U.S. funds look for 'crazy cheap' stocks as indexes hit record highs

  • By David Randall,
  • Reuters
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Record highs in the U.S. stock market and the anticipation of equity-friendly interest rate cuts by the Federal Reserve later this year are prompting top-performing large-cap fund managers to seek out unloved stocks in hopes of further gains.

They are now making bets on stocks ranging from financial companies like Charles Schwab Corp (SCHW) that may see their margins hit by lower interest rates; cyclicals like FedEx Corp (FDX) that are tied to trade with China; to healthcare companies like Teladoc Health Inc (TDOC) that face the risk of further regulatory overhauls after the 2020 elections. They expect that these contrarian bets will pay off at a time when the benchmark S&P 500 (.SPX) is on pace for its best first six months of the year since 1997.

“You’re seeing really good companies trade at valuations that are crazy cheap right now,” said Mark Mulholland, portfolio manager of the Matthew 25 fund, which is up 28.1% since the start of the year, well above the 17.3% gain in the S&P 500 over the same time.

Mulholland has been adding to his positions in companies including Goldman Sachs Group Inc (GS) and FedEx, and is starting to look for a natural gas pipeline company as the energy sector continues to wane, all in search of macro trends that he can buy into at a cheap price. FedEx, for instance, is part of his play on e-commerce at a time when he is avoiding traditional bricks and mortar stores.

“In three to five years, without question, FedEx will be a player in retail to some degree” whether through a partnership with Amazon.com Inc (AMZN) or another large company, he said.

Shares of the company are down nearly 2.5% for the year and trade at a trailing price-to-earnings ratio of 13.4.

Joseph Dennison and Anthony Zackery, two of the portfolio managers of the Zevenbergen Growth Fund (ZVNBX), said that they have been seeing opportunities in healthcare companies like diagnostics company Exact Sciences Corp (EXAS) and telehealth company TelaDoc Health Inc. Though both companies are up more than 25 percent for the year, volatility in the healthcare sector due to the prospects of a Democratic victory in the 2020 presidential election and a Democratic takeover of the Senate has continued to offer opportunities to add to their positions, Dennison said.

“There are a lot of trades that happen in baskets and people don’t always dig through the weeds and find the companies that are growing organically,” said Dennison, whose fund is up 37.3% for the year.

The broad stock market rally has been a boon for active fund managers, who are posting stronger performance numbers this year despite shedding more market share to passive index funds, said Todd Rosenbluth, director of mutual fund research at independent research firm CFRA. Approximately 47% of large-cap active funds are beating the S&P 500 this year, compared with 36% that beat the index last year, he said.

Brian Yacktman, whose YCG Enhanced fund (YCGEX) is up 26.7% for the year to date, said that the market’s expectations of at least two interest rate cuts over the next 12 months left financial companies at attractive valuations given their growth rates. He has been building his position in companies like Charles Schwab and Wells Fargo & Co (WFC), both of which are down more than 1 percent for the year to date due to expectations that their margins will suffer as interest rates fall.

“If the Fed does cut rates and investors push prices down further, that’s no problem, we will buy more,” he said. “We’re investing in the things that people are scared to invest in.”

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