Money managers expect a market revival after rough 1st half
With crude oil prices touching $100 per barrel, subprime write-downs still mounting and Wall Street layoffs on the rise, it’s easy for doom and gloom to prevail.
Jobs data, which was released on Jan. 4, showed the U.S. economy rapidly losing steam in December. The private sector lost 13,000 payroll jobs, the weakest performance in four years, while the jobless rate rose to 5% from 4.7%. On Jan. 2, the second-most important set of data, the Institute for Supply Management’s manufacturing index, dropped to its lowest level since 2003 as the activity in the sector contracted.
But money managers believe that after a rocky first half of the year, the U.S. economy and the stock market will revive in the second half of 2008.
“The market will end being up between 8% and 12% by the end of the year, but likely will be down in the first half,” said Virginia Parker, chief executive officer and chief investment officer of Parker Global Strategies LLC, Stamford, Conn., a hedge fund-of-funds manager.
“That’s because the Fed will continue to lower interest rates through the first half of the year, and more negative information likely will keep coming from banks regarding subprime exposure. The combination of the bad news and a bit of a slowdown in the U.S. economy will continue to fuel the stock market sell-off in the first half, but we believe the market then will pick up in the last two quarters of the year,” Ms. Parker said.
Ernie Ankrim, chief investment strategist at Russell Investments, Tacoma, Wash., agreed that the first half of the year will be “scary” as the market struggles with identifying the size of the overhang from the credit problem. Mr. Ankrim expects U.S. large-cap value stocks to return 11% to 12% this year, while U.S. large-cap growth stocks will rise 15% to 16%.
Optimistic assessment
The most optimistic note came from William Knapp, managing director of New York Life Investment Management's equity investor's group and chief investment strategist for mutual fund subsidiary MainStay Investments. Knapp indicated that the market could go up about 10%, perhaps more, if we do manage to dodge a recession. Within equity, Knapp felt large-cap growth should have another year of relative outperformance. And given our expectation of good earnings and performance within the technology sector, the Nasdaq may do better than the S&P.
More typical was Roger J. Sit, president and co-CIO of Sit Investment Associates Inc., Minneapolis, who predicted the S&P 500 will rise 7% this year, with growth stocks outperforming the market as a whole.
However, many managers believe the worst is not yet over.
John Linehan, portfolio manager at T. Rowe Price Group, Baltimore, said the subprime crisis has already spread into the overall economy. “It’s clearly going to get worse before it gets better. The real question is how much of that has already been priced into the market.”
He said value managers need to buy stocks selectively. “In certain instances, the market has thrown the baby out with the bathwater,” he said. Home Depot Inc., Amgen Inc. and Time Warner Inc. are attractive holdings, he noted, declining to say which stocks the firm is buying.
“The consumer is starting to be a little more cautious. Retail sales numbers over the holidays were not that great,” Mr. Sit said, noting that even Target Corp. sales were lower than expected. Plus, housing and auto sales are on the skids, he said.
Officials at Sit Investment, a growth-stock manager, remain overweight in technology stocks. The firm favors technology services over hardware stocks because companies may hold back from making capital expenditures. It has holdings in Intel Corp., Accenture Ltd. and software giants SAP AG and Oracle Corp.
Gordon Telfer, managing director and senior portfolio manager of Voyageur Asset Management Inc., Minneapolis, another growth-stock manager, agreed the current environment favors large-cap growth stocks. Among the stocks he favors: Cisco Systems Inc., Apple Inc., Adobe Systems Inc. and Paychex Inc. He also likes health-care stocks such as Stryker Corp. and Thermo Fisher Scientific Inc.
Wayne Wicker, CIO of Vantagepoint Investment Advisers, a subsidiary of ICMA Retirement Corp., Washington, said he favors large-cap stocks with a global franchise such as Microsoft Corp., General Electric Co. and Google Inc.
Credit problems
Some managers said the economy will be in for a rough ride until credit-market problems are sorted out.
“We see structural challenges that are going to be accelerating and will contribute to less job growth going forward. The rating agencies have revealed themselves as useless at best and even destructive. If they had not rated a lot of securities AAA, a lot of these securities would not have been bought and a lot of capital would not have been destroyed,” said Julian Mann, vice president at First Pacific Advisors LLC, Los Angeles.
“Until we achieve some transparency, credit creation is going to be constrained. We’re returning to eyeball-to-eyeball lending, as opposed to a machine that securitizes loans without regard to the quality of those loans,” Mr. Mann said. “There will be less credit available, and this will lead to a weakening economy.”
James L. Melcher, president and managing director of Balestra Capital Ltd., a New York hedge fund and fund-of-funds manager, warned the U.S. economy might already be sliding into a recession that will hurt the value of stocks.
“The market continues to rise because there is money elbowing its way in, but investors are not paying sufficient attention to economic factors. I hesitate to use it, but the word that comes to mind is ‘delusional,’” Mr. Melcher said.
Nearly all managers predict the unemployment level will remain below 5%, but Mr. Melcher said that figure is misleading because it fails to include undocumented workers. What’s more, “the nature of the U.S. economy has changed. Jobs are not the best indicator any more,” he said, arguing that it’s hard to keep track of job losses in high-paying industries such as real estate.
Like most managers, Mr. Melcher praised the Fed for navigating a narrow path between inflation and recession. However, he said, a recession now could be very damaging, given the weakness of the dollar and high levels of consumer debt. “This one could be the worst (recession) since the Great Depression,” he said.
Some managers cite other overhangs on the market: the reassertion of inflation, seen in rising commodities prices, and the possibility of further terrorist action and potentially explosive situations in the Mideast and Pakistan.
Defensive bond holdings
Bond managers are playing their cards conservatively.
“We are into high-quality assets, like Treasuries, high-grade corporate bonds that do not have a lot of exposure to volatility, that are more recession-proof, such as companies that may derive a larger portion of revenues from sales outside the U.S. or in the energy sector,” said Mark Giura, managing director for taxable fixed-income at McDonnell Investment Management LLC, Oak Brook, Ill.
Officials at fixed-income powerhouse BlackRock Inc., New York, are investing conservatively, but they don’t find Treasuries attractive at current prices. Instead, BlackRock managers are sticking with high-quality agency, mortgage and corporate bonds, said Scott Amero, global chief investment officer for fixed income. “We don’t want to go further down in quality” to BBB corporates, he said.
In contrast, officials at Pacific Investment Management Co., Newport Beach, Calif., are taking a bit more credit risk, even as they warn the Fed will have to cut the federal funds rate to 3% to 3.5% from 4.25% because of a “perfect storm” hitting housing, said Mark Kiesel, executive vice president and generalist portfolio manager.
In 2007, PIMCO officials started the year in high-quality corporate bonds, avoiding subprime exposure. Following the credit market implosion, managers now are nibbling at mispriced bonds with higher spreads, especially new issues. In banking, for example, they’ve bought bonds issued by Citigroup Inc. and Goldman Sachs Groups Inc. “We think these companies are survivors,” Mr. Kiesel said.
PIMCO has also shifted some of its long-bond exposure to the U.K. from the U.S., and has softened its negative views on the dollar, Mr. Kiesel said.
(updated)