Several international money managers are turning defensive as rising interest rates in many countries bury hopes that struggling stock markets can soon resume their gains.
Although Japan is one of the few beacons on the global equity scene, few other developed stock markets offer much promise now.
As a result, some many money managers plan to increase, or have increased, their holdings of cash or bonds.
Lazard London International Investment Management has increased its allocation to bonds in balanced portfolios to 30% from 10% or less three months ago.
Morgan Grenfell Investment Services Inc., London, already is overweighted in bonds for balanced accounts. For those with a benchmark of 50% stocks and 50% bonds, the firm is now 60% in bonds. That figure could go higher.
For its equities portfolios, Henderson International, London, has raised cash to about 8% from about 3% at the beginning of the year. The firm has become "cautious" for the short term, although it remains "optimistic for the medium and long term," said Nitin Mehta, deputy chief investment officer.
Scottish Widows Investment Management Ltd., Edinburgh, is likely to be scrutinizing bond opportunities, believing a number of bond markets may have become oversold.
MacKay-Shields Financial Services, New York, reduced equities in Europe in the third quarter, bailing out of smaller markets. It also lifted its weighting in commodity-linked markets, such as Australia and Canada. And, it raised its weighting to Japan.
Globally diversified portfolios of Bailard Biehl & Kaiser Inc., San Mateo, Calif., this month saw their weighting in international bonds drop to 15% from 20% and international stocks drop to 15% from 20%. The extra money went to cash, but is earmarked for global bonds once the markets stabilize.
Arthur Micheletti, investment strategist, said the firm is positive on financial assets for the next 12 months, but cautious for the short term. Portfolio managers generally prefer non-U.S. to U.S. assets, and generally bonds over stocks, he said.
Some managers' cautious views come amid a lackluster 1994 so far. Through the third quarter of this year, many managers' performances lagged that of the Morgan Stanley Capital International Europe Australasia Far East Index.
Specifically, the median manager in the Frank Russell universe of non-U.S. equity managers posted a 5.3% total return through this year's third quarter. In comparison, the EAFE returned 9.1% for the period.
Typically, managers' underperformance reflected lower-than-index weightings in Japan. But aided heavily by currency gains, Japan's market is the only developed one that has surged so far in 1994.
Looking ahead, many managers remain high on Japan.
Although stock valuations are high there, interest rates aren't expected to rise anytime soon; yet, corporate profits should start growing smartly as Japan's recession ends.
"We're still keen on Japan," said David Gould, a director of Lazard London. The firm has an overweighted 51% holding in that market for EAFE accounts. But in its balanced global accounts, the firm already has begun pulling in its horns.
Michael Bullock, chief investment officer of Morgan Grenfell, believes "the risk-adjusted return potential has shifted to bonds over equities."
In his view, 1995 holds the specter of rising interest rates in most major economies and fears of higher inflation coming by 1996 at the latest. "This is not the background in which stock and bond markets can make much progress. It spells caution."
His firm expects to raise some cash from equities after an expected near-term rally in stocks and bonds, and to put that money in bonds.
Schroder Capital Management International, London, also foresees a rally in the next two months in stocks and bonds. If that happens, the firm would raise some cash as well - up to about 10% from about 2% now.
"After next year's first quarter, it would be wrong to say that markets would be looking sharply negative, but they may be lumbering along in consolidation" for a while after that, said Gavin Ralston, senior vice president.
However, to Michael Perelstein, managing director, international investments at MacKay-Shields, there's even "a bear market out there." He cites "classic" signs including markets that don't climb on good economic news such as stronger growth but still fall on bad tidings.
Although a number of stock markets posted a third-quarter bounce, it was an aberration to Mr. Perelstein. The firm used it as a chance to become positioned for the "real ugliness" coming "in the next three to six months."
Emerging markets are considered safe havens to some.
A bullish Barton Biggs, chief investment officer of Morgan Stanley Asset Management, New York, recommends sizable weightings in this sector. Mr. Biggs recently wrote: "A typical global balanced portfolio, like a pension fund, should have at least 26% of its assets in emerging markets equities, debt, real estate and direct investment." What's more, equity accounts, with a performance benchmark that is half EAFE countries, half emerging markets, should today have a 75% to 80% weighting to emerging markets, he said.
But such an exposure would be hard to swallow for Mr. Perelstein, who sees emerging markets as a danger spot. He believes interest has become excessive. He notes funds have even been created for countries without stock markets, such as Vietnam.
A number of other managers say although they are bullish long term on emerging markets, the current climate looks questionable, perhaps especially in Southeast Asia and in some Latin American markets that rallied this year.
Lloyd Beat, assistant director, investment manager of Edinburgh Fund Managers, Edinburgh, Scotland, subscribes to the attractive long-term story about the Pacific Basin and its economies. But the firm was cautious about that area this year because of fears of a spillover effect, which materialized, from higher U.S. interest rates.
The firm will be keeping an eye out for opportunities to lift its exposure to that area again. But overall, it sees emerging markets as "just one of the factors" that will affect overall performance, said Mr. Beat.
Barry Gillman, managing director of PCM International Inc., Short Hills, N.J., is "still positive going forward." He continues to favor the markets of Japan and Korea, and has a 50% weighting devoted to the two. The exposure stood him in good stead this year, especially in the first half. Although Japan's market softened in the third quarter, PCM still has been able to outperform the index this year, he said.
But there are those with a different view on Japan.
Boston-based Acadian Asset Management sees "better opportunities elsewhere," said John Chisholm, senior vice president. His case: While corporate earnings should indeed be on the rise in Japan, "valuations are extended. And interest rates, which are now fairly low, could pick up as the economy improves."
Acadian started 1993 with an overweighting in Japan, trimmed it during that year and now has a five percentage point underexposure to that market. Instead of Japan, the firm prefers Europe these days and has moved back "in a significant way," according to Mr. Chisholm.
Not only does he expect substantial corporate earnings growth from that region, but he also sees room for Europe's now-relatively high interest rates to slide during the next 12 months.
To many investors, real bond yields are particularly attractive in Europe right now.
Rate rises already have occurred in various countries, although more on fears of inflation than actual evidence of it. In many cases, rates are now well above inflation levels. Among the more glaring examples: Swedish 10-year bonds have a real yield of 8.3%, with local inflation only 2.7%; Belgian 10-year bonds offer a 6.1% real yield, vs. the 2.5% inflation rate in that country; and in Denmark, 10-year bonds yield 9%, compared with the local 2% inflation rate.
Given these differentials, it may be safe to assume, as does Allan McKenzie, investment director of Scottish Widows, that "perhaps bonds have become oversold."
But even if bond prices do reverse themselves and rally, such an event may not quickly revive a bull market in equities.
"You could see a run on equities if bond prices improved," said Mr. McKenzie. But if that happened, his firm could possibly seize the opportunity "to take some money out."
"We're in the latter stages of a long bull market. It's become more difficult to get stock selection ideas. And the fact that markets are nervous further underscores that the bull market is waning."
How quickly markets recover will depend on governmental policies, he maintained. It could be a delicate balancing act. In Mr. McKenzie's view, "how quickly the bull phase is renewed will depend on how good governments are at maintaining inflation" while (allowing for) economic growth."