A Conversation with Jerry Jordan
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Energy and the Economic Downturn
I recognize that historically, oil is a risk in a recession. But historically, when we have been in recession, we haven't had this tight of a supply demand going in. Right now, 80% of oil usage in the United States is from transportation. So, even if you see trucking or package-delivery slip some more, I don't think you are going to see a huge demand drop-off as you did in the past.
—Jerry Jordan
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How have things changed since October?
I don't think much has changed. Back in October I said, “Look, the economy is slowing down,” but now my guess is that we are probably in a recession, and, I would assume we're halfway through.
When the numbers finally get calculated, long after it will not have mattered, we will find that the fourth quarter was a recession quarter, and the first quarter that we're in right now was a recession quarter.
Everyone is talking about how to deal with the recession, regardless, as you've said, of whether we are technically in one, or not. How about the Federal Reserve?
I am making the leap that the Federal Reserve ("Fed") is finally figuring out that there is a problem. And therefore they are going to have to get far more aggressive than they've been, and in my opinion, they are going to have to cut rates dramatically, i.e., another 100 basis points (1%). Quickly. Not over the next six months like they were looking for, but over the next eight weeks. I think they will do another 50 basis points (0.5%) next month, and another 50 (0.5%) by the time we get through the next meeting. I'm not a big fan of the Fed in general. But I figured that they would figure it out and get aggressive. And they didn't. So now they are being forced to play catch-up, and I'm hopeful that they will get aggressive. If they do, and we cut rates by 100 basis points (1%), then the market—the equity markets in particular—may sniff out the fact that they are getting ahead of this thing, or trying at least to get in front of it. And therefore, you can start, as we like to say, “Looking across the valley.” So, we're in the valley right now, a downturn, but we hope to be able to look ahead to things getting better by the third or fourth quarter. So, you are pricing in an improvement in a company's fundamentals in the second half of the year and you can start buying stocks.
Looking back to October, you did not view technology stocks favorably.
I'm still not a big fan of “tech.” For the most part it's because the companies that have high growth are far too expensive, and the companies that don't are down for good reason. And we're in a recession where the overall demand for capital expenditures is going to slow down. What I have been buying are some of the more “growthy” sort of software names, where the underlying demand remains firm, either because of their product line or the cycle they are in.
I bought Oracle recently. Oracle's visibility appears to be terrific. They've got a new product cycle that they're planning to start ramping up in the second half of this year, so near-term, things look okay. Then they're planning a new product roll-out the second half of the year to continue to drive growth. It's not a particularly expensive stock, with strong visibility for the next 18 to 24 months. It therefore should garner a premium. And that actually touches on a lot of what I've done with the portfolio to this point. But basically I'm still very underweight in technology.
Yet Google and Apple figure prominently in your holdings?
Well not anymore. They used to be. On the first day of the year, I sold all of the Apple and two-thirds of the Google.
How are you selecting growth stocks in this economic cycle?
I think what you've got is a situation where people pay too much for the 50- and100-percent growers, and not enough for the 15- and 20-percent growers. I think the market is going to circle back and look at the 15- and 20-percent growers and say, “Hey, I feel good about these, especially the non-economically sensitive names. So I'll pay a higher multiple for those.” Now I'm not saying they are going to trade at 40x price earnings (P/E) ratio, but I am looking at companies that are trading at 20x P/E like Genzyme, one of the bigger holdings in the portfolio. It is a large-cap biotechnology company, but it is basically just a big pharmaceutical company that sells biotech products. No single product drives their business, for good and for bad. There's nothing that is going to make their growth a lot better than expected. But also, barring unforseen events, there is nothing that is going to make the growth a lot worse than expected. The company reaffirmed guidance in 2008 for Earnings per Share (EPS) of $4 a share. I think it's a stock that is currently trading at 20x trailing P/E and may go to 25x trailing P/E.
More and more financial advisors are looking at the Jordan Opportunity Fund for their clients. What differentiates your approach from others?
What I would hearken back to is what we've talked about a number of times. It essentially boils down to a belief that the way to outperform over time is to focus on, 1) your best ideas, 2) your best risk-adjusted ideas, and, 3) concentrate on those handful of themes that have big opportunities.
Sometimes the opportunities don't pan out, and sometimes they happen faster than you think. But being diversified can reduce your ability to outperform. We view our job, as a money manager, to try to find the ideas that have the best opportunity to work, while recognizing that there are inherent risks in certain things, and then we try to balance out the portfolio to take advantage of, you know, to be aware of those risks.
Right now, for example, as the economy decelerates there is risk in energy. But I do not think there's a lot of risk because the stocks have not done a lot in aggregate over the last 12 months, versus what their earnings have done. And I think that people have been compressing the multiples, over the last six months in particular, in anticipation of this slowdown. So I believe there is actually plenty of room for these energy stocks to start going up again in anticipation of the economy getting better. At the same time, we own health care stocks where the P/E multiples are historically low even with very good earnings growth. And now there's room for a potential expansion of the multiple. Which may or may not happen. At the same time, we're looking at other areas where we think are a little bit too beaten up, where there is some opportunity.
How would a financial advisor view the Jordan Opportunity Fund in context of their investment strategy?
Let me answer it differently. What I would say is that an investment advisor should be thinking about a two-pronged approach for their equity investments. Number one, they are trying to take advantage of the historical 6% to 8% gains that are made in equities, versus the 3% to 5% gains that are generated in fixed income. And while that doesn't sound like a lot, you know it's a 40% to 50% increase in equities over fixed income over time. So, they're trying to have their clients benefit from this over the long haul. But the issue is that there are more and more funds out there, especially really, really big ones, that have struggled to perform well; either because they are too diversified or they are too big and don't want to take the risk of becoming less diversified. You know, by definition, the less diversified you are, the more volatility you're going to have. And if you are wrong, it has a bigger negative effect. Obviously, if you're right, it has a bigger positive effect. That's what we've always tried to focus on. So what I would say to an advisor is that they should be thinking about reducing their exposure to big money-manager funds, where they've got billions and billions of assets, and move a lot of that money into ETFs [exchange-traded funds], where they'll get all of that market exposure, no turnover, and a low fee. But, all they'll get is the market. And they should be doing that with—well it's their decision essentially, whether it's through ETFs, through custom baskets, or through whatever, basically focused on the low-fee side of things.
Then take the other half of the money, and farm it out to, you know, five or 10 smart men or women who manage funds, who are trying to be nimble, be interesting, and really try to beat the benchmark, and that's where they can add that Alpha. The fees are higher, and that's part of the point. Because even with higher fees, you find those good managers, like we've been, where over a five-year or ten-year period, you had attractive returns versus your benchmark, and that's after fees too. Whereas the index side of the equation gives you the benchmark, the alpha managers like us, seek to outperform the Index. And I believe that is one way to not only potentially improve the overall return on the fund, it could also mitigate the risk of the fund, because you are bound to have a number of managers who tend to cycle at different times. And then, finally, it shows their clients that they're really working for them by giving them half a portfolio at a really low fee, and then going out and helping them find really interesting fund managers. And you sometimes may get in early with a manager, and can take advantage of all the things that come with that situation.
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Trailing Price-to-Earnings (Trailing P/E) uses actual earnings for the four most recently completed quarters.
Price-to-Earnings Ratio (multiple) is the value of a company’s stock price relative to company earnings.
Alpha is a measure performance on a risk-adjusted basis. So for each point that the Alpha increases you are outperforming the benchmark index by 1%.