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A Discussion on Today's Market and Our Cornerstone Growth Fund

By Neil Hennessy

April, 2008

The current market is one of the most volatile and tumultuous that I have seen in my nearly 30-year tenure in this business. Emotion clearly drove the market down in the first quarter of 2008. Investors are understandably nervous about the weak dollar, record oil prices, the continued housing slump and credit crunch. The non-stop headlines predicting a severe recession would scare anyone, however, the most important market metrics, interest rates, unemployment, inflation and corporate earnings, remain fundamentally strong in our opinion. We believe we will stave off a major recession, and that prospects for the market long-term remain quite positive.

All too often investors focus on what the market is doing right now, get caught up in the heat of the moment, and lose perspective about their long term goals. If we look back in history we can see that while there have certainly been corrections along the way, the long-term direction of the equity markets is positive. In late 1989 to 1990, the market was plagued with spiking oil prices, a slumping real estate market, the Savings and Loan crisis, low consumer confidence, concerns over inflation, and the Fed was lowering interest rates. Sound familiar? In 1990, the S&P 500 fell 19% from July to October. However, for the calendar year 1990 the S&P 500 was down just 3%, recovering 12% in the final 3 months of the year. Could you have invested in the S&P 500 at the beginning of 1990, and you held your investment through that correction in 1990, the correction of -19% in Jul-Aug of 1998 and the bear market of 2000-2002, by the end of 2007 your average annual return would have been roughly 10.5%.

The media is constantly bombarding us with short-term reasons not to invest in the stock market – apparently that garners ratings and sells newspapers. No one really knows what will happen to the stock market over the short-term. We do, however, have a great amount of historical evidence that shows that the stock market is one of the best returning investment vehicles over the long run. This is why we don’t let emotions or short-term fluctuations dictate our investment principles, and why we never waiver from our time-tested formulas.

We understand that the short term returns of the Cornerstone Growth Fund have been disappointing, but we always try to keep a long-term view in mind when assessing performance. Since its inception, the Fund has experienced a total of six different corrections, where performance has fallen more than 20%, including the most recent period of late 07 into 08. However, had you purchased the fund on its inception date of 11/01/96 and held it through all the corrections, as of 3/31/08, your average annual return would have been +11.86%, approximately 60% higher than the return for the S&P 500 over the same period.



Please click here for complete standardized performance information.

Corrections can be painful and disheartening while experiencing them, and it is understandable that investors may second guess our investing formula during difficult times. However, I believe the historical performance data shows how patience, discipline and a long-term investing view can be rewarded. It is the non-emotional, time-tested, formula-based investing that has allowed the Cornerstone Growth Fund to outperform the S&P 500 over the long run. Savvy investors know that when things look bleakest, it may be a good time to buy rather than sell. We believe that in the future we’ll look back at the 2007-2008 market with the same type of “20-20 hindsight” with which we view other past corrections and bear markets.

The Cornerstone Growth Fund portfolio was rebalanced during the first quarter of the year, with 48 of the 50 stocks being replaced and only two previously held stocks continuing to meet our criteria of low price to sales ratio and earnings and stock price momentum. As per our prospectus, we have followed the exact same stock screening process, but the Cornerstone Growth formula has generated some interesting results in the new portfolio, frankly ones we haven’t seen since the fund’s inception. We see a notable decline in the percentage in small cap stocks (under $2.1B market cap) in the portfolio, decreasing by 18%. Our mid cap exposure decreased by 14% as well, thus increasing our large cap exposure (over $11.8 billion market cap) by 32%. Historically we have averaged a 4% exposure to large cap names and since 2000 we have never had more than 10% of the companies fall into the large cap category. The new Growth portfolio is made up of 38% large-cap names. The median market cap of the new portfolio is $6.55 billion, versus last year’s portfolio at $1.72 billion, at time of stock selection. Our exposure to foreign companies, through the use of ADRs, is now at 24%, whereas the average since 2000 has been approximately 5%, with the highest previous amount of 10% in the 2007 portfolio. Nearly half of the large cap names that came into the portfolio are ADRs.

We believe that our Cornerstone Growth formula, which marries value and momentum, can foresee some potentially interesting trends. Stocks that have been in the headlines over the last couple of quarters, namely financials, housing and auto stocks, are still absent in the new Cornerstone Growth portfolio. We see more weighting in multi-national corporations, perhaps signaling that while the domestic economy is slowing there is still opportunity for reasonably priced growth stocks overseas. No specific sector represents even 10% of the portfolio, which now consists of 31 different industry classifications, from Electronics to Energy, from Steel to Soft Drinks. We believe that this supports our belief that it will continue to be a stock picker’s market, and that returns will not be about picking the right sector or asset class, rather finding undervalued stocks throughout the market.

If you would like a full list of the stocks in the Cornerstone Growth portfolio, or if we can answer any questions or provide any additional information, about our funds or about our views on the market, please do not hesitate to contact us via email at fundsinfo@hennessyfunds.com or by phone at 800-966-4353.
 
Legal Notice

 


 

Past performance does not guarantee future results.

Small and medium-capitalization companies tend to have limited liquidity and greater price volatility than large-capitalization companies. Investments in foreign securities involve greater volatility and political, economic and currency risk and differences in accounting methods.

Opinions expressed are those of Neil Hennessy and are subject to change, are not guaranteed and should not be considered investment advice. The S&P 500 is an unmanaged index commonly used to measure the performance of U.S. stocks. One cannot invest directly in an index. Exposure is subject to change and should not be considered a recommendation to buy or sell any security.

Price-to-sales ratio is a tool for calculating a stock's valuation relative to other companies. It is calculated by dividing a stock's current price by its revenue per share.