Rational Advisor

Just came out of my quarterly conference call with David Dreman and his team.These are one of my favorite managers, only because they have a great discipline and a rational approach

Here are my notes from the call

- Markets have broad concerns around confidence. Market participants do not have confidence that anyone has a good handle on this subprime thing.
- We expect a slowdown. But not a recession. The chances of a recession are increased as the housing problem in the US increases. Short term funding stress is NOT over.
- Concern is on how the US consumer reacts to this slowdown. Job reports are making us worried about the consumer. Consumer is leveraged going into this still relatively high rate environment.
- 3rd Quarter reporting period will increase volatility, a lot of companies will be showing the impact on 3Q numbers. Remember they want to keep the best reporting for their 4Q period. So will get a lot of dirty laundry in 3Q numbers
- A lot of European holders on US debt – as the US$ drops they are concerned about the quality of their paper.
- In our view, there is another correction coming, the rosy picture is just too rosy for a slowing economy. – we do not know if it will be a 2 foot wave or a 10 foot wave but we do think it is coming. The greatest concerns will be in Financials (because of sub-rime) and Health Care (because of elections). Also October is a heavier re-pricing month – what this means is that the largest amount of variable rate mortgages were sold in Oct 2005. These are now coming due in the states, so can expect some fireworks around that. Even though most of them were not to sub-prime candidates, will still see some bleeding into that area. Ultimately a slowdown will affect earnings.
- Most companies in the US have taken advantage of the lower interest rates, and made their balance sheets stronger.
- As a value manager we are excited because we can see some good opportunities coming in the financial sector (this is the sector most impacted by sub-prime). Currently our weighting in financials is lower than the benchmark. As interst rates are lowered the spread of banks profits increases (Spreads refers to the difference between what the banks pay to depositors and what they receive from lenders, as interest rates fall, they pay less to depositors, and they keep higher the amount to lenders)
- We did not add to any stocks in this recent quarter. We think our patience will pay off . This was just too volatile a sector.
- We do not have anything directly related to sub-prime, interestingly one of our positions Band of America is doing a David Dreman on Countryside Financial, in that they are adding/give it capital at the time when they have the most bad news. We will indirectly benefit from this as BofA has made a good decision.
- Energy was an area of strength for us. These stocks that we hold are low in P/E and have a good dividend yield >2%
- We will be keeping our eyes open for good industrials.
- We continue to stay away from Consumer Discretionary positions – mainly because these would have the largest impact from a consumer led slowdown.
- Our only technology position was Verizon, and Tyco electronics
- In the S&P 500 you got a quicker recovery, because it is higher in weighting in industrials and technology, a lot of these firms get their revenue from outside of the US so were deemed more attractive. The issue we have is that we do not believe in a lot of their offshore earnings, particularly those related to the emerging markets. We are not finding a lot of value in techs.
- We are not commodity players; we do not have exposure to gold. There are not any gold companies that offer dividends and are value plays. We feel that the portfolio is very well placed.
- We will continue to be patient, 4Quarter will require it – there is no material change to the portfolio.
- With interest rates falling and a slowdown, we expect the US$ to go lower, by how much we do not know, eventually it will become an election issue. On the other side, as the US$ goes lower the exports of US goods increases, and to purchase these goods they have to be bought with US$’s. So, there is a level of equilibrium.
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