Morningstar's $207 billion CIO was dumping US stocks before they got rocked during Red October - here are 2 under-the-radar global markets he's buying instead
- US growth stocks no longer offer the most attractive returns relative to the risk of investing in them, according to Daniel Needham, the chief investment officer of Morningstar Investment Management.
- He was gradually shedding exposure to US stocks even before the corrections that hit the market in February and more recently in October.
- In an interview with Business Insider, he shared two market contrarian opportunities where he believes investors can get paid handsomely for taking risks.
Daniel Needham has been gearing up for a big reversal in the stock market.
During the sell-off in October, when the biggest growth stocks led the sharpest monthly decline in seven years, his message to clients was to get defensive.
As chief investment officer of Morningstar Investment Management - where he oversees $207 billion in assets - Needham heeding his own advice long before the so-called Red October and the correction earlier this year. For him, being defensive means positioning yourself in risky corners of the market where you're getting paid for taking the chance.
In his view, US companies with high growth potential no longer offer such an opportunity. Investors have been willing to overpay for such stocks, notably in technology, but have recently started taking notice of the risk that these companies may not live up to expectations.
Going forward, he expects that instead of the huge returns investors have enjoyed throughout this bull market, earnings growth is going to slow.
Apart from shedding US growth stocks, Needham is turning more defensive by cutting his exposure to high-yield credit and maintaining a reserve of cash.
"We've been looking for places that offer attractive reward for risk, and given the aggregate market has been getting less and less attractive, have had to look more and more at smaller markets and sectors to find opportunities," Needham told Business Insider.
Here are the two stand-out opportunities that he has identified:
1. European telecoms
Telecommunication stocks are broadly viewed as a defensive market play because they offer steady dividends, even though their growth is slower.
However, they're also seen as capital-intensive and fraught with uncertainty about regulatory action. In the US, for example, the telecom sector was the market's biggest loser year-to-date before it was folded into the communications services sector.
That's why investors have chosen to instead pile into companies with more spectacular growth - until recently.
Looking into the European market, Needham found the fundamentals of the sector to be reasonable. Companies had increased their pricing power, and their competitive behavior in some of the core markets was fairer. In his view, this made the sector an attractive contrarian pick.
He also noted a key opportunity that exists in the rest of Europe which UK telecoms companies already have: bundled packages that offer landline, mobile, broadband internet, and cable TV. When customers receive all of these services from the same company, they're less likely to switch providers, thereby creating a stickier base that creates more value over time.
Morningstar's latest regulatory disclosures show that the firm owns Telefónica, a Spanish telco, and BT in the UK.
2. Russian stocks
The oil-dependent Russian market has been rocked by the US investigation into interference with the 2016 election and economic sanctions following the country's invasion of Crimea. That's why Needham was quick to acknowledge that the range of returns investors can earn by investing in Russia is "undoubtedly wide."
"There are concerns around Russia, around the government's role and things like that," Needham said, "But some of the cheapest companies in the world maybe can be found in the Russian stock market."
Besides valuations, he noted that some listed companies in Russia have "some of the best assets in the world," including companies that supply huge amounts of the gas that powers Europe.
For many such companies, Needham has invested through an active manager or by buying a broad market portfolio.