The famed fund manager says consolidation in the financial sector should lead to higher profit margins for some companies. By Manuel Schiffres, Executive Editor September 22, 2008 For now, at least, ace fund manager Ken Heebner has turned bullish on financial stocks. At the same time, Heebner, who has been running mutual funds for more than 30 years and is known for his uncanny ability to measure the pulse of the market, has dramatically pared back his funds' commitment to commodity-related stocks.Heebner, who trades feverishly, says he now has more than 30% of the assets of his flagship CGM Focus fund in financials and only about 10% in commodity stocks. As of June 30, according to Morningstar, Focus (symbol CGMFX) had 86% of its assets in energy and industrial-materials stocks and nothing in financials. Heebner revealed his moves on September 19, as stocks rallied furiously in response to an array of government actions designed to end a crisis in global financial markets. The climactic step, which involves the government's plan to buy as much as $700 billion of bad debt from financial companies, came after Uncle Sam's takeover of mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE) and insurance powerhouse American International Group (AIG) and growing concerns that Wall Street titans Goldman Sachs (GS) and Morgan Stanley (MS) could follow Bear Stearns and Lehman Brothers (LEHMQ.PK) into oblivion. Heebner made his comments before the news broke on September 21 that Goldman Sachs and Morgan Stanley would dramatically shift their business models by becoming bank holding companies. Wishing to avoid tipping off his moves to other investors, Heebner normally lets his funds' quarterly filings do the talking about his positions. So, it comes as no surprise that he won't say any more about what he's been buying lately. Advertisement However, Heebner is certainly familiar with Goldman Sachs and Morgan Stanley, stocks that appeared among the holdings of CGM Focus as recently as March 31, 2007. Focus, a concentrated fund, had a big position in JP Morgan Chase (JPM) as recently as last March 31. All three stocks staged big rallies starting in the last hour of trading on September 18 and continuing through September 19. I asked Heebner if the latest government actions were specifically designed to bail out Goldman and Morgan Stanley, the two remaining independent U.S. investment banks. "I wouldn't use the words bail out," says Heebner. "These are healthy companies. I'd call what the government did protection from short sellers" who figured they could have severely damaged the investment banks by driving down their share prices far enough to prompt bond-rating agencies to downgrade the debt ratings of the companies. But the battering of Goldman's and Morgan's stocks was unwarranted, says Heebner: "They are bastions of financial strength. They have no problems with their balance sheets, and Morgan Stanley just reported a quarterly profit of more than $1 billion. Yet early in the day (of September 18), Morgan Stanley's stock got as low as $11.70." It wouldn't surprise me in the least if Morgan, which closed at $27.71 on September 18, is now a CGM Focus holding. Because of consolidation among regular banks, says Heebner, the outlook is much brighter now for that sector, too. He says: "There's a tremendous opportunity in the bank stocks. Strong banks will gain hugely from the consolidation that's under way. You're going to see profit margins reach levels they never reached before because of a shortage of lending capacity." Heebner also expects the Federal Reserve to cut short-term interest rates, a move that should further improve banks' profitability. Advertisement Heebner is agnostic on the short-term outlook for the stock market. He says the global economy "is sliding into recession," with activity declining most rapidly in Europe and China starting to show cracks as well. But the U.S., which Heebner says led the global into economy into recession (although the keepers of such records haven't officially declared a recession here yet), will lead the world out of the slump. In particular, Heebner thinks American consumers, most of whom he says have not been overly burdened by the housing downturn, will resume their spending ways a year from now. "A majority of home owners will feel better, start spending more aggressively and will carry the country forward," he says. The implication is clear. Because the stock market typically anticipates developments in the economy six to nine months ahead of time, a sustained upward move in share prices may be just months away, if it hasn't already begun. As smart as Heebner is, he's no miracle worker. Year-to-date through September 19, CGM Focus was down 12.8%, a half percentage point ahead of Standard & Poor's 500-stock index. Over the past ten years through August 31, Focus returned 27% annualized, thumping the S&P 500 by an average of 22 percentage points per year. Over that period, Focus is behind only Turner Emerging Growth, which is closed to new investors, among diversified domestic stock funds. Focus requires an initial minimum investment of $2,500 and charges annual expenses of 1.27%. Don't invest in CGM Focus unless you can withstand plenty of volatility. For more on its risks, see An Investor's Guide to CGM Focus.