In Major Shift, Investment Pros Lose Their Appetite for Risk
They Seek Out Large Stocks,Look Cautiously Overseas;
Bets on Consumers Are Off Cozying Up to the 'Big Uglies'
By E.S. BROWNING
July 7, 2006; Page A1
For the first time since the last bear market ended in 2002, a broad swath of professional investors are reevaluating where to put their money.
They are moving away from the high-flying investments that have rewarded them handsomely for years and are now seeking out something they had come to despise: quality.
Brett Gallagher, co-head of global stock investment at Julius Baer Investment Management in New York, is dumping once-trendy stocks from far-flung places like India, betting instead on developing economies with what he considers better long-term prospects, including Poland's. He's avoiding regional banks with lots of exposure to consumer loans, preferring bigger global players. Also off his radar: anything favored by fast-money hedge funds -- "renters, not owners," he scoffs. Instead, he likes more staid stocks, such as General Electric Co.
"It is clear which stocks have an investor base and which are powered by near-term speculation," Mr. Gallagher says. "For anyone who is an investor as opposed to a renter of stocks, upgrading to quality in the portfolio is going to pay benefits."
Money managers are concluding that it's time to cut back on their holdings of the volatile and increasingly speculative investments that until recently had been soaring -- gold, industrial commodities, real estate as well as small stocks and many developing-country stocks.
"Starting in 2002 and 2003, it was 'the riskier the investment the better.' Now, the tide has shifted," says Jeff Schappe, chief investment officer of BB&T Corp.'s BB&T Asset Management in Raleigh, North Carolina.
As the era of cheap borrowing ends and the economic climate grows more conservative, investment pros are betting that higher-quality investments will fare better in a slower economy -- and suffer less if there's a bear market. But they don't all define "quality" in the same way. Here is a look at some of their strategies:
Pick Less Volatile Stocks
Money manager Janna Sampson of OakBrook Investments in Lisle, Ill., decided it was time to adjust her investment approach in May, after CNBC anchor Maria Bartiromo reported on an off-the-cuff remark made by Federal Reserve Chairman Ben Bernanke at a May social gathering in Washington. He told the journalist the market was wrong in its perception that the Fed was poised to stop raising rates.
"It was after Bernanke made his now-famous comments at the White House Correspondents Dinner," Ms. Sampson recalls. After that, "we started to see every Fed president and every Fed board member making more hawkish comments."
Ms. Sampson trimmed holdings of stocks such as McDonald's Corp. and Waste Management Inc. that were up sharply and could fare less well if economic growth slowed. She cut back on H.J. Heinz Co., because it was up on speculative buying, not on fundamentals, after an activist investor pressed for strategic changes. She shifted money into stocks that haven't been as sought-after and for which expectations are lower, such as Kimberly-Clark Corp. and Microsoft Corp.
In April, Susan Malley, president of Malley Associates Capital Management in New York, pulled back from the bets she had made on economic growth last year. She reduced holdings in smaller companies and in those closely tied to economic expansion. Among them: oil drillers such as Diamond Offshore Drilling Inc., and technology companies like communications-chip maker Broadcom Corp., and software maker Cognos Inc.
She shifted toward larger oil-industry stocks, including Schlumberger Ltd. and Baker Hughes Inc. and boosted exposure to companies with steady sales streams, such as PepsiCo Inc., Kellogg Co., CVS Corp. and Procter & Gamble Co. Although they tended to be laggards until recently, these so-called Big Uglies look safer and more stable now, she says.
A typical account at her firm went to 14% tech stocks, down from 18% at the end of March. "We have reduced them not because we don't like them but because we want a little less volatility," she says.
Mr. Gallagher, of Julius Baer, notes that stocks such as U.S. Steel Corp., Apple Computer Inc., copper-producer Phelps Dodge Corp. and chip-maker Advanced Micro Devices Inc. all have seen rapid buying and selling in recent months. He sees that as a sure sign of excessive interest by hedge funds, the fast-trading investment pools that cater mainly to deep-pocketed investors.
Because fickle hedge funds can suddenly dump large amounts of shares -- making stock prices fall sharply -- he is bullish on stocks in which trading has been quieter. He likes GE, United Parcel Service Inc. and PepsiCo -- companies whose fundamentals he believes make them good long-term prospects.
Beware Consumer Stocks
BB&T's Mr. Schappe has a secret weapon to track consumer demand: his father, who sells real estate in mobile-home parks in Punta Gorda, on Florida's west coast.
"A year ago, we liked consumer discretionary stocks a lot more," Mr. Schappe says. But his research showed loan delinquencies on the rise, and his father reported that his customers' buying power was weakening.
To cut its exposure to discretionary stocks -- those that rise and fall with consumer spending on nonessential goods -- BB&T trimmed holdings of handbag retailer Coach Inc. and women's clothing retailer Chico's FAS Inc. It also pared holdings of computer-chip makers such as Broadcom and National Semiconductor Corp.
"Consumers have pretty much tapped out of their home equity, and that cash register has shown signs of going silent," he says. "We are tending to focus on businesses that sell to businesses." To that end, he boosted investments in companies such as Boeing Co., Oracle Corp. and Caterpillar Inc. -- companies with large-scale contracts and good global growth prospects.
Henry Herrmann, chief executive of money-management firm Waddell & Reed in Overland Park, Kan., says pros there have recently sold some stocks and boosted cash reserves. "I am not thinking that this is all over yet," he says of the declines in stock prices.
As his money managers gradually put cash to work, they're buying U.S.-based infrastructure stocks -- linked to energy, industry and construction.
Mr. Gallagher of Julius Baer is staying away from regional banks, for fear of bad consumer loans. "We prefer the big diversified companies that have overseas earnings," such as Citigroup, he says.
Strategist Joseph Quinlan at Bank of America's global wealth and investment-management division is telling clients to focus on capital-goods companies and infrastructure builders. Such businesses stand to benefit from continued, even if slowed, economic growth. He has calculated that big banks, brokerage firms and insurance companies as a group now receive 25% of their revenue from abroad, insulating them somewhat from the U.S. consumer.
Think Big, Not Small
The Russell 2000 small-stock index more than doubled during the current bull market, hitting repeated record highs, while the Dow Jones Industrial Average rose roughly half as much and never hit a record. Now, the tables may be turning. Since peaking in May, the Russell is down 7.8%, while the Dow has fallen only 3.6%.
Small stocks typically do best when economic growth is accelerating, because small companies are more nimble and can grow faster. But they also tend to be more dependent on bank loans, making them suffer more when rates rise and economic growth slows.
"If you are at the start of an economic boom, smaller companies might have more room to run. But that isn't what we are seeing now," says Marc Stern, chief investment officer at Bessemer Investment Management in New York.
For some time, analysts have been urging investors to return to once-popular big stocks that had languished and become cheap, and now some investors are listening to that advice.
"A good proxy for quality is size," says Mr. Schappe of BB&T. Even fund managers at his firm who specialize in small stocks, he says, "are buying larger small stocks."
Large stocks, says Ms. Sampson of OakBrook, often are better protected from difficult markets -- "by patents, strong brands or barriers to entry."
But not everyone is persuaded that the small-stock run is done. Small stocks have become particular favorites of hedge funds, precisely because they can rise more sharply when they become hot, says Mr. Herrmann of Waddell & Reed. And hedge funds represent as much as half of stock trading on some trading days.
Seek Quality Foreign Markets
Among the worst places to be over the past two months have been what investors call "emerging markets" -- stock markets of developing countries. India, for example, is down 15% from its recent high, in May. Colombia is down 29% from a January high, and in the Philippines the stock market is off 14% from its May peak.
"Emerging markets have become the tech stocks of this decade," says Russ Koesterich, senior portfolio manager at Barclays Global Investors in San Francisco.
Nevertheless, investors such as Julius Baer's Mr. Gallagher are using the downdraft as a chance to buy back in and upgrade to better quality in the process.
Mr. Gallagher has been selling stocks in countries "that are less good fundamentally, and taking the opportunity to buy those where we think the long-term story is still in place," he says.
One problem: Not everyone can agree on which countries offer the best investment quality. Mr. Gallagher favors Eastern Europe because he sees continuing development without inflation or Asia's dependency on exports. "Asia is very much dependent on the U.S. consumer. To the extent that the U.S. consumer stumbles, these markets will be more affected," he says. He dislikes Mexico, which he says is losing exports to China, and likes Brazil for its strong domestic market.
Mr. Quinlan of Bank of America, who urged clients to get out of emerging markets earlier this year, was largely ignored then, he says. Now, he is telling them to start selectively buying again. But scared off by the recent declines, they still aren't listening. He sees quality in more-advanced economies such as South Korea, Brazil, Hong Kong and Singapore, but not in Turkey or India, where he sees inflation risks.
Plenty of people remain skeptical of emerging markets in general, preferring Japan and Western Europe.
"We have a saying in the firm: An emerging market is one you can't emerge from in an emergency," says Richard Steinberg, president of Steinberg Global Asset Management in Boca Raton, Fla.
Find a Shield From the Dollar
With investors hoping that the Federal Reserve can stop raising U.S. interest rates some time this summer, and with governments in Europe and Asia sending signals that they will boost rates in the future, investors are starting to think the dollar could come under attack again.
The dollar is affected by a wide variety of factors, from trade flows to world demand for U.S. investments. The dollar tends to be stronger when U.S. interest rates are high compared with foreign rates, since higher interest rates make the dollar more attractive to hold.
That's why many pros are looking for ways to invest abroad, and why they are looking for other ways to bet against the dollar as well.
Mr. Steinberg is betting that the euro will rise again. He is buying an exchange-traded fund that tracks the euro's value. He thinks the dollar could weaken ahead of U.S. elections, especially if the Fed signals an intention to stop raising U.S. rates.
"We think the thing to do with all this turbulence in the dollar is to keep a higher allocation to foreign markets," says Peter Wall, chief investment officer at Chase Private Client Services, a brokerage and money-management arm of J.P. Morgan Chase.
But not everyone is so sure. "Money is coming back to the dollar," says Mr. Herrmann of Waddell & Reed. He thinks nervousness about foreign investments could keep money at home and prevent the dollar from falling too hard.
To profit from any dollar decline without taking much risk, some investors are simply focusing on large multinationals that derive profits in many currencies. If the dollar weakens, their offshore income rises. If it doesn't, investors still benefit from the stocks' overall quality.
Bob Bissell, president of Wells Capital Management, a money-management arm of Wells Fargo, fears U.S. stocks could remain in the doldrums this summer. "Now, people are being paid to wait -- they are getting a good return in money-market funds," he says. |
