| 2011 All-America Research Team |
The world economic crisis has accelerated the globalization of finance — at least in the eyes of many investors. Asset managers that once focused primarily or even exclusively on the U.S. have been compelled to look beyond its borders not only to keep abreast of developments overseas that could affect American markets — the Arab Spring and Europe’s sovereign-debt debacles, among others — but also to avail themselves of better opportunities that exist in other countries.
“Our clients, particularly the larger ones, are global,” explains Noelle Grainger, J.P. Morgan’s head of U.S. equity research. “They might not be investing truly globally, but they have to think about issues globally, and it’s important to make sure that we’re driving our strategic initiatives in that direction as well.”
This broader focus applies to corporations as well as countries. Stuart Linde, head of global equities research at Barclays Capital, offers one example. “Consumer staples is a big global business,” he says. “If you’re covering General Mills, if you’re covering Kraft, you need to know what’s going on at Nestlé. If you’re covering P&G, you need to know what’s going on at Unilever,” he explains, comparing U.S.-based consumer goods companies with their European peers.
There’s another reason, notes Stephen Haggerty, head of Americas equity research at BofA Merrill Lynch Global Research. “The U.S. is becoming a more mature market,” he observes. “Our economic growth rate is not going to be off the charts for the foreseeable future, given what has to happen to restructure the U.S. economy. It’s harder to find alpha if you are just looking at the U.S.”
To deliver the kind of research that clients find most helpful, analysts covering U.S. stocks are working more closely these days with their counterparts in Hong Kong, London and around the world. The researchers who outperform all others when it comes to providing the perspective that money managers require can most often be found at J.P. Morgan, which leads the All-America Research Team for a second consecutive year — but by a very narrow margin. J.P. Morgan captures 40 total team positions, six fewer than last year and only one more than the two firms that tie for second place: BarCap, which repeats at No. 2 despite a loss of four positions, and BofA Merrill, which rises one notch even though its total drops by three.
That margin widens dramatically, however, when team positions are weighted: J.P. Morgan is the clear favorite, thanks to having 17 analysts who win the top spots in their respective sectors — that’s more than double the No. 1 spots captured by BarCap and four times the number claimed by BofA Merrill (see Weighting the Results, page 92). Survey results reflect the opinions of more than 3,500 buy-side analysts and portfolio managers at over 1,000 firms that manage some $10.7 trillion in U.S. equities.
Ensuring that analysts provide the worldwide perspective that investors demand prompted a research department restructuring at J.P. Morgan, with Grainger rising from deputy to replace Thomas Schmidt as head of U.S. equity research last October, when the latter was tapped to oversee global equity research. The firm is emphasizing collaboration among members of its regional teams via written reports, conference calls and “the dialogue that happens day to day behind the scenes between the analysts,” Grainger says. “That’s a relatively new structure for us and an important evolution.”
BarCap is employing a similar strategy. For a worldwide approach to succeed, Linde says, a couple of things have to happen — including support for the initiative at the top. “If the senior people participate and understand it’s important, it will become pervasive in the organization,” he says. Aligning nonequity forces is also key. Haggerty concurs. BofA Merrill brings its “economists, equity strategists, currency strategists, credit strategists, mortgage-backed strategists together for conference calls for big events,” he says. For instance, a Sunday evening call in early August on the Standard & Poor’s downgrade of the U.S.’s credit rating drew 1,600 clients — and 2,200 more listened after the call was made available for replay.
Citi, which jumps from eighth place to tie for sixth (with Morgan Stanley), picking up three positions, for a total of 26, is also leveraging its entire platform to assist investors. “The focus is on global insight, being able to tell clients in the U.S. how what is happening in Asia, Europe, Latin America is going to impact the outlook for the stocks they care about,” explains Jonathan Rosenzweig, director of Americas research. “That’s different than trying to make a global call, such as which stock in a sector do you buy in the various regions.”
Related to investor demand for a global perspective is the soaring interest in macroeconomic research. Ever since the financial crisis began, “we’ve seen macro dominating stock selection,” observes Yin Luo of Deutsche Bank Securities, who debuts in first place in Quantitative Research. Before the meltdown an overwhelming majority of money managers — upwards of 90 percent, he says — were more interested in stock picking than anything else. But since 2008 “we have seen the trend changing, and now half our clients say the most interesting, the most relevant topic is macroeconomic analysis,” Luo says.
Aware that fund managers are on the lookout for new ideas, Luo is constantly on the hunt for new information sources and over the past year has tested a wide range of databases, including options data, bond data and high frequency trading data. “One thing we’ve been working on and getting a lot of interest from our clients about is borrowing ideas from other asset classes,” he explains. “We can no longer be just equity investors.”
That’s because the stock market is still searching for direction. Nonetheless, portfolio managers still value top-notch insights about companies and sectors, such as those provided by J.P. Morgan’s C. Stephen Tusa Jr., who captures top honors for the first time in Electrical Equipment & Multi-Industry. Even though shares of many of his companies are well above their 2009 lows, he says, the market is waiting for the next stage of earnings growth and looking for signs that business confidence has returned. “I’m a believer that, while this isn’t a normal cycle, we’re not going back into recession,” Tusa says. This time is different, he adds, because growth is slower than in previous downturns. Among companies in his sector, average organic growth for a five-year period is usually in the 5 to 7 percent range; Tusa forecasts growth for the next three years in the low single digits.
Tusa’s view is echoed by his colleague Steven Alexopoulos, No. 1 for the first time in Banks/Midcap. On average, midcap bank stocks are down 24 percent this year, Alexopoulos says, but clients are still waiting for the bottom. “Investors are looking at bank stocks and saying: ‘Now wait a minute. If you don’t have room left on the deposit side to further reduce rates, your margins are going to get really squeezed — squeezed to the point where you’re no longer earning the cost of capital,’” he notes. The situation probably won’t improve anytime soon. “We may not see rates up for another two to three years,” he adds. “You need the economy to show some strength and consumers and businesses to see increased confidence for rates to go up. All that’s going to happen simultaneously — and it’s probably a 2014 event.”
Alexopoulos is downright giddy compared with BofA Merrill’s Tal Liani. “I’m negative — way more negative than others,” declares Liani, who finishes in the winner’s circle for the first time in Data Networking & Wireline Equipment. (He’s also ranked second in Telecom Equipment/Wireless.) “The growth rate has slowed down materially in the past three quarters, and investors are still not reflecting it. People know it conceptually, but they haven’t translated it yet to lower expectations and lower earnings-per-share forecasts.”
Investors need an “EPS reset,” agrees Credit Suisse’s John Pitzer, in his first appearance at No. 1 in Semiconductors. Companies in his sector are seeing EPS estimates fall further than those in other tech sectors and in the broader economy, with estimates down 8 percent in the second quarter alone, Pitzer says. “People are trying to figure out, ‘Is it enough? Is there one more earnings cut to come, or are there going to be several?’” He believes semiconductor companies in general are back on the path to achieving the 9 to 11 percent growth they enjoyed before the tech bubble burst in 2000 — but it will take a while to get there. “We’ve just gone through an eight- to ten-year period in semis where it was too easy to add capacity,” he says. “We’re now going to go through a three- to five-year period where supply growth is going to structurally slow, and that should give pricing power back to semis.” In the near term the big issue is “the macro headwinds and how those headwinds are going to impact the sector in the next couple of quarters,” he says. “Semis are the most cyclical sector in tech, and tech is one of the most cyclical sectors in the market.”
Paul Sankey of Deutsche Bank, who tops the roster for the first time in Integrated Oil, can relate to that. His companies are “now the cheapest subsector of the cheapest sector of the market,” he says. Even so, “we’re still not very positive on the group — it has low growth and arguably falling returns at the margin,” he explains. “The demand side is weak, partly because oil prices are so high and partly because the economy is so feeble. It’s a tough environment for people to get excited about integrated oil.”
The grass is much greener on Stephen Maresca’s side of the energy fence. The Morgan Stanley analyst, at No. 1 for the first time in Master Limited Partnerships, says that, even though the product market is weak, demand is strong to develop the infrastructure needed to transport oil and gas from the producers to the consumers — and that’s where MLPs come in. They have the operating expertise as well as the access to capital. Infrastructure investment “is a big driver of cash flow growth for MLPs, a big driver of distribution-per-share growth for MLPs. And we think that growth will continue at least for the next two to four years and likely beyond,” Maresca says.
The MLP business model is an advantage when economic growth is tepid and the stock market is volatile. The revenue stream is “essentially guaranteed because they’ve got a commitment from five or ten oil and gas producers who say, ‘We will commit volumes to you for the next five years, the next ten years,’” he explains.
Oil prices may be on the high side, but natural-gas prices are low, and “demand is growing just about everywhere around the world — and the U.S. definitely has a competitive advantage,” says Citi’s Faisel Khan, who tops the roster for the first time in Natural Gas. In fact, there is so much supply in North America that Khan holds “a bullish outlook on the competitiveness of U.S. industrial companies, which are energy-intensive companies that use a lot of natural gas.” In a global economic slowdown, everybody is hurt, Khan says, but the U.S. “maintains a competitive advantage when it comes to energy costs, so that should help, to some degree.”
That’s true, says J.P. Morgan’s Jeffrey Zekauskas, who leads in Chemicals for the first time. “The performance of the U.S. economy — short of a second long and deep recession — is now less important than it historically has been to the chemicals industry,” he believes. The global price of chemicals is set by the price of oil, but U.S. chemicals companies use natural gas to make their products — and inexpensive prices for natural gas lead to higher profitability, he says. Demand from Brazil, China, India and other emerging markets now accounts for 25 percent of overall business annually for U.S. chemicals companies, compared with 5 percent a decade ago. Thus, Zekauskas says, “the profitability of the chemicals industry today should prove higher, more durable and less cyclical than its historical pattern” — and investors should take advantage while they can. He predicts a quarter or two of contracting domestic demand because the slowing economy is causing customers to reduce inventories, leading to a short period of quarterly earnings pressure. But that won’t last long and “should present opportunities to purchase chemicals stocks at attractive prices before an acceleration of earnings growth in 2012,” he adds.
If only the same could be said of the alternative-energy space. Stephen Chin of UBS, voted the sector’s best analyst for the first time, notes that his companies are highly dependent on government subsidies and bank financing. Unfortunately, “alternative-energy product prices are still not low enough to be independent of these subsidies, and a lot of banks don’t want to take on more debt to lend into these projects,” he says.
J.P. Morgan’s Tycho Peterson, in his first appearance atop the roster in Life Science & Diagnostic Tools, says companies in his sector are facing the same problems. Government grants for academic research can account for anywhere from 25 to 80 percent of funding for these companies. “What happens to the core [National Institutes of Health] budget as a function of the supercommittee coming up with $1.2 trillion in budget cuts?” he asks, referring to the special bipartisan committee tasked with identifying ways to reduce federal spending. In this environment “it’s hard to see people rushing to own the group,” he notes.
One analyst keeping a close eye on the budgets that determine government funding is Andrew Laperriere, new leader of ISI Group’s top-ranked team in Washington Research. The supercommittee’s work is one of the most pressing issues at hand, Laperriere says, with the potential to affect several sectors, such as health care and defense. The 2012 U.S. presidential election — “one of the most important elections in the last few decades for investors,” he believes — gains added import because of the state of the economy. The postelection president and Congress must deal with the nation’s long-term budget problems. “If they don’t tackle that issue right out of the gate, there’s a likelihood of further downgrades and the likelihood of a loss of confidence,” he cautions. Laperriere also thinks it’s “very likely that there’s going to be another deficit-reduction package that’s going to be front and center in 2013 — and that will have major sector implications.”
Citi’s Gregory Badishkanian, who claims the pole position for the first time in Leisure, knows only too well the impact the broader economy can have at the sector level; discretionary spending is usually the first cut that cash-strapped consumers make. “It’s hard to predict a recovery in leisure since we believe it’s largely predicated on improvements in the macroeconomic environment,” he says. Such improvements have been much discussed — but remain to be seen.
