May was a particularly tough month for equity investors, as the S&P 500 stock index fell more than 8 percent. This loss was not entirely unexpected, as the market has risen more than 75 percent from its low in March 2009. A 10-percent correction can be expected at least once every 12 months. The problem is that no one knows when it is coming. However, the correction provides long-term investors with the opportunity to buy stocks at extremely attractive valuations. While equities sold off, particularly in foreign markets, bonds held their values and were up about 1 percent for the month.
The market is focused on any number of things, most of them negative. Toxic debts, out-of-control government spending, health care legislation, a China bubble, double-dip recession, default of sovereign debt in Europe – the list goes on and on. However, if the fundamentals that eventually drive the market (corporate profits, real US GDP growth, inflation at zero and short-term interest rates at zero), then this market should be considered a good place to be.
For longer-term investors (not traders), the most encouraging news is in corporate profits and the balance sheets of US corporations. Corporate profits at the S&P 500 companies are projected to be around $70 per share in 2010, growing to $80 per share in 2011. Based on the current level of the S&P 500 index, the 2010 PE ratio will be about 15 times earnings and 13 times on future earnings in 2011. These are pretty compelling valuations and indicate a fair to somewhat undervalued market. We read in an interesting article that if 2000 was the era of “irrational exuberance,” when many were buying stocks of companies without earnings and without regard to values, today must be the era of “irrational pessimism,” in which the culture is more influenced by potential Armageddon fears than by current economic results. Too many were too exuberant then; perhaps too many are too pessimistic now.
We remain somewhat defensive in our portfolios, with trades we instituted a few months ago. We continue to underweight stocks with a healthy cash position and a defensive stance to the contnuing devaluation of the Euro against the dollar and the European debt problems. As we see a more settled market and if the market continues to move lower, we will begin reinvesting cash to take advantage of very attractive valuations.
New Small Cap Fund
Finding quality small-company money managers can be very difficult. Typically, those who have been successful in the past either close their funds to new investors or grow so large that they no longer can be nimble enough to buy or sell and not affect stock prices. We have completed our due diligence on Brown Capital Management, the advisor to the Brown Capital Small Company Fund (BCSIX), and have recently added investments in the fund.
Eddie Brown, the firm’s founder, is an electrical engineering graduate turned investment manager. Before setting out on his own, Mr. Brown worked at T Rowe Price for 10 years, serving as both a VP and portfolio manager. Brown Capital began in 1983, just as the country was emerging from the depths of the double
recessions of ’80 and ’82. The management team, most of whom joined in the early ‘90s, has an average of 25 years’ of experience.
The firm uses a bottom-up approach to investing, meaning they look at the overall fundamentals of a business rather than overlaying sector themes. Management tries to identify businesses early in their lifecycles that have the potential to grow exponentially. In 2009, the fund’s turnover rate was 8 percent, the equivalent of holding a stock for 12.5 years – truly long-term investing. This strategy has proven very successful during the last 10 years, as Brown has managed to annually add 5.5 percent over their benchmark, placing them in the top 15 percent among their peers.
Client Survey
Just a note to thank you for your responses to the client survey we initiated a month or so ago. We had a great response and are currently compiling the results. We will have a detailed report on the survey results in the quarterly WJournal and will take action on those issues our clients feel would help serve them better.