Merrill Lynch gets bearish
Bernstein explains brokerage's shift toward bonds, scaling away from stocks
August 4, 1998: 3:19 p.m. ET
Special report: Dow sell-off
Bears step in on Wall Street - Aug. 4, 1998
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NEW YORK (CNNfn) - One normally bullish broker, Richard Bernstein of Merrill Lynch, has recently turned cautious and is making some radical changes in the way he is allocating assets, taking money out of the stock market and putting it into bonds instead.
He told CNNfn's "In the Game" that while the brokerage forecast sharply weaker corporate fundamentals ahead, it had stopped short of issuing a general sell order in June and the market outlook was "not necessarily apocalyptic."
A partial transcript of his comments follows.
BEVERLY SCHUCH, CNNfn ANCHOR: Tell me what your quantitative research is telling you right now.
RICHARD BERNSTEIN, CHIEF QUANTITATIVE STRATEGIST, MERRILL LYNCH: Well, as of June 1, we actually became a little more cautious on the market for two reasons. No. 1, valuations by our models are finally beginning to get a little lofty here. I know people have talked about that for two or three years in some cases. By our models, it's finally beginning to happen -- valuations are deteriorating.
And no. 2, our sentiment models are showing that people are actually willing to admit they are bullish -- you know the bullishness in the street is growing. That wasn't true a year ago, it wasn't true two years ago, and certainly wasn't true three years ago. So those are really the two reasons why we are starting to get a little more cautious here.
SCHUCH: The bullishness is growing, you say. I'm wondering if that is a lagging response, though, because the majority of stocks are not in the positive column.
BERNSTEIN: Well, that is actually a pretty good point. I mean, this model that we have is one of the most powerful models we have in terms of timing the direction of market, and it is a very reliable contrary indicator. In other words, if Wall Street gets really bullish, that would be a bearish sign. We came very close this past month to getting a formal sell signal on the market there. Largely, you know, because bullishness is growing, but the fundamentals are weakening. And that is what you normally need for a sell signal.
SCHUCH: So, you think the fundamentals are reflected in the market then and what it is doing.
BERNSTEIN: No, no, actually in terms of fundamentals, we think they are actually going to be a lot weaker than people think. We think we are actually going to see a formal profits recession in the United States. In other words the S&P 500 earnings will be down year on year, minus 5, minus 10 percent for 1998. That is a lot weaker than most people think. So again, our cautiousness is largely predicated on the weakness in earnings here where fundamentals are weaker than people think.
SCHUCH: Yes. In fact, most people are saying that the fundamentals are still good, and the market's weakness is not equate with that, but you are saying the opposite. And you say you almost put out a sell on the market. Tell me about how you've changed your asset allocations.
BERNSTEIN: Well, on June 1, we changed our asset allocation. A benchmark allocation for us is 60 percent stocks, 30 percent bonds, 10 percent cash -- that would essentially be "no opinion" for us. For most of the past three years, we have been way, way above that. . For a large part of three years, telling people be fully invested in the equity market.
June 1, we went to 55 percent equities, 35 percent bonds, 10 percent cash -- just a slight underweighting of equity, slight overweighing of bonds -- to emphasize to people that our really incredibly bullish (run) in the last 3-1/2 years was basically over.
SCHUCH: And Richard, I'm really hearing from you the strongest negative on markets that I have heard in a while. And I have heard caution from some others as well.
BERNSTEIN: Yes. I think from certainly, from me personally, this is the most cautious we have been in 3-1/2 years. It is actually pretty remarkable for people who have followed our work to now think our group is actually turning cautious on the markets.
SCHUCH: What's you best advice to confused investors?
BERNSTEIN: Well, I think you know, you have to realize this is not necessarily apocalyptic. A lot of times people want to take a bearish forecast and turn it into, you know, just really horrible. Remember, real interest rates in the United States are very high. If earnings really did start to weaken, if the stock market did start to tail off, the Fed would have a lot of room to ease.
I mean this is not necessarily an apocalyptic outcome. What it does mean, however, is that on the margin bonds are becoming more attractive (compared) to stocks. It doesn't mean that financial assets are going down the drain, but it does mean the shift in asset allocations. Probably, if you have new money, you probably want to look at the bond market instead of the stock market.
SCHUCH: All right. Some interesting information also. But if you are looking at stocks, tell me where you might find some value. What sectors do you like?
BERNSTEIN: We have been emphasizing quality. If you agree with us and you think profitability is going to weaken as dramatically as we think it will, the key is not going to be fundamentals but the certainty of fundamentals associated with the companies. Obviously, the certainty is greater if you look at higher quality companies. So, we look a lot at consumer staples -- the drugs, the foods, the soft drinks. You look at utilities, you look at some of the high quality retailing stocks -- not retailers across the board, but the higher quality retailers are very attractive in our work as well.
SCHUCH: All right. And a final note of caution --stocks that you would avoid, sectors that you would avoid.
BERNSTEIN: I would avoid anything that connotes commodities, whether it be papers, or chemicals or traditional commodities. I would also be very wary of sort of the more modern day commodities, like semiconductor stocks, as well.
Again mention of Semiconductor's a negative tone...!!!
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