Mary Chris Gay joined the research department of US-based Legg Mason in 1988. In 1989 she became part of Legg Mason Capital Management, where she analysed various industries for the equity funds and became a portfolio manager in 1998.
She now serves as the assistant portfolio manager of the US-domiciled Legg Mason Value Trust mutual fund (managed by Bill Miller) and portfolio manager for several domestic and international mutual funds that provide investors with access to the investment portfolio and process implemented by the Value Trust. She also works with Legg Mason's foreign subsidiaries and outside financial partners to establish fund relationships in Europe, Canada and South America.
Markets want to believe in a pick-up, but the indicators seem fragile, do you believe that the US economy is truly re-starting?
Gay: We believe the market advance since March 2009 will mark the beginning of a new cyclical bull market that could carry the S&P 500 significantly higher into next year. We believe the recession is in the process of ending, that the economy will show signs of growth in the second half of 2009, that stocks are attractively valued especially relative to cash and Treasuries, that the recovery in corporate earnings could surprise investors on the upside, and that, given all of the foregoing, investors are generally far too negative about the outlook for the stock market.
Unlike many other observers, who appear to expect a sluggish recovery, we believe the severity of the financial crisis argues for a fairly sharp snapback in GDP initially, with growth levelling out at a moderate, but still attractive, rate after that. As the economy begins to improve, we believe that some portion of the tremendous liquidity on the sidelines (variously estimated at between $4 and $8 trillion), earning very low rates of return, could contribute materially to a surprisingly strong advance in the market, while keeping market corrections contained to the -10% to -15% range.
The US has always been a few steps ahead. What is your argument to convince institutional investors to place their money in American equities?
The global equity markets have experienced a very dramatic and severe financial crisis during the past year. In fact, only one other time in history -- during the Great Depression -- was the 10-year return for US equities negative on a compound annual basis. On balance, the economic evidence continues to surprise the market and investors on the upside and is contributing to the strong returns we have seen for the markets.
We believe US equities are very well positioned to lead most other developed markets, especially in Europe in part because of the dramatic stimulus that is in place which will help fuel growth and the longer term appreciation of the US dollar relative to the euro which we believe is structurally overvalued relative to the dollar. With a new administration in Washington, we also believe we will be facing a favourable fiscal and monetary environment until there is clear and widespread evidence that the economy is stable and growing. With that as a backdrop, and with US large-cap stocks at 5-10 year lows with attractive growth prospects both in the US and developing world, we believe a broad number of US companies, especially in the technology sector are well positioned to benefit .
Given the US share as a percentage of the world market, we believe all investors should have some portion of their active investments in the US especially with the market trading at such a low multiple on an inflation adjusted basis with what we believe is no prospect for higher inflation or higher interest rates for the foreseeable future.
While we have seen a rise in the US since March 2009, if you look back to September 2008, the S&P is still 20% below those levels today and the news is getting better. We are also still 40-50% below the peak levels of the market in October 2007. We think coming off of very low levels, being invested and being properly positioned long-term is going to work out really well and we have our portfolio positioned to take advantage of the recovery.
How should one invest in the US equity market? What strategy? Which sectors? What market caps?
Each investor needs to think about their whole portfolio and determine their best asset allocation for their given level of risk and time horizon. With that being said, our primary mandate over the past 27 years is to invest in the US. We believe this is one of the best times to be investing in the US stock market. Valuations among large-cap equities have not been this attractive since we began investing in the early 1980s. The current ten-year compounded total returns for the market were negative through the beginning of this year; in fact, at the March 9 low they reached a negative 5.8%. The only other time in history when we have had a negative 10-year trailing number was back in the Great Depression. We would venture to say the probability of the next 10 years will likely be very good and will be led by the very largest names. Large-cap US securities have among the most global reach, the most diversification in their earnings base, the greatest financial stability and their valuations are below that of the other 400-450 names in the market.
What kind of performance can we hope to see on the US equity market?
As of now, we believe the S&P 500 Index has the potential to reach 1,250 to 1,350 by the end of 2010, implying upside from the current level of 20-30%. Depending on how strong the recovery in the economy and corporate profits turns out to be, we could adjust that target range either upward or downward.
As we see things today, we believe the surprises are more likely to be on the upside than downside. We also believe that all the conditions that are always present at the beginning of a bull market are in place today. Those four conditions are: economy is bottoming, profits are bottoming, the Fed is stimulating, and valuations are low.