to buy, first in small amounts but he has been building since. Today Staples is trading at about $17.
What about the shops and malls? On a recent visit to Chicago courtesy of Neptune Investment Management, I couldn’t help but notice the almost spooky emptiness in huge outlets of Banana Republic and Abercrombie & Fitch (whose share price has collapsed from $80 to $15).
Yet Fish has started to buy Ralph Lauren, whose finely tailored share price was also ripped apart in the autumn, slumping from a high of $76 to below $32. Since then – although really just in the past few weeks – it has started to crawl back up, and is now trading at around $36.
Fish acknowledges that Ralph Lauren has debt on its balance sheet, but repayment does not become due until 2013, which gives the company a breathing space and may enable it to survive in better shape than its competitors.
But what about these green shoots in California? If it’s America that leads the way into global recession and it’s America that leads us out, it might be California that we have to watch for the first sight of a recovery.
“I agree that it is in the housing market that we have to see signs of life. And we may be starting to see that in California,” says Fish. “Home sales are up around 50% month on month. Around 70% of the sales are foreclosures, and the year-on-year price decline is around 45%. But we are clearing the inventory. It’s not getting any worse. We don’t need things to get better but to be less bad.”
He says now is the time to invest in equities relative to treasuries. “It is clear we are close to all-time lows across many different metrics, including economic activity, consumer confidence and housing, and given the view it is often darkest before dawn, we have started to add more risk to the portfolio. Any recovery in stockmarkets could be dramatic, even if timing is unclear, so the portfolio has been adjusted now to ensure we are in the right position when it happens.”
Fish is not just upping his weightings in consumer discretionary stocks, but also in financials. His favourite is Charles Schwab. “As there has been such massive dislocation on Wall Street, they have been gaining market share. They are picking up a lot of high net worth customers who used to be with the investment banks.”
Schwab fell from $26 to $11, partly because it has relied in the past on management fees from its giant money market funds. As interest rates have fallen, these funds are now yielding just 0.1%. Try charging a management fee on that. Schwab has, to its credit, waived the management charge but that has cost it about $180m in revenue. But Fish reckons Schwab customers will soon start migrating away from cash funds into more profitable equity funds.
Maybe British investors will start doing so too, especially once the attractions of corporate bond funds wane amid inflation fears. Dollar weakness would be a worry here on out for any British investor in America but for an early punt on recovery, the US is looking like the place to be.