• Eagle Asset Management’s equity and fixed-income portfolio managers regularly meet to discuss current events in the financial markets, where they believe things are heading and potential opportunities for investors.
• The global economic recovery is generally continuing to move along, albeit slowly. There remain some areas of concern but also reasons for continued optimism.
• The general consensus is that growth will be harder for companies to find if the recovery continues at its pace but there are good investing opportunities in many asset classes.
• Eagle managers continue to believe independent, diligent research is paramount in selecting stocks and bonds for long-term investors.

Eagle’s portfolio managers gather regularly to discuss market trends and what they are doing in their portfolios.  Twice a year, we publish their comments. 

The global economic recovery is moving along but there remain some areas of concern.
Our managers’ discussion included such things as rising commodity prices, lingering real-estate problems and – perhaps most interesting to readers – how they have investment
portfolios positioned.

Included in the most recent roundtable were Bert L. Boksen (Small Cap Growth and Mid Cap Growth); James Camp (Fixed Income); Ed Cowart (Equity Income and Value); Todd McCallister (Small/Mid Cap Core); Jack McPherson (Small Cap Core Value); Eric Mintz (Small Cap Growth and Mid Cap Growth); Richard Skeppstrom (Large Cap Core); and Stacey Serafini Thomas (Small/Mid Cap Core); and Cooper Abbott (Head of Investments), who served as moderator.

Moderator (Cooper Abbott, Head of Investments): 2010 ended with a surge in consumer confidence and the new year has brought unrest in the Middle East (some democratic-ish, some less so); a re-emergence of sovereign-debt issues in Europe; S&P’s comments on the U.S. debt rating; an increase in commodity prices; and budget battles in states across the country. Nevertheless, the stock market has kept posting positive returns in the meantime.

So let’s open by discussing your view on the market and generally how you’re positioning your portfolios to meet your long-term objectives.

Bert Boksen: I was at this conference two years ago and it was gloom and doom; the mood could not have been worse. The thought was the world was coming to an end. Last year, I came and said, “We have had a very strong rally from the bottom but I don’t think you missed all of it.”

We remain bullish today, notwithstanding the debt crisis, the trillion-dollar budget deficit and rising gas prices, although gas prices are our biggest concern. Economics are good, not great, but improvement keeps coming. The political scene is benign and, of course, there’s a presidential election next year.

You would think that with some stocks at an all-time high, sentiment would be positive and there might be a bubble growing. But we don’t see that happening. Investors are wary: They got wiped out in the dot-com bubble and again  in the financial crisis of 2008-’09. I don’t believe investors have emotionally recovered.

In the small-cap space, for example, there is reason for optimism. This is a relatively slow-growing economic recovery but big companies are sitting on a lot of cash. There’s been a pickup in mergers-and-acquisitions (M&A) activity because the way some of those larger companies are going to grow in this environment is by buying smaller ones. And small-cap companies are still reasonably priced.

Two years ago, I asked advisors how many of their clients were begging for stocks and not a hand went up in the room. I asked the same thing last year and got three or four hands. How about this year? That’s improving; there are about 25 hands up now. Maybe next year everyone in the room will have their hand up.

Next year might be a little tougher as the market tries to start seeing past the 2012 presidential election – which is when some hard decisions may get made in terms of interest rates, the deficit and tax rates – but I believe we’re looking at smooth sailing for the rest of this year.

Moderator: Let’s take a look at the large-cap space. What are you seeing there?

Ed Cowart: Well, I believe it’s helpful to reflect back on some of the investment opportunities that were in the market two years ago.  In the fixed-income market, you could buy high-yield bonds with 25 percent yields; today, the average is less than 8 percent. You could buy investment-grade bonds, if you didn’t want to take the risk of high-yield, with 10 percent or 11 percent yields; today, those numbers are around 4 percent. And, if you didn’t want to take any risk at all, you could go to the bank and buy a six- or nine-month CD with a 2.5 percent return; today, CDs offer returns that are barely above zero percent.

What has happened is the market has doubled and earnings have doubled right along with it. There appears to me to be a pretty solid floor under stocks right now. They’re not dirt-cheap but, especially considering the strength of corporate balance sheets and cash flows, people are rightly getting comfortable getting back into stocks. In March 2009, the S&P 500 Index was selling at 13 times estimated year-ahead earnings. Today, it is still selling at 13 times estimated earnings.

I joke with consultants about if the market has gotten high enough for people to want to buy stocks. And they give a wry smile and say, “Well, it’s getting there.” It’s funny: Stocks are the only things American people seem not to want to buy on sale; instead, they wait until the prices go up. And then up a little more. That’s partly human nature, particularly after two crushing markets in the last decade.

That said, people have obligations – retirement, college tuition and the like – that are down the road that they need to fund. Stocks are really the only instruments right now that, in my mind, promise a positive rate of return.

We’re actually encouraged by the skepticism a lot of people still have about stocks. We clearly are a long way from the euphoria that’s going to mark the top of the market. We don’t believe the market is likely to double from here but large-cap stocks in particular will grind out a positive, high-single-digit, maybe low-double-digit rate of return.

There are some real issues that we, along with everyone else, will keep our eyes on – Middle East uprisings, the end of the Federal Reserve’s second round of quantitative easing, sovereign-debt issues – but the market historically has gone down when it’s unsure what it’s facing. These things are out there; everyone knows about them. We’re going to work through them and that’s why we’re pretty comfortable with a lot of the large-cap stocks right now.

Moderator: Todd, how about what you’ve seen in the small- and mid-cap space, to bridge the gap between Bert and Ed?

Todd McCallister: Stocks have done well despite all the worry. There remains a good bit of headline fatigue over the things Ed just mentioned. But companies are earning cash and many are still largely holding it more than spending it.

Company executives now have tools to measure and manage their businesses in ways that weren’t previously possible. Many people predicted the end of the world in 2009. Sales dropped substantially; investors panicked; and managers cut back: on capital spending, on employment and outstanding debt.

The number of S&P 500 companies that currently have margins of greater than 20 percent is simply astounding. It’s a testament to Corporate America, really, and its measured reaction to the economic crisis. However, the margin performance is completely out of sync with the economic cycle and that’s never really happened before. We’ve had record-high margins against a backdrop of 1.8 percent gross domestic product (GDP) growth. There is plenty of dry powder when companies decide to spend. I hope they start doing so soon before we get too far along in this cycle.

The other thing I believe you must pay attention to is energy costs. Oil will reach a price equilibrium in the short term but it’s a long-term concern. I’m convinced that, despite their assurances to the contrary, Saudi Arabia is producing all the oil it really can. The way prices for less-desirable high-sulfur crude oil rose just as much as those of low-sulfur crude is something that wouldn’t have happened, in my mind, if there weren’t real concerns about increased capacity.

Further, ChIndia – a made-up word to describe the growing economies of China and India – will be ready to gobble up whatever production we can eke out of the system.

I’m a little nervous about the metals markets even though – or maybe because – the correlation between the market and metals has been enormous the last three years. Maybe not when I go to the gas station but as portfolio manager I remain more constructive on energy.

Stacey Serafini Thomas: One of the themes that I believe will be prominent in the market over the next several years – especially if we see continued tepid economic growth – is an increased level of corporate M&A. Large-cap companies have underinvested, they have a ton of excess cash and they need to grow. That growth will be hard to come by on their own. Therefore, they will need to rely on acquired growth. Small- and mid-cap companies fit the bill here.

Moderator: Jack, talk about what you’re seeing in the market and how you’re positioning your portfolio.

Jack McPherson: Lower-quality stocks outperformed higher-quality stocks for the last couple of years but there are emerging signs that investors’ risk tolerances are shifting back to more historic levels so that bodes well for good stock-pickers. Small caps have done so well relative to large caps that you really can’t hide from the fact that small-cap stocks are a little more expensive now than their larger-cap brethren.

But that speaks to the broad indices, not all the companies in them. As always, the market is about setting expectations. It’s not likely small-cap stocks’ outperformance can continue at the same pace but I believe it can continue. It’s our job to find those companies that aren’t currently overpriced.

The economy is in recovery mode, albeit slowly. There clearly are known risks but for now, things seem to be improving. I believe that’s a favorable backdrop for the kinds of small-cap stocks we like.

Moderator: Discuss your observations on the S&P 500
and how that translates to your portfolio.

Richard Skeppstrom: I’m going to add a dramatic flair to this conversation by describing the market as diabolical. The largest large-cap tech stocks, for example, are extremely inexpensive while those that are tilted toward the “endless” growth of China and India are nearly twice as expensive.

It presents a real dilemma: You can buy Caterpillar, for example, and pray that China doesn’t slow down so all the growth and earnings numbers work out. Or, you can buy Microsoft at less than 10 times earnings, knowing it doesn’t have a tablet device in the marketplace and what that might mean.

On the one hand, I would like to believe that Caterpillar has a very dynamic, growing business over the next five years and that China’s and India’s construction boom will continue unabated. On the other hand, we’ve just been through one of the greatest global construction booms ever and there’s a lot of existing Caterpillar equipment already out there that isn’t going to rust away in the next couple of years.

In the meantime, competitors around the world will be “reverse-engineering” their machines and building copies to sell. History leads me to say that Caterpillar’s managers will be the last people to know there are too many machines in the world. They’ll “know” well after the rest of the market has noticed and the stock already has fallen.

Large technology stocks reacted to the tech wreck by becoming less capital intensive and less cyclical. Microsoft has had ridiculously strong numbers for two years but its stock has done nothing but go sideways in the great market. It’s confusing.

Moderator: James, tell us about some fixed-income dynamics going on. Much was made of possible municipal defaults and concerns about the U.S. federal debt.

James Camp: I believe an interesting perception about fixed income right now is that many investors’ default mind-set is that interest rates are going up, they have to go up. Many Wall Street economists have said, every month since 2002, that interest rates are going up! I would argue that that conclusion could be erroneous and potentially costly for investors if they abandon bonds because of it.

I don’t know that we’ve really resolved any of the problems that got us into the debt super-cycle. The Federal Reserve knows this and, for the first time at least in my career, has established a policy of wanting risk assets bid up. Why? Banks aren’t interested in lending. Loan rates are the lowest they’ve been since the 1970s. They know what they’re doing and, based on the run stocks have had, they’re getting the results they wanted. I’m not saying that’s wrong but it has risks, not the least of which would be investors abandoning the asset-allocation “religion” we all said we learned in 1998.

The second problem that we continue to have is the housing market. I started this conversation a year and a half ago and said it is likely we will experience a double-dip in housing and the S&P/Case-Shiller Index is telling us that housing is double-dipping right now. We are at 2009 levels. One in five homes in this country is going to default. And banks aren’t lending because they’re worried about another downturn in housing so, instead, they continue to bolster their balance sheets.

The debt super-cycle is not gone. And it’s going to be difficult to get a real “pop” from the consumer when employment, while improving, is not great and – again – housing values slide. Further, wages are lower. The good news, such as it is, about that is that we don’t have an imminent inflation problem – despite rising commodity prices, which tend to be temporal – because it’s not likely we have an imminent wage problem.

I point these things out to challenge the notion that interest rates have to go up. So, it probably makes sense to find relative value in the market where it is now. One area that may be is municipal bonds, which were tossed aside months ago when people were convinced every government entity across the country was going to default.

Municipal bonds now are really inexpensive and they
offer the same tax protections today as they always have. I can’t tell you when, exactly, taxes are going to go up but they likely will go up. And it’s a $3 trillion – with a T – market where good managers can find really solid, tax-preferred investments.

In the world of taxable fixed income securities we remain committed to holding higher quality, shorter duration bonds that offer more protection in a difficult interest rate environment. However, in the short run, more risky lower quality bonds have been rewarded. We do not expect that trend to continue.

Moderator: The Fed has said it is technically winding down its second round of quantitative easing, also known as QE2. What will its legacy be? And what of the fact the Fed will continue to purchase some assets?

Cowart: The disappointing thing to me about QE2 is that all that ultimately happened was that the Fed bought bonds from the banks, which essentially said “Thank you very much” and put the proceeds on their books and kept them there. QE2 didn’t stimulate any loan growth.

McPherson: What I want to know is how the government can wind down nearly $2 trillion worth of assets on the Fed’s balance sheet. The market – which does about $10 billion a month – cannot absorb that. Consequently, I believe we have a non-legislated, non-regulated financing deal on the Federal Reserve’s balance sheet that we just must abide.

Next, we still haven’t replaced the secondary market for mortgage securities or commercial credit in this country. Fannie Mae and Freddie Mac, really the largest bank failures in history, still constitute 95 percent of what I would say is a non-functioning market.

How QE2 really ends depends on how the economy progresses. There could be QE3 pretty quickly after QE2 if things start wobbling when it’s removed.

Camp: There is an unprecedented amount of policy intervention and manipulation in the economy right now. The “risk on” trade is still working in the equity markets and I still have money there. But we all should ask ourselves what happens when the unforeseen happens.

The government seems willing to provide a lot of support in the hopes that if we prime the pump long enough, what’s next will show itself eventually.

Moderator:  Macroeconomic drivers in the equity markets have made it tough of late for fundamental stock-pickers to outperform. Are you seeing any regime changes in 2011?

McCallister: Correlations were historically high – near 70 percent – in 2010. What was particularly noteworthy about that is that it was the first time a correlation rate even close to that high has come in a bull market. Those kinds of numbers usually happen during market corrections. The upshot is that being a high-beta investor worked in 2010.

What we’re seeing recently is the correlation numbers coming down to what we would expect to see in this kind of market. I believe that may be because people are getting more comfortable with the market. If you’re not sure about things, maybe it’s easier to buy an ETF over the phone and if things get hairy, it’s easy to sell. Now, maybe people are more willing to be more committed to the market.

Part of the higher correlation may come from black-box, computerized programs or the increased use of exchange-traded funds (ETFs) that simply buy huge swaths of the market based solely on trends rather than fundamentals on a company’s long-term prospects. Maybe that makes our lives as stock-pickers a little harder in the short term but I believe it will help us in the long run.

Boksen: It absolutely will. I think it’s great for us that
ETFs are around. In the long run, what really matters are earnings growth, cash flow and balance sheets.

McCallister: I believe clients and advisors – after experimenting with ETFs – will find they didn’t live up to the hype surrounding them. No less than John Bogle, who started the Vanguard index funds, has said ETFs’ focus on short-term, near-constant trading leaves individual investors with returns that lag a comparable index fund.

Cowart: That’s particularly true in the more exotic emerging-market and long/short ETFs. I believe this is going to turn out to be a fad that, as they all usually do, fades over time. Look, just because an ETF buys a stock doesn’t mean that stock is worth owning. People probably will figure that out and look for someone who can find them good stocks, the ones that are worth owning. What we are trying to do is separate some of the noise from the prices and make a judgment about long-term valuations with the belief that once we get on the other side of whatever volatility the market serves up on a daily basis, we’re going to be okay.

McPherson: Following up on Todd’s point about correlations: It was interesting to watch the market move in such lock-step last year though we have seen that tail off a bit since December. I think Todd’s right that it’s a proxy sentiment gauge.

I view periods such as this as opportunities for those who are patient and disciplined. The key, in my mind, is
not to get sucked into something simply because it’s working at the time. It’s going to be ugly, especially in the small-cap space because of the trading-liquidity issues there, on the day investors abandon the “It doesn’t matter what I own” mentality.

Camp: Any time I see a market – be it ETFs or others – grow up nearly instantaneously, I start asking about what’s really “underneath the hood.” At a level, ETFs remind me of 2006 when all sorts of new mortgage products hit the market. And five years later, it’s clear the market didn’t understand at all what was going on.

Look at what’s new, what’s really grown. Look for what seems cheap, great, “the next best thing” and that probably is where your next Wall Street failure will be. That’s how things often happen.

Moderator:  There remains an unprecedented level of cash on the balance sheets of many companies, particularly large-cap companies. They can use that to hire more employees, which they may soon need to do. They could use that for capital expenditures. We haven’t yet seen a big increase in those areas.

We also have seen that they can use that money for mergers and acquisitions. Some large-cap companies are buying peers but more often, they are buying smaller companies that can add strategic value or a particular business line to their overall mix. Some may be buying units from larger conglomerates. Give us your views on what you’ve seen last year and thus far in 2011 on the M&A front.

Serafini Thomas: I talked earlier about large-cap companies being underinvested. Let me throw out some numbers for perspective: Large-cap companies’ current capital-expenditure-to-sales rate is about 6 percent. That is down from 8 percent in the ’90s and around 8 percent-10 percent throughout the 1980s. How much cash do large-caps have right now? A recent Credit Suisse report suggested that if the S&P 500 companies were to put their excess cash to work in the form of M&A, they would be able to buy 56 percent of the market cap of the Russell 2000 Index!

We believe M&A activity will be largely concentrated in a few sectors, notably technology, healthcare and industrials. That’s simply because those are the areas where large-cap companies seem to be struggling the most to find secular growth opportunities.

McCallister: We had 14 takeovers (across disciplines) in 2010 and I believe that will continue. It’s not a mystery how to get takeovers in this environment: Look for companies that have real cash flow and don’t overpay for them.

McPherson: The market – not just the stock market but also the business market – is always looking for good opportunities. Do your homework and pay the right price for something. Maybe the stock market won’t pay you for it but someone – a competitor, a private-equity group, a larger company looking to expand – eventually will.

We had 11 takeouts last year and already a couple of more this year. The larger companies do have a lot of dry powder so we believe this trend will continue.

Cowart: I heard a figure that private-equity firms are
sitting on something like $500 billion that needs to be spent within the year or it has to go back to the owners. Now, which is more likely: That they’ll turn aside an opportunity to make money and give the capital back or that they’ll put some deals together? I’d say a lot of deals are likely to get done.

The usual M&A headlines are about large-cap companies gobbling up a small- or mid-cap company but there have been other interesting moves. Some big companies have looked at how they can grow and then decided growing doesn’t make sense. So, you have some companies such as Pfizer and Procter & Gamble that have decided to get smaller, to sell off their assets that may not make as much sense anymore while there is a fertile M&A environment. That’s a way even large companies can create value.

Boksen: We’ve had about four takeovers in the various products this year and we recently had two companies put themselves on the auction block. At these interest-rate levels, there’s plenty of room to finance acquisitions and so just about every morning, I turn on my TV to see who is going to get bought out.

It’s been a fun time in small-cap world and I believe it
will continue.

Moderator: Discuss oil and the impact its price has on
the consumer, particularly their willingness to spend in
other areas.

Cowart: Oil is selling at a premium now based on what is going on in North Africa and the Middle East and I believe we’re going to have to deal with that for a while because I don’t expect things to settle down in the Middle East anytime soon.

Recall the third quarter of 2008 when oil was spiking to $140 dollars a barrel. The energy cost to the American consumer was, on average, about 6.2 percent of income.
Oil prices plummeted pretty quickly thereafter. Today,
that number is a little less than 6 percent, maybe in the
5.7 percent-5.8 percent range but we’re creeping back into the “danger zone” for prices where consumers will use
less gasoline: the phenomenon the industry calls demand destruction.

I share Todd’s view about energy stocks being attractive long-term investments even though some of them may
have short-term challenges. Consequently, the energy weighting of our portfolios is pretty equal to that of the benchmark indices.

Currently, we own some supply and service companies, such as Halliburton, Lufkin Industries and Oceaneering International. Perhaps you remember the stories of the California gold rush: Those who got really rich weren’t the gold miners but those who provided supplies to the miners. That’s what these companies essentially do.

Eric Mintz: The surge in oil prices in March and April due to unrest in the Middle East provided a great example of the market’s price-discovery mechanism. Basically, the so-called invisible hand took prices to the level where demand was rationed enough to offset the loss of Libya’s daily production of roughly 1.5 million barrels of light sweet crude oil. Not surprisingly, the rolling four-week average of U.S. demand for gasoline has now turned solidly negative.

Oil prices have retraced some of their recent gains due to a softening in recent economic data but we continue to believe that higher oil prices will be a fact of life for the foreseeable future and remain overweight the energy sector.

McCallister: We like Oil States International, which is a company that does what Ed just talked about. The days of getting oil from convenient locations is probably long past. So, more and more exploration and production companies find themselves out in the boonies. Meanwhile, they need employees who can get to work easily. One of the things Oil States does is build and maintain on-site living facilities for workers. We believe drawing oil from sands and shale will only increase over time and Oil States has this tremendous leg up on any potential competitors.

Moderator: Are there any opportunities in nuclear power in the wake of the Japanese earthquake/tsunami that hobbled Northeast Japan’s plants? Alternative energy?

Cowart: I’m afraid nuclear energy is dead in this country. There’s always been a psychological antipathy to nuclear energy in this country but it’s seemingly turned to aversion now. The Tennessee Valley Authority has been working since 1973 to get a nuclear plant approved and online. That was before the Japanese disaster!

I think the handwriting is on the wall and that few companies will want to endure the pain and the suffering that’s involved in bringing a nuclear power station online.

Boksen: The challenge is that Chinese officials don’t
have to worry about public sentiment and so they’re continuing along with their aggressive nuclear power policy. I’m afraid it helps put this country further behind
in energy independence.

Cowart: The best option in the meantime might be coal or natural gas. There’s no question this country is going to continue to need more electricity. We talk about alternative energy and electric cars but those cars plug into walls. Magic doesn’t create that electricity; in most cases, it’s coming from a hydrocarbon-fueled power plant. Natural gas has the advantage of being a little more “clean.”

Moderator: Let’s shift gears a little bit and talk about the United States as a creditor. Moody’s reaffirmed its AAA rating on U.S. debt, saying that the current situation is as positive as it has been in a long time to address debt issues, at the same time S&P provided negative guidance. Does the deficit matter overall? Does it matter to the market? Does it matter to those at the individual companies you follow?

Boksen: The deficit is important but there won’t be
any action on it for the next year and a half. Washington will have to deal with Social Security and healthcare and the embedded costs of those programs but no one there will touch those during an election year. That’s just the way it is.

They’re going to have to address those issues eventually but that’s going to be a 2013 event and it’s likely the market will start taking that into consideration in mid-2012.

McCallister: We used to talk about “crowding out” in economics. Government would push up interest rates and crowd out investment. We don’t talk about that anymore, though, because there are so many foreign investors. These big deficits haven’t affected the market at all on a short-term basis but when people start talking about “crowding out” again, we’ll need to be more concerned. But I bet I haven’t heard that phrase in 15 years.

Skeppstrom: The market is just ignoring Washington right now. Stock prices have been going up and are
very likely to continue to go up until something pinches growth. Traditionally, that’s been the Federal Reserve raising interest rates but they’ve said they’re holding steady.

But I’ll say this: If Washington stops spending $1.6 trillion it doesn’t have and/or raising what they don’t have and in some combination raise taxes, I think the market would have trouble figuring out whether the economy would grow. The market currently is turning a blind eye to this but that’s what it often does.

Moderator: Real estate remains on overhang. There had been some talk of increased sales but recent reports have shown values going down in many areas. What are your impressions of what’s going on there?

Camp: Every time I hear a monthly economic release about new housing starts being below expectations, I ask, only somewhat facetiously, “Why are we even issuing house permits?”

What we see in the residential space is a weak asset for some time in terms of economic value. There are so many empty houses and, as I have mentioned previously, something like one in five likely to foreclose.

The point I would make about real estate is simply this: Fannie Mae and Freddie Mac are multi-trillion-dollar enterprises and they’re bankrupt. We continue to talk about what to do with – or for – the person who bought a $400,000 house that’s now worth $200,000. And our point is: It doesn’t matter. It’s bad debt, it’s out there and it’s a problem that needs to be addressed. Instead, we have transferred wealth from savers to the financial system.

Real-estate valuation, obviously, it’s all local and there are certain areas doing better. However, there still isn’t really a meaningful financing mechanism in place for anyone who isn’t a cash buyer. I don’t know if that’s a bad thing because I’m not sure that getting us back on the exact same treadmill – we need more housing permits to get people back to work in the housing-related industries – is really a good thing in the long run.

That said, some people might not like to hear this but it may be time to develop some sort of reinsurance for mortgage financing. Fannie and Freddie are in trouble but I believe they are too big for the government not to be involved. There are people who are good credit risks so there needs to be some mechanism – something akin to the Federal Deposit Insurance Corp. (FDIC) – that helps make financing available to good borrowers or, in my view, real estate has nowhere to go but down.

McCallister: The issue does remain significant because the reported numbers, particularly on the existing number of houses for sale, overlooks the houses being sold short and the shadow inventory of people who would love to sell their house but cannot because they are so far underwater.

I believe the existing inventory could be years instead of months. So, I can’t get excited about any homebuilders or other investments tied to residential real estate.

Moderator: Let’s touch on the employment situation, where there has been a slight increase. How is that impacting the market at this point?

McPherson: The early indicators are that employment is improving, albeit slowly, but it is improving. Companies are still being cautious on increasing their full-time employment and, instead, have opted for temporary staffing. Historically, that’s been a good leading indicator for full-time employment. In the meantime, we’ve taken advantage of the trend by way of owning some temp-agency stocks.

McCallister: Historically, unemployment tended to go up if the GDP were at today’s levels. Maybe the market has adjusted its expectations. We used to talk about “normal” employment levels of about 5 percent. There’s a presumption that 2 percent-3 percent of jobs were housing-related. If those jobs aren’t coming back any time soon, maybe the new “normal” is 7 percent-8 percent.

Moderator: Talk about a few ideas or names that may be recent additions to your portfolios that you feel good or optimistic about.

Camp: Municipal bonds now are really inexpensive and they offer the same tax protections today as they always have. I can’t tell you when, exactly, taxes are going to go up but I believe they will go up. And it’s a $3 trillion – with a T – market where good managers can find really solid, tax-preferred investments.

There remain some concerns in the investing public about default rates and incidents of bankruptcy. Our position continues to be that there may an increase in those things but they are likely to happen in traditionally risky sectors – community-development districts and golf courses, for examples – and from smaller issuers. We generally avoid those areas of the market anyway.

And one of the things we are careful about, too, is ensuring that we buy bonds from agencies that provide transparency in their finances. Municipalities are subject to standards set forth by the Governmental Accounting Standards Board, which take general fund accounting principles into consideration. This provides greater insight into a government’s ongoing ability to raise taxes, the costs of activities that compete with those resources and its overall ability to repay debt.

We’re happy the Municipal Securities Rulemaking Board and the U.S. Securities and Exchange Commission have taken steps to improve disclosure efforts, including an online system. Nevertheless, Eagle purchases high-grade bonds from issuers that regularly disclose their financials and we don’t hesitate to contact issuers for more information if necessary.

Skeppstrom: I’m excited about owning large-cap stocks generally. Many are making indispensable products sold around the world; most have the financial strength to survive a severe downturn and the wherewithal to grow in an expanding economy; some have yields of 8 percent-10 percent; and currently, many are selling at incredible discounts to their historic average.

More specifically, technology is a sector that stands out for being inexpensive vs. its peers currently and vs. itself on a historic basis. Technology has been growing and likely will continue to do so. One company might find its products obsolete or out of vogue but the entire group – Microsoft, Intel, Cisco, Google, Apple – is likely to
keep chugging along if there’s even nominal global economic growth.

I also look to finance, which is another area that has underperformed pretty dramatically. There clearly remain significant issues with residential real estate, which is a large portion of financial institutions’ business, but I believe most banks now have adequate capital reserves. We haven’t seen much loan activity yet but we will and that will help these companies as well.

The only question is whether these companies become GM where they have 25 years of no earnings growth or price growth and nobody cares that they’re cheap. But I don’t believe that will be the case with these companies. People talk about Microsoft not having a tablet to compete against Apple. Microsoft will have a tablet. Meanwhile, the computers that most companies use have a Microsoft operating system. Windows 7 is still only about halfway through its adoption, which has been better than expected. Microsoft will stop supporting Windows XP and there’s no real alternative for companies other than to move to the next Microsoft product.

I just don’t believe you’re taking a big risk here with these kinds of stocks.

McPherson: We have been buying stocks over the last three to six months in the healthcare, financials and technology sectors. Quidel is a good example. The company does diagnostic testing, and for a long time, half its revenue came from flu-testing. That’s obviously a seasonal thing and maybe it had a nice run when something like the H1N1 scare popped up a few years ago. The company had a nice balance sheet and, better, brought in new management a couple of years ago that stepped up the company’s research-and-development effort. Now, Quidel has a pipeline of new products that will lessen its dependence on the flu season.

It is selling at a discount to its peer group and we believe it has good earnings power. One other aspect of healthcare investing for us these days is finding companies that are part of the long-term solution to the country’s healthcare issues rather than part of the problem in terms of saving the system money. So, here’s a company selling low-cost tests that help doctors identify illnesses early on when they’re usually less expensive to treat.

In financials, we own the $260 million Walker & Dunlop, which originates mortgages for multifamily projects. Bigger banks have pretty much abandoned this segment of the market to deal with their problems. These kinds of loans are generally for five to 10 years, not 30, so there is a good flow of deals that must be refinanced. At its size, Walker & Dunlop doesn’t need to do billions of dollars worth of originations to be successful.

In the technology space, we like Emulex, which makes
the technology that allows information to go from a server to a storage device in data centers. Historically, Emulex essentially has split what had been a relatively mature market with one other company, which led investors to look to other industries with the sector where they believed they could find better growth stories.

As always, technology is changing. Data centers are growing and they need updated equipment to handle ever-larger volumes of data. Emulex has updated its gear and already has won contracts with nine of the top 10 server companies. It has $4 per share of cash on its balance sheet and has continued to generate free cash flow while things are still slow. We have a multi-year horizon when we look at things so we’re not expecting this to explode in the next three to six months but we do believe it’s a good long-term opportunity with limited downside risk.

Cowart: A stock that we just bought in Value portfolios in the context of an improving financial situation is Citigroup. We sold Bank of America to buy Citigroup.

There probably will be books written about how JPMorgan and Bank of America navigated the financial crisis of the late 2000s. There will be sections on how JPMorgan bought Bear Stearns and Washington Mutual and how Bank of America purchased Merrill Lynch and Countrywide. The big distinction is the Countrywide deal, where it’s clear Bank of America ultimately had no idea what it was getting into. Bank of America is going to survive and be fine but it became clear to us that its better days are a little further away than we previously believed.

The reason to own large financial stocks right now, in our view, is for the prospects of dividends and share repurchases over the next couple of years. We’ve already begun to see some of that at JPMorgan, and US Bancorp, which are beginning to raise their dividends and likely will be buying back their stock at some point.

Citigroup has made remarkable progress in fixing itself over the last couple of years. Citi doesn’t have much mortgage exposure, it has a bad bank that’s been segregated from the rest of the company and it has an unparalleled global brand.

Citi’s going to do a reverse 10-for-one stock split, which doesn’t really mean much by itself. However, there are a lot of investment firms that cannot buy sub-$5 stocks and so the level of shares held by institutional investors is less than historic levels. Citi has a 10 percent capital ratio. We believe it can continue to grow, particularly internationally. So, Citi is cheaper than Bank of America. It’s a problem child for sure but we believe we could see this $45 stock (pre-split) go to $60 or $70 dollars a share.

In general, we believe, especially in our corner of the investing world, that value portfolios aren’t going to work if financials don’t work. What has disappointed us about financials in the last three to six months has been the lack of loan growth. We may be grasping at straws here but the most recent survey of loan officers indicated that credit conditions are loosening, at least with respect to business and commercial lending. And there is a suggestion that history suggests we may see some loan-demand growth in three to six months and we believe Citi will participate in that.

Boksen: In healthcare we like generic-drug manufacturers because, as Jack suggested, it’s better to get on the “solutions” side of the table. Generic drugs obviously lower healthcare costs and so we believe it is an area that likely will keep growing. Further, these companies don’t have the same research-and-development costs – and risks – of better-known pharmaceutical companies because they merely have to wait for brand-name drugs to lose their patent protection.

In the consumer space, I gravitate to vitamin stocks given my age. Really, it has been a great space for us and likely will continue to be as Baby Boomers do what they can to keep their health. The Vitamin Shoppe has been a terrific stock for us in the small-cap space. General Nutrition, or GNC, has just gone public. Herbalife, a mid-cap stock, has been growing like a weed. Its pyramid sales – or, as they prefer, multilevel marketing – structure apparently really works in Asia.

These companies are dominating here but an increasing portion of their revenues are coming from China and India.

McCallister: A lot of people like Netflix; the business is good but the stock is kind of expensive. You can, though, play the economics of Netflix via Liberty Starz, which licenses content to distributors such as Netflix. Twenty-nine of Netflix’s top 30 movies come by way of Starz. Netflix will re-do its contract with Liberty Starz this fall and we believe the deal this time will be much larger than the existing $25 million flat-fee contract. Starz is a $75 stock with $20 per share in cash.

In healthcare, we own St. Jude Medical, a large mid-cap company that we view as one of the most attractive healthcare opportunities. It’s selling at 13 times earnings and has been mostly ignored despite the fact we believe it can grow 10 percent to 15 percent annually for the next five years.

Past performance does not guarantee future results.

Opinions and estimates offered constitute Eagle’s judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. The meeting of Eagle’s portfolio managers occurred May 2, 2011. Under no circumstances does the information contained within represent a recommendation to buy, hold or sell any security and it should not be assumed that the securities transactions or holdings discussed were or will prove to be profitable. Any Index is referred to for information purposes only; the composition of each Index is different from the composition of the accounts managed by the investment manager. An index is unmanaged and has no expenses, and it is not possible to invest directly in an index.

 

 

 

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