Bottoms-up stock pickers like to say they don't pay much attention to economic news. They buy stocks because they like a company, the stock is cheap, earnings are growing rapidly, or for any number of other reasons that don't relate to the economic environment.
By contrast, if you ask a bond fund manager about the economy, you're likely to get an earful. Bonds, for all their different yields, issuers, credit ratings and other variations, are at their core interest-bearing securities whose fortunes are inextricably tied to the ebb and flow of the economy. Not surprisingly, Dan Fuss, vice chairman of Loomis Sayles & Co. and manager of the $1.7 billion Loomis Sayles Bond Fund, has his share of thoughts about where the economy has been, and where it may be headed.
While economic prognostication isn't hard to come by these days, Fuss' opinions get more play than most. At age 67, he is something of an elder statesman in the world of bond fund management. With near-instant encyclopedic recall, he can tell you what the bond market has been up to since before John F. Kennedy took office, and how it relates to what's going on today.
Beyond historic knowledge and some good yarns about his hometown of Milwau-kee is the solid long-term performance of the fund Fuss has managed since its inception in 1991. From that year through the first quarter of 2001, the Loomis Sayles Bond Fund has returned an average of 10.76% annually, compared with 8.19% for the average triple B-rated corporate bond fund, according to Lipper. That makes it first in its category over that time frame.
But the fund hasn't kept pace over the last year. With a one-year total return of just 0.54%, it ranked 149th out of 153 funds in its Lipper category for the year ending March 31, a time when the average fund in the category returned 9.64 %. While Loomis Sayles Bond Fund is one of the more volatile offerings in its category, it is also one of the highest yielding, sporting a recent 30-day SEC yield of 8.58%.
Fuss may be a mild-mannered Midwesterner, but among rival fixed-income managers he is known for his guts. Chalk up at least some of the fund's recent under-performance-as well as its solid long-term track record-to Fuss' trademark style of rooting for the underdogs of the bond world. By buying bonds on the cheap when few investors want them, he looks to lock in a high current yield, as well as upside potential when a company's credit rating improves.
The aggressive fixed-income strategy works best in a strengthening economy. But with the economic slowdown, many of Fuss's beaten-down bonds have just gotten cheaper, instead of turning around.
A high exposure to foreign bonds also has hurt the fund. With 28% of its assets in foreign bonds, many of them high-quality Canadian government issues, the continued strength of the U.S. dollar against foreign currencies has taken its toll on performance. "We have very distinct performance cycles," admits Fuss. "But the things that have hurt us will eventually swing around to help us."
A late-year recovery?
Which brings us back to that age-old tie between the bond market and the economy. The turnaround in performance that Fuss is looking for will depend largely on whether the economy is in for a solid recovery, a soft landing, or a hard thump later in the year. With its heavy emphasis on bargain bonds, Loomis Sayles Bond Fund obviously would be best served by a recovery.
To help understand why he thinks that's likely to occur later this year, Fuss harks back to 1958, a time that he says bears a striking resemblance to what's going on today.
"I was just getting out of the Navy," he recalls. "The post-war economic boom had come to a grinding halt. For the first time since World War II, companies just stopped spending money to build and expand. The capital spending boom had turned into a capital goods recession." By the time the 1960 presidential elections rolled around, John Kennedy's motto was "Let's get the country moving again." It would take another three years, says Fuss, for that to really begin to happen.
What is similar today, he says, is the sudden slowdown in spending by corporate America after several years of aggressive expansion. "Companies are putting off any kind of expansion," he says. "The only borrowing they're doing is trading in their short-term debt to issue long-term debt. Things are at a standstill and will probably remain that way for the fist nine months of the year."
Still, he doesn't see the protracted recession reminiscent of his post-Navy days around the corner. "The factors in play now are very different than those of the late 1950s," he says. "The point everyone seems to be missing is the enormous demand created by non-Japan Asia, which represents two-thirds of the world's population. When you talk about an economic recovery, it's short-sighted to focus only on what's going on in North America. The models that worked in 1958 don't necessarily lend themselves to the picture in 2001."
Fuss believes there are several arguments against a worst-case scenario in which consumers decrease their spending and tip the economy into a recession. "Low inflation gives the Federal Reserve latitude to lower interest rates and pump liquidity into the economy. Banks and the corporate bond market are healthy. And the budget surplus gives the government flexibility to stimulate economic growth."
For the time being, at least, he doesn't see inflation as much of a concern. "What you really need to watch for are signs that world peace is being threatened on a large scale," he says. "A military buildup in the U.S. could cut into the budget surplus and create an inflationary threat. So far that isn't happening. But with China and other countries so volatile, the situation bears watching."
He remains optimistic about a late-year pickup. "I think we'll see the beginning of a moderate recovery later in the year. It won't be enough to ring any inflationary bells. But next year at this time, we'll be talking about how bond upgrades are exceeding downgrades."
That would obviously be good news for a fund that depends on credit upgrades for some of its pricing push. The question is whether the sluggish earnings that have impacted the stock market so profoundly will continue to spill over to the bond market as well.
"Earnings jitters are not good for the corporate bond market," says Fuss. "But we believe corporate bonds will post good returns in 2001 because at this point there are two things working in our favor: time and the relative cheapness of these securities."
Reflecting that view, the fund had 35% of its assets in industrial bonds, with another 16% in financial, electric, gas and telephone companies. With an average credit quality of Baa1, the fund's focus is at the lower end of the investment-grade bond spectrum. Because of concerns about the business environment, Fuss has been able to pick up bonds of unpopular companies such as Lucent Technologies and Columbia/HCA Health on the cheap.
Fuss calls telecom-supplier Williams Communications one of his more "arguable" bond picks. He defends its recent addition to the portfolio because, despite the telecommunications industry's current woes, demand for cable remains strong. "Williams is a single-B credit with a lot of credit risk attached," he says. "But the company has already made most of the expenditures it needs to lay cable, and the demand for its services is rising."