It’s small, small world according to GARP. That’s an investing stratagem followed by Jay Wong, senior equity strategist with Payden & Rygel’s Payden Small Cap Leaders fund, part of Payden’s $35 billion in assets money management empire downtown.
First off, Wong’s “GARP” stands for “growth at a reasonable price.” He aims to buy small cap stocks that have solid prospects for growth, but which are not overly expensive on Wall Street. With the S & P; 500 and the Russell 2000 indexes both trading at close to 30 times earnings (and recession in the air), finding bargains on Wall Street is harder than ever. But Wong, through careful selection, has managed to put a portfolio together which is cheaper than Street averages and which he projects will be more profitable than the typical small cap stock.
“The Small Cap Leaders fund has stocks with an average price-earnings ratio of 16.5,” said Wong. “That compares to an average price-earnings ratio of 28 on the Russell 2000 (a small cap index).” In addition, Wong sifts through the thousands of small caps trading, looking for those with a strong earnings outlook.
The typical stock in Wong’s portfolio projects earnings increases of 26 percent going forward, versus 19 percent for the run-of-the-mill Russell 2000 stock. By sticking to his discipline, Wong has managed year-to-date gains of 8.4 percent on his $20 million portfolio, a very handsome return when compared with the minute 1.85 percent return on the Russell 2000, the 8.5 percent decline on the S & P; 500 or the 17.5 percent drop endured on the Nasdaq composite.
Wong likes to stay invested in a mix of industries. In his portfolio of 60-plus stocks are Arch Coal Inc., a St. Louis-based coal mining outfit that sells to power plants; UCBH Holdings Inc., a San Francisco-based bank holding company for United Commercial Bank, a well-run bank which caters to the Chinese-American community; and Charlotte, N.C.-based Sonic Automotive Inc., a growing and profitable chain of luxury car dealerships.
In the ’80s and ’90s, the blue chips thumped small caps as an asset class, partly because the giant mutual funds could only buy stock with huge “floats,” or market capitalization. The tide has turned in the last two years.
But for how long?
“Things tend to run in cycles, and I think we are entering a new period,” said Wong. As small caps outperform blue chips, investors will start paying more attention to the small cap sector, and small cap mutual funds will experience inflows. That will lead to more demand and upward price pressure, something of a virtuous cycle for small cap stock owners, he said.
But Wong conceded that price-earnings ratios tend to be rich on Wall Street today, with even his “reasonably” priced stocks trading at multiples that would have been considered rich only 10 years ago. “That means you want to focus on valuations… this is a very choppy market, but a stock picker’s market,” he said. “If you pick the right stocks, you can make money.”
No More Money
The oracle of the San Gabriel Mountains, Michael Bazdarich of the La Canada-based MB Economics, has changed his tune.
Bazdarich has penned a monetarist manifesto weekly for the past several years for CBS Marketwatch Web site. “And I guess I have always been a dyed-in-the-wool monetarist… but now I think the money supply might not be as important as before. And that is a different opinion than I had in the past,” said Bazdarich.
What gives? The big item is capital (business) spending, but globalization and a forward-looking bond market play roles too. In the late 1990s, robust spending by American businesses on plant and equipment spurred the domestic economy, said Bazdarich. But that spending has been sliced by one-third in 2001, and won’t pop back just because interest rates have fallen a few percentage points.
“Businesses will spend on equipment when they see the demand for product, not a cut in rates,” said Bazdarich. And that’s unlikely when the telecom and Internet sectors are overbuilt, and many other purveyors of capital goods are sitting on large inventories.
Trade is another problem. As the U.S. economy becomes internationalized, domestic growth can reflect buying and selling from offshore. Right now the world economy is slowing, and U.S. exports softening. “What can (Fed chief Alan) Greenspan do about that?” asked Bazdarich, rhetorically. Not much, is the answer and a warning for future Fed chiefs.
Lastly, bond markets have responded to Fed cuts but not by much. Yields on long-term bonds have stayed high. “It is somewhat of a perverse effect,” said Bazdarich. “Bond investors see the Fed cuts, and think the economy is going to rebound. And that means interest rates might rise in the future. So bond investors keep the yields up. That means the Fed cuts, perversely, don’t lower long-term rates, and that helps prevent a recovery,” he said.
The upshot? “I don’t think we will see a recovery until next year,” Bazdarich said.
Direct Capital
If you looked for the Web-based Direct Stock Market (dsm.com) recently, you found your virtual way to a German plastics manufacturer.
“Yeah, we sold that web address for a pretty penny,” said Clay Womack, founder and chief executive of the former Direct Stock Market, now called Direct Capital Markets Inc., and still based in Santa Monica.
In his latest incarnation, Womack runs a Web site offering private equity placements and some smaller bond offerings (usually under $100 million). He has also linked arms with Los Angeles-based real estate brokerage CB Richard Ellis to offer a rather arcane investment tool called a “1031 exchange interest.”
Under section 1031 of the federal tax code, sellers of real estate can defer capital gains taxes if they invest in more real estate with their proceeds. Of course, not all sellers of, say, apartment buildings want to get back into the business of hands-on property ownership and management. Accordingly, Womack’s site is touting a real estate trust put together with CB Richard Ellis. “Sellers can take their proceeds and buy into a pool of institutional grade office buildings,” said Womack.
From a legal standpoint, buyers are investing in a private placement, and they keep the tax deferral. Womack anticipates that such investments will become more liquid in the future, but for now he is offering only distribution, not trading, in units in the CB Richard Ellis pool.
Contributing columnist Benjamin Mark Cole writes about the local investment community for the Los Angeles Business Journal. His new book is “The Pied Pipers of Wall Street: How Analysts Sell You Down the River,” published by Bloomberg Press. He can be reached at [email protected].
