Download If you`ve got it, flaunt it

perform
Fourth quarter 2006
I D E A S A N D I N F O R M AT I O N F R O M T U R N E R I N V E S T M E N T PA R T N E R S
If you’ve got it, flaunt it
A slowing yet still-thriving global
economy is not only helping to make
the rich richer but to make the rich more
numerous. According to Merrill Lynch,
more than 8.7 million people worldwide
now qualify as millionaires, with their
ranks growing by 10% annually. They
are prime customers for “aspirational
brands”—high-status, luxury brands
of products such as watches, jewelry,
clothing, and handbags. Asian customers
are increasingly prime, accounting for
40% of luxury-goods spending.
Observes Halie O’Shea (at right), security
analyst/portfolio manager, who covers the
consumer sectors for our growth-investing
team: “The rise in global affluence is
driving double-digit growth in revenue
and profits for the leading luxury-goods
companies. We think high-end companies
that cater to the wealthy should have some
insulation from the economic slowdown.”
Currently Wall Street is as divided as the
Hatfields and McCoys about the outlook
for consumer spending, in light of mixed
economic signals recently; real-wage
growth is at the highest level in four
years and gasoline prices are falling, but
same-store sales are generally soft and
the housing market is weak. “However,
high-end consumers have the biggest—
and most diversified—asset bases to
draw on,” she says. “So we think high-end
spending should prove less sensitive to
any economic pressures, to the benefit
of the luxury-goods firms.”
INSIDE
2
David Honold on a less risky financial sector
3
Why is active management underperforming now?
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Paper: 12 lessons learned about tech investing
PROFILE
PORTFOLIO MANAGER SPOTLIGHT
David Honold: “As long as employment remains solid, we think the slowing economy
won’t prevent stocks from going higher.”
David Honold, 30, is a security
analyst/portfolio manager on
our growth-investing team.
On that team he is one of three
portfolio managers/analysts
who cover the financial-services
sector. He joined Turner in 2005
and is a principal of the firm.
Before coming to Turner, he held
positions with Keefe, Bruyette
& Woods, UBS, and the Federal
Reserve Bank of New York. A
member of the CFA Institute and
the CFA Society of Philadelphia,
he earned a bachelor’s degree in English with a concentration
in economics at the College of the Holy Cross.
On the market’s near-term potential
“The economic pieces appear to be falling into place for the
stock market to continue rallying; as we see it, the economy is
undergoing a classic mid-cycle slowdown at this point. Inflation
appears to be in check. The Federal Reserve is in an accommodative
stance on interest rates, and we may even see rate cuts in 2007.
The S&P 500 Index companies have just achieved their 18th
consecutive quarter of double-digit earnings growth. Earnings
growth is slowing but should continue to beat Wall Street’s
earnings expectations. As a result we think the market will
especially reward companies that can sustain above-average
earnings growth, which should bode well for growth stocks.
“If anything spoils the rally, it perhaps would be the diminishing
of what Alan Greenspan called the wealth effect, which could
throw a wrench into consumer spending, the economy, and
ultimately stocks. As housing prices begin to decelerate and
even correct in some markets, consumers may feel less wealthy
and less inclined to tap the equity in their homes to spend more.
But overall, as long as employment remains solid, we think the
slowing economy won’t prevent stocks from going higher.”
On the reduced risk of a financial crisis
“The likelihood of a crisis in financial services is less than it was
10 or 15 years. There’s been a definite increase in the sophistication
of regulatory oversight and financial institutions’ risk-management
processes. For example, securitization activity [the packaging
of pools of loans or receivables for sale to investors] has helped
to diffuse the risk of a credit-related crisis. Financial institutions
can now pick and choose what risks they are willing to retain
and what risks they want to shift from their balance sheets to
the capital markets. As a result the risk of a future financial
crisis—of one company or a group of companies suffering a major
catastrophe—seems to have decreased.
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FOURTH QUARTER 2006
“That’s one reason why the relative valuations of financial-services
stocks to the broader market has gradually increased. Also, the
market is recognizing that financial companies provide a set of
services that, although often commoditized, are always needed,
regardless of the phase of the economic cycle. That has resulted in
a steadier earnings stream for financial companies. So financial
stocks are trading at higher multiples and represent a major
market weighting—about a 23% weighting in the S&P 500 Index
today, for instance.”
On the prospects of the exchanges
“We like the prospects of the financial exchanges, which are
benefiting from the proliferation of derivatives, futures, and
commodities, as well as the shift to electronic trading. Also, we
think the international consolidation of the exchanges that’s
taking place makes sense, because the market for securities
is global and operates 24 hours a day. We think the exchanges
that acquire more scale should thrive. For instance, the Chicago
Mercantile Exchange is the premier platform for interest-rate
futures, and its acquisition of the Chicago Board of Trade will
increase the scope of its booming futures and related options
businesses, which have grown more than 30% annually in the
last couple of years.”
On insurers’ pricing power
“The property/casualty insurers have raised their prices sharply
over the past two years, in the aftermath of Hurricanes Katrina,
Rita, and Wilma. The 2006 hurricane season has been fairly
benign, so the property/casualty companies’ year-over-year price
increases are likely to be more modest. I’m no climatologist, but
it’s easy to see that the insurers’ business models have taken into
account the potentially higher frequency and severity of weather
catastrophes. Insurance pricing is cyclical, and what we’re now
seeing is a new, higher base of insurance prices.”
On the appeal of brokers and asset managers
“We think certain brokers and asset managers have stellar
long-term prospects. The brokers are benefiting from the increased
trading activity that has been a byproduct of increased volatility
in the markets. Goldman Sachs, for example, derives about
two-thirds of its revenue from trading and generates a return
on equity approaching 30%. We think Charles Schwab is doing
a good job marketing to the ‘mass affluent’—the more than 20
million U.S. households with $100,000 to $1 million to invest.
And the asset managers have significant operating leverage to
gain from gathering new assets and riding the upward direction
of the capital markets over time. Among asset managers, we
think T. Rowe Price should bolster its profitable position in the
defined-contribution retirement-plan market.”
IN RESPONSE
ASK US
Q:
“Active management, whether in the growth- or
value-investing styles, is woefully underperforming
this year. That would seem to be counterintuitive,
in that the market has been rising for most of the
year, and active management has historically done best in rising
markets. Be that as it may, the typical institution in its overall
portfolio has only a handful of investment managers who are
beating the market in 2006. And in the mutual-fund world, the
results are little better: for the year-to-date through October 31,
the great majority of large-cap, mid-cap, and small-cap funds
lagged their indexes. Why is active management doing so poorly
now, in Turner’s judgment?”
Ronald L. Ryan
Investment manager
Shell Oil Company, Houston
A:
“Active management doesn’t outperform at all
times, and this certainly is one of those times.
The lagging performance of active managers this
year has been blamed on increased market efficiency,
the best investing talent leaving active management
to run hedge funds, and outflows from mutual
funds to passively managed exchange-traded funds,
among other things. All of those reasons may have
at least some legitimacy, but we think there’s a
more basic reason why active managers are having
performance problems in 2006: a dramatic change
in the business fundamentals of commodity-related
companies—a change that has made this stock
market unlike any other in the past 30 years.
“Commodity prices generally are at all-time highs,
with the Commodity Research Bureau Metals
Sub-Index up more than 60% this year. As a result
commodity-related companies have gained lots
of pricing power and have generated the strongest
earnings momentum. Their stocks, displaying
growth-like characteristics that reflect soaring
commodity prices, have done so well that they
simply have become too expensive this year for many
value managers to own. Conversely, most growth
managers haven’t held big positions in commodityrelated stocks because those stocks have traditionally
been in the value camp; as a result of not owning
enough commodity-related stocks, growth managers’
relative investment results have suffered.
Commodity-related sectors have clearly been the
place to be this year; as of October 31, the two
best-performing sectors in the broad-based Russell
3000 Index were utilities/communication, with a
22% gain, and materials/processing, with a 14% return.
“Robust demand, especially from China and India,
and tight supplies, the result of years of underinvestment, have produced the greatest boom in
commodities in decades. We think most commodity
prices may have in fact peaked but could remain
above their average of the past 10 years, since a
healthy global economy is unlikely to significantly
change the supply/demand equation soon. So
commodity-related stocks could continue to do well.
Until commodity stocks surrender market leadership
to stocks in other value or growth sectors (as they
inevitably will), we think active managers in the
value- and growth-investing styles may continue
to have a tough time outperforming.”
Tom DiBella
Senior portfolio manager
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NEWS
NEWSPAPER
INVESTMENT BRIEFS
Barron’s profiles our firm
As Barron’s noted in an October 16
feature story about our firm, we
have flourished by buying shares
in companies with outsized earnings
prospects, even if they’re richly priced.
The story quoted this observation,
among others, by Bob Turner,
chairman and chief investment
officer: “Growth stocks are always
Bob Turner
expensive, [but] with really great
growth companies, you can have 1,000% gains over time.”
“Growth-stock managers may be perpetual optimists,” Reporter
Jack Willoughby wrote, “but Turner finds much to like” about
today’s stock market, including double-digit earnings growth,
reasonable price/earnings ratios, robust corporate free-cash flows,
and downside protection in the form of many private-equity buyers.
To get a free reprint of this feature, call us at 484.329.2329.
Among the lessons we think are noteworthy: buy the leaders
in their industries, especially in the early stages of product
life cycles; don’t equate valuations with return potential in
tech stocks; and evaluate tech companies on their ability to
innovate and the quality of their management and technical
talent. To read all 12 lessons, call us at 484.329.2329 for a
free copy of the paper.
DISCLOSURES
1. Any companies, industries, or securities mentioned in this publication
should not be perceived as investment recommendations by Turner
Investment Partners. The views expressed represent the opinions
of Turner and are not intended as a forecast or guarantee of future
results. References to specific companies’ prospects relate to the
financial fundamentals of those companies; it should be noted that
a company’s fundamentals and earnings growth are no assurance
that a company’s stock price will increase.
2. The indexes mentioned are unmanaged statistical composites of
stock-market performance. Investing in an index is not possible.
3. Past performance is no guarantee of future results, and historical
patterns are not necessarily accurate predictors of future events.
Bill McVail: we prize growth
In an October 10 interview on
Bloomberg TV, Bill McVail, senior
portfolio manager/security analyst,
discussed the diverse metrics we use
in our fundamental analysis of growth
stocks. For instance, we apply metrics
such as square footage growth in
retailing stocks, the number of design
contracts won in semiconductor stocks,
and the chances of the Food and
Drug Administration approving a
new drug in biotechnology stocks.
Bill McVail
The point in such fundamental analysis, he told Anchor Lori
Rothman, is to identify dynamic companies—companies that are
“leaders in their sectors, that have some kind of secret sauce that
differentiates them from the competition.” Above all, our growthinvesting approach prizes earnings growth, not growth at a
reasonable price, he said.
FOURTH QUARTER 2006
New paper: lessons on tech investing
In our judgment, the tech sector, although
it’s maturing and increasingly cyclical
in nature, still offers some compelling
investment opportunities. Over the years
we think we have accumulated some
useful lessons about investing in the
sector, which are discussed in our latest
position paper, 12 lessons learned about
tech investing.
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Perform is published quarterly for institutional clients and
consultants by Turner Investment Partners, 1205 Westlakes
Drive, Berwyn, Pennsylvania 19312. Founded in 1990, Turner
manages more than $20 billion in stocks in separately
managed accounts and mutual funds for institutions and
individuals, as of September 30, 2006.
Editor: Bruce Zewe
Web site: www.turnerinvestments.com