Fund Times: Managers Say Stocks Have Been Cheaper

Many managers have been telling us and their shareholders that the stocks in their portfolios are cheap--really cheap. As in, "I have never seen valuations so low before in my investment career" cheap. While it may be true that stocks may offer potential returns in excess of their historical cost of equity or historical returns, they have been cheaper. The last time stocks were very cheap, according to two prominent fund industry veterans, was back in 1982, almost 27 years ago. And the market would have to fall a lot more to reach those levels, they say.

GMO's Jeremy Grantham (registration required) has seen many different market cycles since helping to start GMO in 1977 and entering the investment business in the 1960s, and he recently described the market's valuation this way:

     "The forecast for the S&P has been jumping around 6% to 7% real, with other global equities slightly higher. To put that in perspective, a 1-year forecast done on the same basis we use today that started in December 1974 would have predicted a 14% return (which, by the way, it did not deliver since the market stayed so cheap). For August 1982, the forecast would have been shockingly high � over 20% real! So do not think for a second that this is as low as markets can get."

I estimated that the S&P 500 Index would have to trade near 550 to offer a 14% real return using GMO forecasts. To reach 1982 levels of "cheap," the S&P would have to approach the 400 level.

John Hussman, manager of Hussman Strategic Total Return (HSTRX), came up with similar numbers with a different methodology. To match the worst historical troughs of market valuations he estimates the S&P 500 Index would have to decline to somewhere between 500 and 550. At that level, "stocks would be priced to deliver total returns over the following decade in the likely range of 14-17% annually," he recently wrote in a commentary. Hussman thinks the market's current valuation would lead to nominal returns in the 9%-11% range. Assuming less than 3% inflation, the estimates are almost identical.

So in two different markets--1974 and 1982--stocks fell to the point where they offered investors real prospective returns of at least 14% before hitting bottom. Even with the S&P 500 now hovering around 750 the index would have to shed about another 200 points (roughly a 25% drop) to reach 1974 valuations. That doesn't mean stocks will get cheaper, but it does mean that they could. That's worth bearing in mind as you reset your return expectations.

Star Manager Elmasry to Leave Morgan Stanley
We can now disclose that Hassan Elmasry, one of the best managers in his field in our view, is leaving Morgan Stanley at the end of April to start his own money management firm in London. Elmasry and his team currently run  Van Kampen Global Franchise  (and its Morgan Stanley clone),  Van Kampen American Franchise (VAFAX), and  Van Kampen Global Value  (and its Morgan Stanley clone), as well as similar funds domiciled in the U.K., Australia, and Luxembourg.

We've covered Elmasry for many years and believe his loss will be a blow to the funds and the firm. Indeed, Morgan Stanley's broad asset-management arm has had its struggles over the years: Acquisitions of MAS, Van Kampen, and Dean Witter left the firm with what our analysts saw as an ill-defined investment culture and an overwhelming emphasis on sales. However, the firm subsequently pursued a multiboutique strategy, and a few real stars emerged along the way. Brightest among them were Elmasry's unit in London, boutiques in the U.S. headed by Jim Gilligan (who came over in the Van Kampen acquisition), and Dennis Lynch's in New York.

Elmasry's funds' records speak for themselves. He took over as lead manager in the group when Andrew Brown departed in April 2002. Over the past five years, the Global Franchise funds have outpaced the MSCI World Index by more than 4.5% annualized. (Elmasry's team has run the other U.S.-sold funds for shorter periods.)

The Global Franchise funds have held up particularly well in the credit crunch, posting losses of 28% (for the Morgan Stanley fund) and 29% (for the Van Kampen fund) in 2008, compared with a loss of 41% for the MSCI World Index. They benefited from their emphasis on companies with strong franchises that offer long-term sustainable growth--this steers them mostly to consumer services and consumer goods issues, areas that have offered pockets of safety amid the market downturn. Conversely, the funds have almost nothing in energy, industrials, or financials, which has insulated them from the wreckage in those areas.

Elmasry will be starting his own firm, which will be based in London, and says he will run money in the same style he uses at his Morgan Stanley offerings. Until then, he states that he will still be running the funds and making buy/sell decisions as usual.

The real question is whether his team will follow him out the door. Elmasry has three comanagers--Paras Dodhia started in 2002, Jayson Vowles in 2003, and Michael Allison in 2005. Our fund analysts have discussed the situation with the team, and, although they are in talks with the firm (and Elmasry) about their future, nothing has been decided at this point. We believe there is a real risk they could leave. For now, given that the team is still intact and the relatively stable nature of the portfolio (Elmasry has a low-turnover, long-term-oriented style), there appears to be little need for investors in the fund to rush to a decision, but there's far too much uncertainty here for our taste.

Putnam Hires Former Fidelity Manager 
Putnam hired David Glancy to run two funds it plans to launch, both of which would invest in leveraged securities. Glancy previously ran  Fidelity Capital & Income (FAGIX) and  Fidelity Leveraged Company Stock (FLVCX) and spent more than a decade with Fidelity. He left Fidelity in 2003 to start Andover Capital, a hedge fund with close to $300 million in assets. Glancy's hedge-fund record was mixed. It gained, before fees, 21% in 2006 but lost 6% the following year.

Statements of Additional Information
The $73 million in assets RiverSource Global Technology  is being merged into the $150 million in assets  Seligman Global Technology (SHGTX). While the Seligman fund has done better than the RiverSource fund, RiverSource shareholders that choose to stick around will be paying for the privilege. The Seligman fund costs substantially more.

 Allianz NFJ Small Cap Value (PCVAX) will close to new investors on April 20. It reopened in early 2008. This bodes well for existing shareholders and shows the advisors are cautiously managing inflows.

 Lord Abbett Small-Cap Value (LRSCX), which has been closed since 2001, is reopening to new retirement plans, and potentially other investors, through TIAA-CREF. This comes on the heels of a management change. Longtime manager Bob Fetch recently left for a new position overseeing all of Lord Abbett's equity funds.

Christopher Traulsen, Morningstar's director of fund research, Europe, contributed to this article.