Advisor Expects Economic Easing and Rewarding Opportunities in 2003
Speaking at a teleconference held on December 4, 2002, investment professionals of National City Investment Management Company shared their thoughts on the economy and the investment climate for the last days of 2002, and what lies ahead for 2003. National City Investment Management Company is the investment adviser to Armada Funds, and has approximately $27 billion in assets under management. The Armada Funds has 32 mutual funds totaling $16 billion in assets under management.
In looking at 2003 and the road to economic recovery, the one overriding question remains, "Is it different this time?" asked Don Ross, President and Chief Investment Officer. Will our current emergence from recession be vastly different from other historical recessionary recoveries? We believe the answer is "no."
We don't think the economy will fall into a double dip recession and we don't think you'll see deflation, disinflation or inflation in 2003, Ross proffered. The Federal Reserve has drawn a line in the sand and we believe the Fed will take whatever steps are needed to prevent any of those scenarios, he added. In our opinion, the year-over-year GDP growth will be between 3 and 3-1/2 percent.
While 2002 will be remembered as the year of "Jail to the Chief," 2003 will offer investment opportunities, Ross said. We believe both the quantity and quality of earnings will return, and small cap stocks will lead the equity horse race. Additionally, the growth versus value pendulum is likely to swing back toward growth stocks. As for the bond market, credit spreads are very wide. "We believe you will be paid for taking credit risk, for the first time in several years" Ross said.
It is not different this time, as many of the same issues were also present during the last and previous economic recoveries, said Dan Bandi, Managing Director of Equity Investments. Despite the snail's paced economic recovery, and the equity market's double-digit jump since October 9th, he believes many stocks have not yet felt the impact of the recovery.
Who are the likely beneficiaries of the recovery? We expect small cap and cyclical stocks, including technology stocks, to rally next year, Bandi said. We like financial services companies in areas leveraged to the economic turnaround. But we don't like banks in the small cap sector because they now have relatively high valuations and not much leverage in a rising economy, and we don't like REITs, Bandi added.
Given the current economic backdrop, there may be ways to play the cyclical recovery in profits in 2003, said Crit Thomas, Director of Growth Equity Investments. For a growth manager, that means looking to technology stocks, which tend to be the most leveraged to a profit recovery. "But we want to be careful about valuations as we anticipate a more muted profits recovery than we've seen coming out of past recessions," Thomas said. Valuations are of a lesser concern in the small- to mid-cap areas, according to Thomas.
We find that there is reason for optimism, especially for the small-cap growth sector which has been the worst performing equity asset class over the past 10 years, Thomas noted. Earnings may be the upside drivers. We've been adding to technology and paring back on both the financial and consumer staples sector as they tend to underperform as profitability returns, he said.
Over the last couple of years, we have underweighted corporate bonds amid accounting concerns, corporate scandals and bankruptcies, said Andy Harding, Director of Taxable Fixed-Income Investments. "Now it's time to reevaluate corporate bonds and high yields," he added. "We believe lower quality bonds will outperform in the coming year."
We think the bottoming out of the economy will push interest rates slightly higher, but not significantly higher, and we expect the yield curve to flatten, he said. "Treasuries have been the best performers over the last two years; but we think that's about to reverse," Harding said.
"Our basic tenet is it's not what you make, but what you keep," said Stephen Carpenter, Senior Portfolio Manager, Tax-Exempt Investments. We use high premium bonds and think that higher coupon bonds are more defensive to principal as rates increase, Carpenter added. Right now, tax-exempt bonds are cheap, but 15 states are on negative credit watch as many state rainy day funds have run dry. We are avoiding states dependent on income tax receipts such as California, New York, and other New England and Great Lakes states, but think Georgia, Maryland, South Carolina and Virginia will stage a comeback as the economy recovers, he predicted.
As for which sectors we prefer, we recognize that the recession has led to the worst deterioration of balance sheets since WWII. Consequently, we are de-emphasizing tourist-related areas and are still avoiding airport bonds. Unlike the Federal Government, state governments cannot run deficits. We also like real revenue bonds, such as water and sewer, but are avoiding healthcare issues as they've suffered problems, said Carpenter.
We are also avoiding tobacco bonds like the plague, Carpenter noted. As part of the settlement of lawsuits states brought against the big tobacco companies, these companies were required to pay the states money to be used for anti-smoking campaigns and to pay health benefits to smokers. But several states have issued bonds based upon these payments. "This is not a general obligation of the state," Carpenter advised. Some states are using these funds, not for their intended purpose but to cover their deficits, he said.
As a top down manager in the international equity style, we are favoring investing predominantly in Europe (75 percent), to a smaller degree in Asia (22 percent), as well as allocating much smaller amounts to the nations of Brazil, Mexico and Canada, said Alfredo Rotemberg, Portfolio Manager, International Equity Investments.
We favor the United Kingdom over other countries in Europe because of its low rates and better growth rates, according to Rotemberg. We are over-weighting U.K. banks that we believe are healthy and have good margins. We also like certain industrials. We love Australia because the country is leveraged to mining and basic materials, and we like Emerging Asia whose success is leveraged to consumer consumption, Rotemberg said.
But we are not currently investing in Germany because we think growth in Germany has come to almost a standstill, unemployment is rising and the government's revenue is eroding, causing taxes to climb, Rotemberg said. And in Japan, the weak banking system will likely mean some banks will be put into bankruptcy.
"2002 has been an exciting year for our funds," said Kathleen Barr, Senior Vice President and Managing Director of the Armada Funds. We have done well expanding the distribution of our funds outside of National City to second-tier wirehouses and regional broker/dealers. We hang our reputation on three core objectives: diversification, asset allocation and risk management. And we are continuing to offer new funds, such as the Armada Short Duration Bond Fund we launched last month, and the Small/Mid Cap Value Fund we launched earlier this year, she said. In 2003, we expect to debut a high yield bond fund.
About the Author
Wayne F. Currie is Chairman and CEO of Incentive Capital Management, Inc. He has been a financial planner and investment advisor since 1970.
The information herein was obtained by various sources; National City Investment Management Company does not guarantee its accuracy or completeness. Investments in securities are not insured or guaranteed by a bank or the Federal Deposit Insurance Corporation or any other governmental agency and involve investment risks, including the possible loss of the principal amount invested.
These views represent the opinions of National City Investment Management Company (IMC) and are not intended to predict or depict performance of any investment. These views are as of December 4, 2002, and should not be relied upon by the reader as research or investment advice regarding any mutual fund or any stock in particular, and are subject to change based on subsequent developments. This material is not intended as investment advice, for which a financial advisor should be consulted. The purchase and sale information provided should not be construed as a recommendation to purchase or sell a security. There is no assurance as of the date of this material that the securities mentioned remain in the portfolios managed by IMC.