By John Kimelman
As a go-anywhere fund manager, Ron Muhlenkamp has the ability to take on as much cash as he likes.
So it says something that the manager of the $2.9 billon Muhlenkamp Fund (MUHLX) now has 100% of his portfolio in stocks.
“If I saw a depression coming, I would have zero stocks and probably 100% in Treasuries,” he says.
Instead, Muhlenkamp sees the Federal Reserve succeeding in engineering a so-called soft landing, an economy that chugs along at 2% or 3% a year and propels stocks forward.
As passionate a student of macroeconomics as he is of fundamental securities analysis, Muhlenkamp is one of those rare portfolio managers who takes a top-down, macro view of the markets before making stock picks.
Over the past decade, his flagship fund has generated a 13.6% annualized return, beating the Standard & Poor’s 500 index by almost five percentage points. His five- and three-year returns have also outpaced the market.
In recent months, some big bets on economic cyclicals such as home builders and energy got him in trouble. But he’s not backing away from his generally positive view of the economy.
Barron’s Online: Unlike most money managers, you actually have a well-researched view of the economy and it greatly informs your investment choices. Tell me what the economy will be up to?
Muhlenkamp: We’ve been saying for a year that we thought that most likely it was a soft landing as opposed to a recession.
We’ve been saying that the odds of a soft landing were greater than 50%, but we think those odds are now increasing. If I’m wrong and we have a recession, then I don’t own the right stuff. If I’m right and this comes out as a soft landing, we will come out looking pretty good.
Q: In an essay on your Website, you point out that the Fed has been notoriously bad over history in engineering soft landings. At a time likes this, we tend to go into recession. So what is it about the economic circumstances now that makes you so convinced that this is going to be one of those unusual times where the Fed gets it right?
A: Since World War II, we’ve had 10 recessions and one soft landing. Now the trouble with soft landings is you are then vulnerable to something from the outside, [such as a war or oil prices going up]. But the Fed has gotten better at letting people know what it is doing. [Former Fed Chairman Alan] Greenspan pretty much followed interest rates rather then led them, and [current Fed Chairman] Ben Bernanke is kind of doing the same thing. But the fact that they let people know what they were doing is different than the past.
Also, this time around, banks’ balance sheets have been in great shape, corporate balance sheets have been in great shape. The concern is how good are the consumer balance sheets? We made a lot of money the last six years, betting that the consumer was in better shape than people feared and figured. We still think that’s true. So our belief was that with not a lot of financial vulnerability in banks or in corporations and the Fed being open about what it is doing, the odds here were for a soft landing.
Q: What about the consumer side of things, are you not as concerned as a lot of other people that this decline in housing values is going to hurt the consumer.
A: Everybody looks at debt-to-income to judge the consumer, which can get scary. We think if you are going to look at debt, which is a balance sheet item, you should look at assets-to-debt, both of which are balance sheet items. And in fact consumer assets are 5½ times debt. A half century ago, it was 4½ times.
We worried about debt in the ’80s; as long as the economy is growing we can grow our way out of this stuff. In the meantime, we’re three times as prosperous per capita as our grandparents were in 1950. On a percentage basis, what we spend on food and clothing has been cut in half. It has literally gone from 38% of the budget to 18% of the budget. Housing has been flat since the 1960s, except that our new houses are three times what they were then in size.
But the long and short of it is the consumer balance sheet is in pretty good shape. If people have jobs, and keep jobs, which they are, then they generate a lot of discretionary income.
Q: So what kind of economic growth will we have in the next year or so?
A: Our best bet going forward is 2½% to 3%.
Q: Give me an example of a stock that you are buying outright for the first time or adding to?
A: I would be buying Cemex (CX), the Mexican-based cement maker, except I already own a bunch of it. If you came in today, I would buy you Cemex. The company has a free cash flow that is 10% of market cap, so I can either get 5% on the bond or 10% from Cemex. Now if they were taking that free cash flow and pouring it down a rathole, then it doesn’t do me any good. But in fact what they are doing, which is the same thing they’ve been doing for a decade, is borrowing money and buying more cement companies. Running them and generating cash, and paying down the debt, and doing it again.
It is just a good well-run cement company. For a couple of years it did nothing for us, and then last year it doubled, which is why it has become the biggest [holding].
Q: What’s another stock you like right now?
A: Allstate (ALL). The company has had problems, but new management has come along and fixed it. They are at about eight times 2006 earnings, generating a lot of cash, and buying their own stock. But that is a company-specific play; I’m not buying insurance companies across the board.
Q: What is the future of property and casualty insurers like Allstate that sell primarily through traditional brokers, given the success of companies such as Geico, which sells direct to consumers?
A: I have no opinion.
Q: You don’t have an opinion, even though you see enough merits to the company to recommend it?
A: If Allstate were 12 or 15 times earnings, those things become relevant. At eight times earnings, I don’t care. It’s a better company than it was; they fixed their problems and they are still selling cheap.
Q: What about a cheap company that’s worth buying?
A: Masco Corp. (MAS). They are the largest supplier to Home Depot and Lowe’s. Now we bought them several years ago because they were selling at half the P/E of Home Depot and Lowe’s. Since then Home Depot and Lowe’s P/E has come down.
Masco has said publicly that they will return a billion shares a year to the shareholders either through dividends or corporate buybacks. The market value of the company is less than $10 billion, so they’re returning 10% to us, that’s not bad.
Now, can I find things that are better, maybe, but that is certainly better than a bond returning 5%. Masco is saying, “If we don’t grow we’ll send the money back to you, or if we do grow, we’ll plow money back into the business.”