Almost two-thirds of institutional investors responding to a Pensions & Investments survey believe the stock market, with the Dow Jones industrial average topping 5000, is overvalued.
And, many have taken defensive measures.
These investors believe there is a better than even chance of a 10% correction in the market within the next six months.
Almost two-thirds (65.2%) of the 129 pension fund executives, money managers and consultants responding to a fax survey said the stock market is overvalued an average of 15%.
Of those who thought the market is riding too high, 65.5% have been concerned enough to take defensive measures, most commonly reducing exposure to domestic equities. The assets most commonly were redirected to cash, followed by bonds and international equities.
Others rebalanced their portfolios back to their typical target weightings for stocks, bonds and cash. A fair number of pension fund executives fully or partially hedged their portfolios using futures and options. Others shifted their domestic equity focus into defensive sectors, and reduced holdings of cyclical stocks.
Value manager Society Asset Management Inc., Cleveland, shifted industry weightings and increased the yield of its equity portfolios, said Judith A. Jones, senior vice president and portfolio manager.
Ms. Jones has been increasing the portfolio's weightings in energy stocks. "We had a fairly large position in McDonald's Corp. earlier, this year and took our profits and re-directed them to Exxon Corp., for example, and Royal .
"Exxon in particular, has been a big underperformer because of environmental problems and we are bit contrarian, looking for the undervalued areas," said Ms. Jones. Society's portfolios have been underweighted in the volatile technology sector, she added.
Society also has been reducing its exposure to aerospace, which had been triple-weighted in the portfolio. "We did even better than expected in aerospace, especially with the restructurings in the industry and big mergers like that between Lockheed Corp. and Martin Marietta Corp.," Ms. Jones said.
The profits Society took from its aerospace holdings were directed at the beginning of this year into electric utilities, such as Houston Industries Inc. The firm also has been moving steadily into natural gas companies.
Banks and financial companies, meanwhile, continue to remain attractive, said Ms. Jones, "because they have been doing so well. We're sticking with them."
More pension fund executives than money managers and consultants lacked confidence in the current market valuations. Still, many of those pension executives indicated they were not making any special changes to protect their portfolios from future corrections. Noted one: "It's impossible to pick the top or the bottom of the market. We don't try."
Another repeated the oft-heard statement: "We're in for the long haul. We won't make changes based on the short term."
Despite the pessimism of the majority of respondents, the remaining 34.8% of institutional investors were vocal in their confidence in the stability and strength of the stock market.
They pointed to low interest rates and low inflation as the primary factors supporting the stock market's current valuations. Corporate earnings momentum, which was expected to continue into 1996, was also cited, as was reasonable price-earnings ratios.
Respondents noted such political considerations as the forthcoming presidential election, a congressional emphasis on deficit reduction and a balanced budget, and a pro-business regulatory environment, contribute to their optimism.
Higher company productivity, technological advances, an expanding global economy and a larger-than-ever pool of investible assets also supported investor confidence.
"I'm more optimistic now about the market's valuation and strength than I was at the beginning of this year," said Jeff Mortimer, vice president at Higgins Associates Inc., Cambridge, Mass., a consulting firm that offers fund-of-funds management for its clients.
"The market has climbed a wall of worry since the beginning of the year, when the bearish tendency was incredibly strong.
"But we have a situation now where we've seen a continued rise in earnings. (Earnings) have actually come in stronger than the market valuations. The real p/e of the market is very average now at about 16.7. Price-to-earnings ratios are actually continuing to drop, and the market fundamentals look stronger than they have in years. Sentiment now is neutral, which is great for a continuation of a strong market," Mr. Mortimer said.
He said Higgins' dynamic allocation model looks at macroeconomic issues and uses mutual funds. The model has been pushing the portfolio allocations to mutual funds with strong weightings in consumer retail, such as The Gap Inc. and Mattel Inc.
Health care also is undervalued and attractive, said Mr. Mortimer, as are financial companies and banks.
The biotechnology sector stocks are also beginning to appear on the firm's "radar" for future weightings. Higgins has been steadily moving client assets out of technology since August.
Mr. Mortimer said he isn't seeing anything on the immediate investment horizon to bring the market down. "We've seen a tendency for very strong markets to be followed by periods of fairly strong correction. That's healthy. But I think it would take some type of wild card variable or something which hits at the very core of the fundamentals to knock the strength out of the market. And I don't see now what that's going to be or when it will happen."
The fax survey was sent to subscribers to P&I Daily, a daily fax newsletter published by Pensions & Investments.