All of a sudden, it's a buyer's market.
From large-cap value managers to small-cap growth funds, the Dow Jones industrial average's precipitous 14.26% decline the week after terrorist attacks on New York and Washington created huge buying opportunities. "The opportunity is more widespread in stocks than I've seen in years," said Hugh Mullin, managing director and co-portfolio manager of Putnam Investments' $27 billion growth and income fund.
Meanwhile, steepening of the yield curve and bigger spreads on corporate debt have led bond managers to rejigger their portfolios.
While money managers say the odds of a longer, deeper recession have grown markedly since Sept. 11, investors expect a sharp, V-shaped recovery to hit sometime next year.
John Fields, senior vice president and senior portfolio manager at Delaware Investments, Philadelphia, said prior to the Sept. 11 attack, he had expected that corporate profits and economic activity would hit a low in the third quarter, but anticipated only a sluggish recovery.
Now, he expects the downturn to be far sharper and to take longer, setting the stage for "what will probably be a much more dramatic recovery next year, probably in the first quarter or second quarter."
Four quarters of weakness
Other managers do not anticipate a recovery to occur until the second half of 2002. "We're probably looking at another four quarters of earnings weakness on the order of 20% declines on a year-over-year basis," Stuart Schweitzer, global investment strategist at J.P. Morgan Fleming Asset Management in New York, said in a teleconference call with investment advisers.
But managers agreed that when the economy bounces back, it will be vigorous, fueled by easing of interest rates by the Federal Reserve and global central banks, and Congress shoveling out massive amounts of aid. In the past two weeks, Congress has approved a $15 billion bailout bill for the airline industry and $40 billion in spending to bolster domestic security, and now is contemplating a short-term stimulus package of up to $100 billion.
However, the impact of any military spending remains an unknown. Managers generally anticipate that President Bush's war against terrorism will involve far more spending on personnel than on ordering new planes and materiel.
What also is apparent is that now, even more than before the collapse of the World Trade Center, the stock market has become a stock-picker's paradise.
"This is a terrible time for index funds," said John Freeman, president of Freeman Associates Investment Management LLC, Rancho Santa Fe, Calif. Stock prices in some sectors have been driven down drastically. That means those sectors have become a disproportionately smaller part of the index, and that limits index funds' ability to benefit from future gains, he said.
The dramatic sell-off in stocks in airline, leisure, insurance and other industries occurred indiscriminately in many cases, creating great values for managers.
In a period of emotional selling, investors don't distinguish between stronger and weaker players, Delaware's Mr. Fields said. And as investors need liquidity, they sell these big-name stocks first. "It's only in these emotional periods that you get to buy good quality stocks at good prices," he explained. As a result, he has traded out of weaker stocks, picking up stronger ones at bargain-basement prices, including General Electric Co. and American International Group Inc.
One area where Mr. Fields missed the boat: energy-related stocks, which have been hammered as energy prices plunged. While the spot oil price initially surged $2.15 to $29.78 on Sept. 14 - the first day the market reopened after the attacks, it then started slipping the following week, culminating in a $4.03 plummet to $21.45 on Sept. 24. The price since has rebounded to $22.73. "As a result, we are doing our homework," he said.
Kevin R. Parke, chief investment officer of MFS Investment Management, Boston, also has been picking up bargains in hard-hit property and casualty insurance stocks. He has been buying stocks of media companies as well, because they are being hard hit by declines in advertising revenue. He declined to name any stocks he has been buying.
Building up tech
In the technology area, MFS has been building its exposure to software stocks throughout the year. Mr. Parke noted stock prices of companies such as Oracle Corp. and Veritas Software Corp. have become very attractive in the past couple of weeks. Less attractive than before the terrorist attack are so-called safe havens, such as consumer staples and pharmaceuticals, he said. And MFS already had been underweight in airline and automotive stocks.
David Kalis, managing director at Segall Bryant & Hamill Investment Counsel, Chicago, said he has been buying stocks of higher quality companies, particularly in media, consumer discretionary and finance companies. Many of those companies' stocks were crushed because of concerns over their short-term earnings.
Companies he's been buying: Univision Communications Inc., AMBAC Financial Group Inc. and Everest Re Group Ltd. And Segall Bryant already has held stakes in SunGard Data System Inc., an informational technology firm, and Symbol Technologies Inc., which has a two-dimensional barcode scanning process that could be used in national identity cards.
But Mr. Kalis has stayed away from stocks tied to sales of big-ticket items. "I think people are frozen and that's going to create a real slowdown in spending," affecting retail, auto and appliance stocks, he said.
Putnam's Mr. Mullin said he has been adding stocks across the board. Without saying which ones he has been buying, he notes that his fund includes holdings in such big names as Citigroup Inc., American Express Co., Ford Motor Co., Chubb Corp., AIG and The Walt Disney Co. The prices on stocks have dropped to very attractive levels, he said.
William Wolfenden, vice president of R S Investment Management, San Francisco, who runs the firm's small-cap growth fund and its institutional separate accounts, said plunging market prices enabled him to buy stocks that fell below the $750 million market cap he applies to his portfolios. One example: Taro Pharmaceutical Industries Ltd., a generic drug company. The stock price - which is up nearly 300% from a year ago - already has bounced back to nearly $35 from a low of $28 on Sept. 19.
Other stocks he likes include UbiquiTel Inc., a Sprint PCS licensee that stands to gain from increased use of cell phones, and BriteSmile Inc., a teeth-whitening process sold through dentists. He also has beefed up his stake in Atlantic Coast Airlines Holdings Inc., whose stock price hit a 52-week low of $8.04 on Sept. 20. It had closed at $26.52 on Sept. 10; it closed at $11.90 on Sept. 26.
Yield curve steeper
In the bond market, aggressive rate-cutting by the Fed and concerns over massive federal spending have steepened the yield curve dramatically. While yields on the two-year note dropped to 2.9% from 3.49% by Sept. 25, 10-year bond yields remained flat at 4.7%, reflecting concern over increased federal spending and possibly a decrease in foreign purchases of U.S. government debt, bond managers said. (On Sept. 27, the two-year bond yield closed at 2.8%, while the 10-year bond yield had slipped to 4.55% as long-dated bonds had rallied.)
As a result, some bond managers have lengthened the duration of their portfolios. In addition, some corporate debt has become cheap.
Bank and brokerage firm bonds have gained from the change in the yield spread, said Tad Rivelle, chief investment officer of Metropolitan West Asset Management LLC, Los Angeles.
Also, spreads have widened on airline and insurance industry debt. For example, Delta Air Lines Inc. equipment trust certificates now are trading at 300-basis-point spreads over Treasuries. MetWest also has picked up holdings in debt issued by Raytheon Co. and Citizens Communications.
John Brynjolffson, senior vice president, Pacific Investment Management Co., Newport Beach, Calif., who manages more than $13 billion in inflation-indexed bonds, said he has lightened up on shorter maturity TIPs and locked in higher yields on longer-maturity indexed bonds.
He also said he has started dipping his toes in the water on selected corporate bonds, including those issued by Waste Management Co., Disney, and The Boeing Co. While Boeing's stock and bonds have taken a huge hit because of the airline industry's crisis, 40% of the company's revenue comes from defense contracts, Mr. Brynjolffson said.
"Whether we are talking about defense or commercial aircraft, most people would consider Boeing to be a national treasure. At this point, if Boeing were to get into financial troubles, I would think the nation would rally behind it. Boeing is a solid company, and unless we think we will not use commercial aircraft in the next century, it is inconceivable that we would let it fail," he added.