illiams, Barry B. Burr and Joel Chernoff
Institutional investors were calm following the wild stock market sell-off last week and the almost unheard of market volatility most are terming a correction.
But unlike the October 1987 crash, when several large institutions committed billions to buying on weakness, the 161.05-point, or 2.9%, decline on the Dow Jones industrial average July 15 didn't entice institutions to start bargain hunting.
Most pension funds, institutional money managers and investment consultants interviewed don't anticipate an end of the bull market, although they are concerned about the recent volatility.
And foreign money managers generally don't think the decline will be matched in magnitude overseas. (During the week Pensions & Investments went to press, the Dow Jones industrial average fell 54.32 points, or less than 1%, to 5456.04 as of mid-afternoon July 18 from the 5510.56 close July 12.) Many markets, including those in the United Kingdom, Germany, France and Japan, declined immediately after the U.S. market did, but by much less.
One reason institutions didn't rush to commit cash reserves when the market plunged is their lack of cash. And most pension executives don't see enough evidence to veer from their strategic allocation or make sudden changes in investment strategy.
Gurudutt Baliga, senior portfolio manager at IDS Advisory Services, Minneapolis, with $12 billion in domestic equities under management, said money managers are not holding much cash following last year's market run-up. He said cash flow from institutions started to slow after the market's strong start early this year and now "liquidity is practically non-existent."
"If you look at what happened in 1987, the general sense was that any correction is a buying opportunity. But these last few days what has changed is that people are starting to wonder about earnings growth, particularly overseas since nearly 40% of earnings of large companies comes from overseas. So people are starting to rethink these assumptions about buying on weakness, at least until we see whether earnings are going to start coming in on target. We need the market to start feeling more comfortable with regard to earnings," said Mr. Baliga.
Astonished at market tumult
The $53 billion New Jersey Division of Investment, Trenton, bought stocks immediately after the 1987 market plunge. Roland W. Machold, director, views the recent market tumult "with a certain amount of astonishment."
"I'm not that troubled," he said. "Some elements of the market were overvalued. This could run a little ways; markets don't react precisely."
"It isn't alarming to me yet," he said. "What would alarm me would be to see an accelerated growth in the economy," more than 3%, which might fuel interest rate and inflation rises.
During the past nine months, the New Jersey fund has been selling off some $3 billion of its $25 billion domestic equity portfolio. But Mr. Machold said it was for strategic reasons: "We wanted to reallocate the funds in the international market."
With the market drop, he said, "We're holding up on some of our sales. We prefer to sell into a rally."
Laszlo Birinyi Jr., president, Birinyi Associates Inc., Greenwich, Conn., said of the recent market drop: "I view it as a correction, painfully short, and not a termination or end of the bull market, just an interlude."
"Sharp, swift declines don't begin bear markets," he added.
Buying opportunities created
At the $38 billion Wisconsin Investment Board, Madison, Michael McCowin, chief investment officer, said the gyrations have "created opportunities, and we have been buying and selling" as the market has moved down and up.
"We don't have substantial cash reserves," he said. Cash in its roughly $15 billion domestic equity portfolio is less than 5%, or $750 million.
"To the extent these cash reserves are there to make purchases, we would move money into the market" on weakness, he said. But the fund has no plans at the moment to do so.
A spokesman for the $100 billion California Public Employees' Retirement System, Sacramento, which put $2 billion into the market immediately after the 1987 crash, said a move to passively managed equities has made it easier to deal with market volatility. CalPERS has about $40.5 billion in domestic equities, of which about 85% is passively managed.
"During and after the market crash of 1987, when we weren't heavily indexed, we did put a lot of cash into the market .*.*. but generally we ride through these things," he said.
James C. Mosman, chief executive officer of the $65 billion California State Teachers' Retirement System, Sacramento, said the fund has about 5% cash, but also noted about 85% of its $20 billion domestic equity portfolio is passively managed.
He said the fund is "near the bottom" of its 30% to 32% target range for equities and if the cash is committed, it will be to continue funding the plan's international equity portfolio.
Clients aren't overly concerned
Craig E. Heatter, manager, Chase Consulting Group, New York, said clients aren't unduly concerned.
"I've had a couple of calls," he said. "But it's just informational. It has not been a panic, and it hasn't been a lot of calls."
The correction the equity market is undergoing is adjusting some stocks that were overvalued, but the overall trend still favors investing in equities, executives at New York-based Bankers Trust Co.'s global investment management unit say.
At a July 16 meeting, Chief Investment Officer Bluford Putnam said Bankers Trust is still bullish on the equity market and plans to remain overweighted in equities and underweighted in bonds, as is has been all year.
Mr. Putnam said he expects the market to rise 10% to 12% by year end, with volatility around 18%, which is normal.
Ronald D. Peyton, president of Callan Associates Inc., San Francisco, said most pension plans were well positioned through strategic asset allocation plans and diversified portfolios to weather the stock market storm.
Mr. Peyton said the July market sell-off might have jerked some pension funds with equity allocations beyond their targets back into balance. "It's not the way you would want to do it though."
Underpinnings still valid
The underpinnings of the bull market are still valid, according to money managers. They noted second-quarter gross national product growth is expected to top 4%; the economy is still growing at 2.5%; inflation is under control; and the Fed is not expected to raise interest rates soon.
IDS's Mr. Baliga added: "A bear market would require some external shock, a war or upheaval in the Middle East or something of the like. We haven't had it. Neither have we had a market correction of 5% or more during the last five or six years."
Paul D. Erlichman, managing director at Brandywine Asset Management, Wilmington, Del., said, however, the market "is in the initial phase of a bear market where people don't believe there is a bear market. We will probably be seeing a more volatile sawtooth pattern in the market, but we have seen the high in the market for the next two years."
The stock market's problems are related to the earnings cycle, said Mr. Erlichman.
"Most earnings estimates are too high for the S&P to stay where it was. We needed interest rates to stay low or drop, or earnings to continue to grow at a rate above their long-term averages, and now earnings are rolling over," he said.
International markets not hit hard
While European and Asian bourses fell on July 16 following the Dow Jones industrial average's 2.9% decline the previous day, money managers generally don't think the U.S. market decline will be matched overseas.
"We are still attached (to the U.S. market), but by a piece of elastic," said David Manning, deputy chief investment officer for Foreign & Colonial Management Ltd., London.
European money managers argue international markets have not enjoyed the meteoric rise of the U.S. market, and thus should not be as badly punished. Nor are technology stocks - whose disappointing earnings triggered the U.S. decline - as important a sector abroad as in the United States.
What's more, managers said other countries are not at the same stage of the economic cycle, particularly in continental Europe and Japan.
Still, a U.S. market correction inevitably spills over around the globe. For one thing, growing nervousness by U.S. individual investors might hinder flows into international markets through mutual funds.
The big question, said James Smith, chief investment officer of Blairlogie Capital Management, Edinburgh, Scotland, is: "Can international markets detach from this or are we facing a sustained bear market into next year?"
Mr. Smith thinks U.S. and markets such as Japan and Germany are not necessarily in lockstep, but "it is a big dilemma for us."
No downside protection
At least one money manager thinks international equity investing does not protect against downside risk.
According to a paper by Khalid Ghayur, group head of global research for London-based HSBC Asset Management Ltd., international stock markets are much more highly correlated during short-term market falls.
Looking at monthly hedged returns from December 1984 through December 1996, Mr. Ghayur found that when the U.S. stock market is rising, it is only 56% correlated to the U.K. stock market. But when the U.S. stock market is declining, the correlation soars to 83%.
"This behavior is common across all markets," he wrote. "Equity markets, in general, appear to be much more positively correlated when they are moving lower than when they are moving higher."
In fact, a global equity portfolio was more exposed to downside risk during short time periods than a U.S.-only portfolio, Mr. Ghayur wrote.
Mr. Ghayur concludes investors can protect against downside risk by diversifying into other asset classes and argues in favor of actively managing the exposures.
Right at long last?
Most European managers have shied away from the United States for some time, missing most of the market rise in 1995 and into May 1996. They would be perfectly happy to be proven right at long last.
Kevin Carter, managing director of Old Mutual International Asset Managers (UK) Ltd., the Hook, England-based subsidiary of South Africa's biggest pension manager, remains profoundly negative on U.S. stocks given their valuations.
He said the U.S. market could easily fall another 10% to 15%. Mr. Carter wouldn't buy U.S. stocks until the Dow Jones average falls well below 5,000.
Felix Lanters, vice president of ABN-AMRO Asset Management, Amsterdam, was the only foreign manager strongly positive on the U.S. market. While he acknowledged the danger of rising interest rates, he said "the U.S. economy is firing on all cylinders," aiding the likelihood of rising corporate profits.
