Investors Aim For Stable Growers That Can Thrive Despite Volatility

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Propelled by the overall market, U.S. diversified stock mutual funds notched a 0.78% gain on average in April. The month's modest gain was far better than the losses of January and February.

But it lagged the 1.7% gain by the average U.S. taxable bond fund  tracked by Lipper Inc.

Going forward, mutual fund managers expect more volatility, and many are looking for stocks with stable earnings growth that can thrive without a tailwind from a robust economy.

In the just-completed month, multicap value funds did best among the mutual fund market capitalization and style categories.

The key impetus was the Federal Reserve's dovish stance on interest rate hikes.

In a late March speech, Fed Chair Janet Yellen said the central bank would "proceed cautiously in adjusting policy" in 2016. In its April meeting, the Fed's Federal Open Market Committee stuck by Yellen's March outlook and declined again to raise rates.

"Economic activity appears to have slowed," the FOMC said, adding that household spending had "moderated."

Those statements told investors that the Fed thinks U.S. economic growth is slower than previously believed. Slower growth and slower rate hikes mean a weaker U.S. dollar.

"That helps U.S. exporters, which is good news for many U.S. large-cap stocks," said Omar Aguilar, chief investment officer of Charles Schwab Investment Management.

And a weaker dollar lowers the cost of paying off debt for most emerging markets, making it easier for them buy goods and services from the U.S. and others.

Putting it bluntly, the Fed did not want to break a fragile U.S. economy by raising the price of money. "The more dovish tone by the Fed brought down market volatility and helped support all of the assets that have been hurt in anticipation of Fed rate hikes," said Mark Hamilton, chief investment officer for asset allocation at OppenheimerFunds.

Jittery investors lifted precious metals funds 28.76% in April, best among sectors. Energy funds and natural resources funds, which had lost 41.45% and 20.54% respectively in the two years that ended March 31, were the next-best-performing April sectors, jumping 11.62% and 10.46% last month.

World equity funds gained 1.33% in April, led by Latin American funds' 6.59% leap up.

Taxable bond funds were paced by high-yield funds' 2.89% advance. With investors willing to take on risk, safe-haven general U.S. Treasury funds slipped 0.33%.

What's Ahead

"I expect mediocre returns and a fair amount of volatility going forward," Hamilton said. When the Fed finally does get around to its next rate hike, volatility is likely to rise, he said.

Broadly, he expects the U.S. economy to outperform for several quarters. That should benefit U.S. large caps.

James Abate, chief investment officer of Centre Funds and manager of $158 million Centre American Select Equity ( DHAMX ), expects a reversal of the recent months' rotation into value away from growth.

"Materials, energy, industrials and other cyclical sectors are likely to reverse," Abate said. "So we've taken the opportunity to amplify our positions in stable-growth-type companies, Nifty 50 type names. Key stocks for us are names like Amazon ( AMZN ), PepsiCo ( PEP ), Exelon ( EXC ) and Carnival Cruise ( CCL ). We sold the one energy stock that we held."

Amazon is the epitome of what he's looking for. "It is strong and has a unique business model that can grow regardless of the economic backdrop," he said.

Exelon is a utility with low cyclicality, he said. Its current return on equity is about 9%. "This is roughly half its 15 year median return on equity," he said. "We see incremental ROE moving higher with plenty of room to expand. With the Pepco (acquisition) closing, we see an increased focus on cost-cutting and rate relief in the regulated utility units contributing to profit margin expansion, with a strong balance sheet to allow future dividend hikes and buybacks."

Equally good, the stock is virtually unaffected by economic developments in Japan or Europe, he said.

He also likes the idea that Carnival has almost nowhere to go but up from its depressed profit margins and returns on capital.

And he adds Merck (MRK), which he calls another low-cyclicality, defensive name. "It's got a strong drug pipeline," he said. "It's seeing improvements in return on assets. It can be another Nifty 50 name."

Abate has stayed underweight in energy, industrials and financials. "In materials, our exposure is to companies that are capable of growing and are not dependent on an acceleration in the global economy," he said. In that area, his names include Vulcan Materials (VMC) and International Flavors & Fragrances (IFF).

Abate says value stocks are unlikely to add a lot to gains they've scored already this year. "So I'm embracing companies that are more stable and less sensitive to the ups and downs of the economic cycle," he said.

He also does not rule out a correction of 20% to 25% some time during 2016, and his fund has hedged that possibility with put options.

"Profits are disappointing," he said. "Profit margins are decelerating. And there's a poor top-line revenue outlook. It's hard to see price-earnings multiples expand further."

Like Aguilar, Abate expects volatility the rest of this year. The best gains should be confined to a narrow band of stocks, he says. "With bond yields low and other asset classes disappointing, we'll see a new Nifty 50 do well," he said. "Diversification is good, but over-diversification can be bad. We're down to 52, down from the mid-60s in 2013."

Polaris Capital Management's Bernard Horn, lead or co-manager of five funds totaling $3.4 billion in assets, is concerned about the impact of sluggish economic growth. He used volatility in recent months to buy shares in larger U.S. and foreign banks at depressed prices, including JPMorgan Chase (JPM). "The valuation became compelling," he said.

He also added to asset manager Franklin Resources (BEN). "They have great long-term performance, but have slumped in the last three to five years. We saw an opportunity to buy into a good long-term franchise with a lot of cash on its balance sheet. They have a relatively low tax rate because they have managers who sit offshore, like Mark Mobius," who's based in Hong Kong as executive chairman of Templeton Emerging Markets Group.

Horn also added to Group (WEB), which creates and maintains websites for small businesses. "They help small businesses get onto social media sites," he said. "A business they just bought does sophisticated marketing and lead-generation for customers."

Another he added to was electronics and technology distributor Avnet (AVT), a company which also assembles products for customers. "They've got a good management team that squeezes out free cash flow and value-added services for customers," Horn said.

In Q1, he added to Thailand-based Siam Commercial Bank. The investment may not ripen quickly, he says. "The Thai economy is a little soft now, so this may take time to play out," he said.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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