Institutional investors should increase their allocations to foreign markets, some market strategists say, because U.S. stocks and bonds have lost their luster after a stellar half-year.
"I think we're approaching a blow-off phase of the U.S. stock market," said Ray Dalio, president and chief investment officer of Bridgewater Associates, Wilton, Conn.
"Price acceleration on the upside is preceding a significant correction - 20% beginning over the next 18 months," said Mr. Dalio, whose firm runs $4.9 billion in global bonds and currencies.
The U.S. stock and bond markets have had quite a run. Total return for the Standard & Poor's 500 Stock Index was 20.21% for the six months, while the Merrill Lynch Corporate/Government Index returned 12.16%.
The more bullish investors think equities, especially growth stocks, have more steam left than bonds over the next six months.
Some managers think Japan and other Far East stock markets might outperform the U.S. market. Others favor Europe.
Robert Heisterberg, global policy analyst of Alliance Capital Management, New York, is becoming more bullish on Japanese stocks, which now are underweighted by four percentage points against the Morgan Stanley Capital International Europe Australasia Far East Index in the firm's non-U.S. portfolios.
David Shulman, chief equity strategist at Salomon Brothers Inc., New York, agrees Japan is becoming more attractive. While the U.S. stock market is hitting new highs, Japan's stock market has sunk to levels not seen in almost a decade, he said.
Others are staying away from Japan.
"Japan's market fall will produce a great opportunity, but I do not want to be the first buyer. We continue to make our major bet by being out," said Donald Gimbel, managing director of Furman Selz Capital Management Inc., New York.
"With Japan at or near its bottom and the U.S. economy beginning to restart, thanks to the fall in interest rates, we will have great markets in much of the world during the next six months. Asia and the U.S. will lead the charge while Australia, South America and Canada will stay at a safe distance," Mr. Gimbel said.
Mr. Gimbel said Furman Selz will continue to be underweighted in Europe, even though "there are great companies in Europe who do a large percentage of their business outside of their home markets." Still, he likes such core portfolio holdings as Nestle SA, Reuters Holdings PLC and Cable & Wireless PLC. In the United States, he sees value based on earnings growth in such companies as Motorola Inc., ConAgra Inc. and Caterpillar Inc.
In Asia, Furman Selz likes Hong Kong, Indonesia and Thailand.
Kemper Financial Services, Chicago, is overweighting Europe and Australia in its international portfolios, and is underweighted in Japan.
Dennis H. Ferro, director of international equities at Kemper, said the world economy is acting like a train coming out of a tunnel: the U.S. economy is the first car, leading others out of recession, and Japan so far has acted like the caboose.
In Europe, Kemper is invested more heavily in financial stocks such as Union Bank of Switzerland, as well as international technology companies such as the telecommunications company Nokia Corp. in Finland and some assorted growth stocks.
In Asia, where Kemper invests mainly in large, liquid stocks, Mr. Ferro likes Hong Kong, Malaysia, Singapore and Thailand.
Alliance's Mr. Heisterberg also likes Europe, especially "early cycle" stock sectors like autos and chemicals.
Mr. Heisterberg's recommended stock allocation is 40% in the U.S. market; 20% in Japan; 28% Europe; 8% other Pacific markets; and 4% emerging markets. For a balanced portfolio that normally has a 65%-35% stock-to-bond weighting, he recommends a shift to 70% stocks in the next six months, with the 30% in fixed income biased to foreign markets.
Bluford Putnam, chief strategist of Bankers Trust Global Investment Management, New York, which runs $165 billion, is still bullish on equity markets even though they are riskier because of uncertainty over the economy's strength and valuations. His asset allocation model calls for an overweighting of small-cap and midcap stocks at the expense of large caps. For conservative investors, he recommends a slight reduction in equities.
Bankers Trust also favors a slight increase in international equities at the expense of bonds and large-cap stocks. Mr. Putnam especially likes Europe and the emerging markets.
Jeffrey J. Miller, managing director of Provident Investment Counsel, Pasadena, Calif., said: "If we're in this period of slow growth and less inflation, there's probably still money to be made in bonds, but I'd rather be in equities." He said growth stocks underperformed value stocks in the three years ended Dec. 31. In the first half, the Russell 1000 Growth Index gained 20.3% vs. the value index's 19.3%. He thinks the spread will widen in favor of growth.
In the U.S. markets, at least two managers favor technology stocks.
John Chadwick, senior vice president at Bessemer Trust Co., which runs $10 billion in stocks and bonds, believes technology issues are poised to outperform the market over the long haul, given global demand.
Thomas M. Regner, chief equity portfolio strategist of Kemper Financial Services, said technology is an attractive sector experiencing a secular change that will go on for years. Earnings have gone up far more than stock prices, he said.
With semiconductors now included in products as varied as toasters and even sneakers, the market has room to grow, Mr. Regner explained.
Mr. Regner noted investors are starting to rotate out of value stocks and into growth issues, which are "on sale" now. Growth stocks are trading at a price-earnings ratio of 16, while the S&P 500 is trading at a p/e of 15.32.
Mr. Chadwick's stock market view, based on a stable interest rate outlook and modestly higher earnings, is for the Dow Jones Industrial Average to reach 4800 - it hit 4556 June 30 - by year end, with the S&P at 578, up from 545 at the midyear mark.
"There's still more upside to the market. There's nothing in historical precedent that says the economy is vulnerable to a major correction," Mr. Chadwick said.
Mr. Dalio of Bridgewater disagrees and is taking a somewhat defensive stance.
"The approach to risk reduction has totally changed. It used to be you'd hold less risky assets to reduce risk. The view today is you can have your cake and eat it too. You can hold riskier assets but control portfolio risk by holding assets with less correlation to each other," he said.
In that vein, Mr. Dalio favors a healthy allocation to inflation-linked bonds in the United Kingdom, Canada and Australia. Such bonds are negatively correlated with both stocks and plain-vanilla bonds. Their return increases when inflation goes up.
He also likes stocks in smaller Pacific Basin markets whose currencies are linked to the U.S. dollar.
Mr. Dalio thinks stocks have become moderately expensive relative to bonds, particularly in the United States. Assuming a normal 65%-35% allocation, he would reduce stocks to 55%, cutting the United States and Japan. He'd put 5% in Asian emerging markets stocks, 5% in private equity, 20% in global bonds and 20% in inflation-linked bonds. Half of the portfolio's bond exposure would be hedged to the dollar.
