The worst is over and financial markets are set to recover. Such was the bullish optimism expressed at the Legg Mason Group’s annual investment conference, held recently in London.
Mark Fetting, the $998bn group’s new president and CEO, led a succession of speakers who heaped praise on the effective (if a little late) response of the US Federal Reserve, Treasury and Congress to the credit crisis, presented as good underpinning for a rebound across several markets – particularly US large-cap growth equities, corporate bonds and mortgages.
“I honestly believe we are past the apex of this crisis and in the recovery phase,” said Robert Hagstrom, manager of the Legg Mason Growth Trust, summing-up the mood.
Legg Mason Capital Management’s chief investment strategist Michael Maubousin said that he expects to see conditions normalising, and pointed out that the S&P 500 was currently trading “reasonably” on 13.8 times 2008 earnings, with company balance sheets looking healthy and the free cash flow yields on large-caps exceeding 10-year Treasuries.
“Dislocations almost invariably present opportunities,” he said, “and investment returns in the most depressed parts of the market offer the best opportunities for the next three to five years.
“Look at homebuilders: they’ve been left at valuations that we’ve not seen since the early 1990s, and yet the industry is now much more consolidated and balance sheets are far healthier,” added Mr Maubousin.
It was a day for contrarians. Furnished with a push-button voting system, the audience of Legg Mason clients, colleagues and peers revealed that 57 per cent of them were underweight US equities. But at the podium, Evan Bauman, manager of ClearBridge Advisors’ US Aggressive Growth Fund, singled out US equities’ earnings-yield prospects as “incredibly attractive”, and Mike Zelouf of Western Asset Management, who last year plumped for Turkish local-currency debt as his top pick for 2007, predicted that US equities would be the best-performing asset class of 2008.
An audience prediction for positive returns on Japanese equities in 2008 was the biggest consensus of the day. Within equities, US large-cap growth got the biggest cheer from the stage – with Brandywine Global Investment Management’s global equity CIO Paul Ehrlichman predicting that the sector “could turn out to be the next big mania.”
Large-cap growth
After three years in the wilderness and some stirrings in 2007, Mr Hagstrom now thinks that declining interest rates, slowing economic growth and attractive valuations make the current environment the best for large-cap growth in 13 years.
“The previous cycle’s leaders are not going to be the leaders in the next cycle,” said Peter Bourbeau, manager of ClearBridge’s US Large-Cap Growth Fund, continuing the contrarian theme. His biggest overweights are consumer discretionaries and financials alongside consumer staples and IT, while energy, industrials, materials, utilities and telecoms have been cut to zero.
The US Aggressive Growth Fund similarly weights utilities, telecoms and materials at zero, while holding significant overweights in healthcare, energy (particularly oil services) and consumer discretionaries.
Mr Hagstrom conceded that the Legg Mason Growth Trust’s positioning – concentrations in internet, global infrastructure (particularly electricity generation and repair services) and technology and wireless stocks – left it down 12 per cent in first quarter, its worst quarter since third quarter 2002 and the fifth-worst in absolute terms (but only the 13th worst relative to the S&P500).
“You can see we’ve made our big bets, we’re geared-up for the rebound,” he said. “When the Trust has had a bad quarter, historically it’s looked remarkably good 6 and 12 months later.”
However, as Mr Ehrlichman observed, if anything credit looks like it is bottoming-out even more conspicuously than US equities. Mr Zelouf noted that the market is pricing-in default rates that have not been seen since the Great Depression, and said it was time to get back into spread products following last year’s flight to quality.
“We started buying high-quality corporates last year, because these assets were the ones most affected by the crisis, and high-yield bonds are also starting to look attractive,” agreed David Hoffman, a portfolio manager with Brandywine.
“But we are even more focused on mortgages: they are priced for near depression conditions – but this is a leverage problem, not a true valuation of default risk,” he added.
As Terence Johnson, Legg Mason’s managing director of international distribution, put it in his opening address, “Depending on which newspaper you read, we’re either all going to hell in a handbasket, or we’re seeing an historically interesting inflexion point in terms of opportunity.”
