Picks and Pans From Market Pros
Gregory Zuckerman
Monday, July 13, 2009




As the historic market collapse felled many investors, a handful set themselves apart by scoring big profits.

Now, several of these money managers expect more bad times ahead, including struggles for consumers, limp earnings and a possible surge of inflation.

They also see pockets of opportunity.

George Soros is bullish on China, India and Brazil. John Paulson is investing in distressed debt, residential mortgages, even companies in bankruptcy proceedings. Alan Fournier, a lesser-known investor with a strong track record, likes some health-care shares, while James Melcher, also successful lately, likes corporate bonds.

"We're trying to make hay while the sun's still shining," says Mr. Fournier, who runs $2.8 billion Pennant Capital. "Maybe we can rally through the summer, perhaps for another year, but there are a lot of difficult issues that we're going to have to deal with."

Mr. Soros is just as wary. The renowned 78-year-old investor and philanthropist calls the current terrain a "trading market," saying in a recent interview that investors should take profits when shares surge, even if they look promising long term.

"I'm not bearish but I don't see how we can have the kind of growth in profits that we had during the superbubble," says Mr. Soros, who these days leaves most day-to-day trading decisions at his $24 billion fund to Keith Anderson, a former BlackRock portfolio manager. The fund scored gains of 32% for 2007, 8% in 2008 and 17% so far in 2009. "He's the player, I'm the coach," Mr. Soros says.

Still, Mr. Soros remains on the lookout for investment ideas. Lately, he is identifying them in Brazil, India and China, even though last year his exposure to emerging markets weighed on returns.

"Maybe we're making the same mistake again by thinking that China and India will decouple from the developed world," Mr. Soros says. But "China is the major beneficiary of the collapse of the financial system. For them it was an external shock," he says. "Because China is in a position to stimulate its economy, it will be a motor for the global economy," partially replacing the U.S. consumer.

As for Brazil, Mr. Soros likes state-owned Brazilian oil giant Petroleo Brasileiro SA, for example. But the firm trimmed some of its position earlier this year in the company, known as Petrobras, which has seen a run-up in the share price.

Mr. Paulson, who scored collective profits of more than $17 billion in 2007 and 2008 by betting against subprime mortgages and financial shares, sat a huge pile of cash at the outset of 2009 -- some $19 billion of his hedge funds' $30 billion, his investors say.

But as Mr. Paulson and his team spent weeks combing through the rubble of the credit markets, they concluded that beaten-down prices assumed a rash of defaults that were unlikely to materialize.

"We completely shifted our focus on the credit markets from one which had a short bias starting in 2006 to one that is aggressively long," Mr. Paulson said in a recent interview.

The posture has its risks, especially if credit woes spread among better borrowers. But over the past four months, Mr. Paulson bought top-rated residential mortgage-backed bonds, commercial mortgage-backed securities, distressed debt and leveraged loans. Mr. Paulson even purchased shares of some big banks and financial companies, the kinds of companies he wagered against in 2008. As the market rebounded, Mr. Paulson's funds scored gains of between 4% and 15% for the year, through the end of May, investors say.

Now, Mr. Paulson is buying shares of financial companies like Capital One Financial Corp. and J.P. Morgan Chase & Co., as well as commercial real estate broker CB Richard Ellis Group Inc. and oil producer Petro-Canada, according to public filings.

"While we don't believe bank stocks in general are undervalued, we do believe many represent compelling investment opportunities over the cycle," he says.

His team is buying selectively, as they fear lower growth ahead as consumers struggle. And Mr. Paulson is concerned that all the money that the U.S. and other governments are shoveling at various problems eventually will lead to a surge in inflation.

The stance is controversial—others say it will be years before inflation becomes a problem. But Mr. Paulson is buying protection now; more than 10% of his holdings are in gold, his investors say.

Like Mr. Paulson, Mr. Fournier was among the first investors to turn gloomy on housing. Mr. Fournier, who once worked for prominent hedge-fund manager David Tepper, operates under the radar in suburban New Jersey. His hedge fund, Pennant Capital, is up about 9% this year, thanks to gains from commercial and residential mortgages.

Now he is bullish on an area that others are beginning to warm to: health care. Mr. Fournier argues that WellPoint Inc., the big managed-care company, is a bargain. Though some are concerned that President Obama's health-care plan will put a lid on earnings of WellPoint and other health-care firms, policy changes "won't be as much of a threat to public HMOs as people fear," says Mr. Fournier, who regularly consults with lobbyists working in the Capitol.

"WellPoint is a very cheap stock," he says, and can generate the cash flow to buy back as much as 40% of its outstanding shares, he estimates. He likes the stock even though it has outpaced the market in recent months.

Mr. Fournier also likes coal and utility stocks, such as Foundation Coal Holdings Inc. He recently succeeded in helping to push out chief executive and chairman at mortgage and fleet-management company PHH Corp., where he sees big upside.

The danger: These companies get caught in a downdraft that Mr. Fournier is sure is down the line.

"I just don't know if the market can sustain itself past this brief window, when the stimulus impacts the economy," Mr. Fournier says. "It's only a matter of time before stimulus effects fade, the economy rolls over, deficits hurt bond yields and the dollar gets hurt."

Mr. Melcher's team at Balestra Capital is finding even fewer ripe investments. Balestra is relatively small -- just under $1 billion -- but the hedge fund has racked up stellar returns for several years, including gains of 199% in 2007, 46% last year, and 7% so far in 2009, according to investors.

It owns top-rated corporate bonds with yields of about 6.5%, investments that found popularity in recent weeks.
But Mr. Melcher has become increasingly concerned that the stock market is beginning to look expensive again, and that investors are overlooking problems.

"The economy is still deteriorating, job losses are still huge, I really don't see where earnings will come from to drive valuations," Mr. Melcher says. "Just because things are getting worse at a slower pace doesn't mean they're getting much better."

To profit from coming problems in rash of countries, Balestra has been loading up on derivatives, known as credit-default swaps, that insure the debt of Latvia, Bulgaria and Romania, his investors say. The firm also has taken positions against the debt of Sweden, Ireland and Greece. Behind the trade: It can cost less than $5,000 annually to insure $1 million of this debt, making it a low-risk but potentially high-paying bet, the Balestra team has argued.

Other investors who anticipated the housing problems, like Kyle Bass of $500 million Hayman Capital, are betting big against the debt of Japan and the U.K., worried about rising debt obligations.

"These governments are all on the hook for bank debt and there's still very high leverage in those economies," Mr. Melcher says. "The best outcome is we trudge along for a while."


Write to Gregory Zuckerman at gregory.zuckerman@wsj.com