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Kimberly A. Scott
Portfolio Manager
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Waddell & Reed Advisors New Concepts Fund - November 2011
While a company’s market capitalization and valuation are important, the true differentiator of return potential in the market today is growth, says Kimberly Scott, portfolio manager of Waddell & Reed Advisors New Concepts Fund. The following is her view of the current market environment.
Today’s investors have more access than ever to stock and bond markets around the world, but our research suggests that growth stocks here in the “good old U.S.A.” are where true opportunities have the potential to shine.
One advantage to investing in U.S. stocks is the potential for relative stability in a volatile market and an economy characterized by protracted slow growth. An additional advantage is transparency. The proliferation of analysts, as well as the wealth and availability of information on domestic companies, means investors can typically get a better sense of what they are buying and gauge the likelihood of a given company’s future growth.
Reality vs. expectations
With so much focus on challenging macro events around the world, investors may be bailing out of the stock market at a time when we see companies that have historically strong fundamental operating positions. In addition, many stocks appear to be undervalued, both on their own merits, and certainly relative to other assets, such as fixed-income securities. We are seeing a potential mismatch of reality and expectations, in which we have stronger 2011 company and economic fundamentals, but 2008-09 investor psyche.
While the current economic outlook is certainly not robust, we see it as being much more stable than the dire circumstances of three years ago; yet investors continue to be concerned that the economy will rapidly come unhinged much as it did in 2008. They are reacting in a knee-jerk fashion to every headline, selling stocks on fears that European dysfunction, a slowdown in the Chinese economy or a U.S. double dip may mean disaster for stocks, only to swerve sharply back into stocks on more optimistic headlines. While we understand the concerns, given the severity of the economic downturn and the stock market reaction of three years ago, we find the indecisiveness of so many investors to be counterproductive and in itself dysfunctional.
Recognize slow growth, focus on quality companies
We choose to focus on two broad factors. One, an economy that will have difficulty receding from a position of such slow growth, and two, companies that are operating from a position of relative strength given:
- The swift and acute restructuring of their businesses since late 2008 and early 2009;
- The general strength of their capital structures;
- Their broad access to low-cost funds, should they choose to invest more aggressively.
In addition, we believe the management teams of these companies are investing prudently for the future, while keeping an eye on the tumultuous past, and more often than not, their organizations are delivering measured and profitable growth.
While we have been concerned that all of the dire news around the globe could create a negative feedback loop that has the ability to create economic stress, we remind ourselves that the economy is already running at a very low level, probably close to base demand. We think the environment would have to change significantly for the worse for the U.S. to see a serious recession. In fact, we believe many key sectors, such as housing and industrials, particularly automobile manufacturing, are operating at levels below that which is necessary to meet intermediate to long-term demand, including, with autos, even replacement demand.
Many U.S. banks, which were the central point of such stress just three years ago, are now overcapitalized and excessively cautious in their lending practices, such that a new credit cycle catastrophe, which would lead to further strict lending practices and recessionary conditions, is difficult to see. Hiring remains slow, as seen in all of the employment data, even as companies grow profits, in many cases, to record levels. The will to do more with less on the labor front also makes it less likely that we would see a spike in joblessness leading to a cascade of economic weakness.
Still constructive on the market
Our evaluation tells us that U.S. companies are as healthy today as at any point in recent economic history. They are generating high levels of profits and returns, and they have generally clear access to capital at historically low cost. Company management teams are working hard to balance investing for the future with a serious respect for the trials of the 2008-09 economic downturn, which had so many of them questioning survival. This prudent approach is part of the reason why the economy is not moving forward more strongly, but is also the reason it will be difficult for the economy to face an extreme challenge to the downside.
So even with so much volatility over the past few months, we continue to remain constructive on the market. We are finding attractive opportunities to invest in companies that don’t need a strong economy to deliver solid organic revenue and earnings growth. There are many mid-sized U.S. companies with exciting growth prospects and investment potential, and we are focused more acutely on the stocks of these “Greenfield Growth” companies – terminology we use to describe companies with innovative products and services as a platform for high visibility and long runway growth trajectories. We find opportunities to invest in Greenfield Growth companies across many different sectors of the market.
Our goal is to continue to seek to provide growth of capital. In helping to manage risk, we search for high-quality growth assets at what we believe are attractive prices, and invest with a long-term perspective that lets our investment thesis mature over an investment period of three to five years. We like what we see as opportunities to own great companies across the growth spectrum, and across all sectors. However, we remain mindful of the many risks inherent in all the issues around the globe. We carefully watch the macroeconomic environment, and are willing to make changes to the portfolio as our conviction level changes.
Past performance is not a guarantee of future results. The opinions expressed are those of the Fund manager and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through November 15, 2011, and are subject to change due to market conditions or other factors.
Investment return and principal value will fluctuate, and it is possible to lose money by investing. Investing in mid-cap stocks may carry more risk than investing in stocks of larger, more well-established companies. These and other risks can be found in the Fund’s prospectus.
Investors should consider the investment objectives, risks, charges and expenses of a fund carefully before investing. For a prospectus, or if available, a summary prospectus, containing this and other information for any of the Waddell & Reed Advisors Funds, call your financial advisor or visit www.waddell.com. Please read the prospectus or summary prospectus carefully before investing.