Has the current market environment begun to favor less speculative companies and investment managers with a more active orientation? Director of Investments, Managing Director, and Portfolio Manager Whitney Georgetalks about valuations, sectors and industries that he believes look promising, and some names in which he has high conviction.
Many of the portfolios you manage or co-manage have done very well so far in 2014. What conditions have helped to drive the rebound?
The market has definitely been improving for our style of investing—we'd like to think it's also normalizing; that is, returning to a more historically typical performance cycle in which company fundamentals matter. This started more than a year ago when taper talk began and interest rates started to rise.
Around that same time it became pretty clear that legislative agendas were being closed down in Washington, creating a gridlock that seems to have removed some uncertainty. Businesses no longer have to guess what might happen politically because it's become almost impossible to get anything done. This isn't likely to change until after this year's mid-term elections at the earliest. Correlation levels across all asset classes are also declining. It feels like a better market for active management overall.
What sectors or industries look most promising to you going forward?
One area that I like is Energy, which has done well so far in 2014 after bottoming out in 2012 and in general not being a significant contributor in 2013. Many of our holdings in the sector have done very well recently, especially following the cold winter in the Northeast. That brought a lot of renewed attention to Energy companies. With the slowly improving economy, some of the more economically sensitive cyclical areas have also improved, such as Industrials and Materials.
In addition, we've seen some more targeted themes that we like do well year to date, such as cheap protein producers, chicken stocks, and egg producers. Beef and pork prices have increased, so these other protein-producing areas have attracted new interest from investors. A recovery in demand for fast-food chains, driven in part by new breakfast menus, has helped to build a growing appetite. And feed costs, principally corn and soy beans, have moderated, creating an excellent fundamental backdrop. For example, Sanderson Farms—a long-term holding—saw its fiscal second-quarter profit more than double because demand for chicken was strong while costs for grain fell. M&A activity, which has been healthy through much of the equity market, has been very robust in these food-related areas.
Can you discuss a few stocks that you feel especially confident about right now?
I discussed Myriad Genetics in January, and I still really like the company. It's a molecular diagnostic company that specializes in genetic testing for cancer. After receiving a mixed ruling from a Supreme Court decision in June 2013 when it was decided that human genes can't be patented, its stock price began to fall. Many investors were concerned that Myriad would struggle to compete or be profitable in the light of the Court's decision. The stock later recovered; it enjoyed a terrific first quarter of 2014. Though its price has been a bit volatile more recently, we continue to believe in the company. It remains a leader in genetic testing with a variety of industry-standard tools for detecting hereditary cancer risk. Fiscal third-quarter revenues, announced in May, were up, helping to make fiscal 2014 nicely profitable.
I'm also confident in the prospects for Kennedy-Wilson Holdings, a real estate investment and services company that operates in the U.S., the U.K., Ireland, Spain, and Japan. The company focuses mainly on multi-family homes and commercial real estate, particularly in distressed areas, and we have liked their expertise in these places for a number of years. In February, the firm made a major investment in Europe in the form of Kennedy Wilson Europe Real Estate Plc, publicly traded on the London Stock Exchange, which one of the business's wholly owned subsidiaries will manage. I think the firm is looking increasingly like a very well-run asset manager.
Finally, I'm pleased to see RV maker Thor Industries revving up a bit so far in 2014. It's a stock that we've owned in some Royce portfolios for more than a decade. Like Myriad Genetics, its share price has been somewhat volatile in 2014, but I like its prospects for steadier improvement. After a difficult winter, the firm saw improvements in profits, margins, and earnings in the spring. It has steadily increased market share in the years since the financial crisis, expanded its operations into former competitors' factories, and successfully gained a greater presence in the high-end RV market. Its stock has done pretty well over the last couple of years, but I think it still has room to run.
What do you make of the current market climate?
I think valuations are a bit above average, but not unreasonably so given near-zero interest rates and low inflation. There are a lot of anomalies in the market, and I see a wide disparity between what looks to us like expensive stocks and those that look inexpensive on an absolute basis. The market seems to be in the process of sorting that out—certainly those areas of the market that don't interest us, and that did well in 2012 and 2013, have been far more volatile so far in 2014. We're still seeing companies that look attractively valued to us based on their fundamentals. All in all, I'd say we are in a stock-picker's market, and I feel really good about that.
Important Disclosure Information
Whitney George is Director of Investments, Managing Director, and a Portfolio Manager of Royce & Associates, LLC, investment advisor to The Royce Funds. He serves as portfolio manager for Royce Premier Fund (RPR), Royce Low-Priced Stock Fund (RLP), Royce Global Value Fund (RGV), Royce SMid-Cap Value Fund (RSV), and Royce Focus Trust (FUND). He also serves as assistant portfolio manager for Royce Micro-Cap Fund (RMC), Royce Value Fund (RVV), Royce Value Plus Fund (RVP), Royce Focus Value Fund (RFV), and Royce Capital Fund – Micro-Cap Portfolio (RCM). Mr. George's thoughts in this interview concerning the stock market are solely his own and, of course, there can be no assurance with regard to future market movements.
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