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By Jason Stipp | 06-24-2010 03:26 PM

Muhlenkamp: Sometimes Values Don't Matter

In times of forced selling and financial panic, institutional investors often sell off indiscriminately without regard to intrinsic value, says Ron Muhlenkamp.

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Jason Stipp: I'm Jason Stipp for Morningstar. We're reporting from the 2010 Morningstar Investment Conference, and I'm here with Ron Muhlenkamp with the Muhlenkamp Fund. He's going to tell us a little bit about his macro take today and also how he's been positioning his portfolio recently.

Thanks for joining me, Ron.

Ron Muhlenkamp: Jason, it's a pleasure.

Stipp: The first question for you, I think that the market has been sending us a lot of mixed signals recently. On one hand, we've got corporate earnings that have been beating analyst expectations this year, but on the other hand, there are some bigger concerns about debt loads on the government, about stimulus wearing off, about the deficit that sort of clouds on the horizon. When you're getting these two signals, how do you think about that and the prospects for the market, given that it doesn't seem like there is certainty about anything?

Muhlenkamp: Well, I'm going to take it back just a little bit. We always look for good companies at cheap prices; that's ongoing. I got in this business in 1968 and from the early '70s, the game changed considerably. We called it changing climate when you had to look – if you only looked at the small stuff, you got bagged, and to some extent, we got bagged a little bit in the last couple years.

What we think happened in '08 that we haven't seen written to the extent that I think it deserves is the amount of forced selling that was going on. We believe that between hedge funds having to de-leverage, and both hedge funds and mutual funds getting redemptions, you probably had over $1 trillion of forced selling in '08.

Well, if you have forced selling, values don't matter. And as everyone knows that in '08, everything went down. The phrase is, all the correlations went to one, but the point is, if you must de-leverage or you get redemptions, if you can't sell the things you'd like to sell, you sell what you can get a bid on. So everything went down in '08, and what we added to our checklist of things to watch and to worry about is who might have to sell and how much? And we think, the forced selling is over in the United States.

However, our fear is that some of the European banks may be just – and forced selling doesn't necessarily have to be legal or to fit a margin requirement. It can be psychological. We saw people in March of '09 who sold because they simply couldn't sleep at night, and what we've been trying to monitor this year is whether there is evidence that specifically, and the trouble is with even in '08 with the forced selling, you couldn't get good numbers on it. We couldn't get good numbers on how much de-leveraging was going on, and when you page through the book of stocks, to some extent, this year being 2010, there are times when the big broadly, widely held international companies tend to act like they're being sold almost regardless of price, more so than the other stuff. Well, this is the kinds of things that if you are a bank in France or Germany or various places, it might be susceptible to, so we think that that's part of what's going on.

And of course, beyond that is simply the macro versus micro; and right now, we're about to get another round of the G-20 meetings, and the European countries are coming and saying, "We're cutting back on our spending." and our leaders are saying, "Oh, but you need to spend more for the stimulus kind of things." To some extent, what we tried to do this time in the recent recession and we've tried it the last couple times was to avoid a recession, and I've argued for 30 years that recession are sort of a useful function in the economy.

Today I would argue they serve a necessary function in the economy, and that sometimes in trying to avoid them, you create more problems that you solve. So what we've managed, it looks to us like in the U.S. that the recession is over. Now when I tell that to the general public, they laugh at me, because they have a different definition than much of what's going on.

But the very fact that we tried to avoid it, we ended up doing some things that have long tail – sometimes, the side effects of the cure are worse than the disease, and we may be flirting with that again, but it has been a period of very mixed signals. When you look at companies, it's very easy to get bullish. When you look at debt and deficits and the direction of that, it gives you a pause as to what's going on out there.

We're trying. We say we want to create jobs and yet we're acting in ways that discourage the job creators. That is the employers. It's very hard to have an employee without having an employer, and yet as an employer, I've got 20 employees, I'm pretty certain that my taxes are going up. I'm pretty certain the regulation is going up. I'm pretty certain that the cost of providing them with health insurance is going up, which is rather discouraging in terms of hiring new employees.

And we have said throughout this recovery that we thought it was going to be slow for employment to come back and that remains true. Behind all that we're finding great companies at cheap prices, and until '08, for 40 years, the thing that kept us in real good stead was when you find good companies at cheap prices, just go buy them, and don't worry too much about what the trigger might be or what the horizon might be. That worked very well up until '08. In '08, I got bagged.

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