The third-quarter carnage in the stock market left shell-shocked mutual fund managers afraid to peek from their foxholes.
Because Federal Reserve Chairman Alan Greenspan doesn’t buy stocks, it’s unclear who’s going to lead the charge to higher ground.
“Some fund managers just get out at any price,” said David Herro, manager of Chicago-based Oakmark International Fund, speaking from London, where stocks have started collapsing. “They don’t care, so you get these implosions in share prices. Right now, it really appears that a lot of people think the world is coming to an end. These are people who are very short-term oriented.”
John Keeley, manager of Chicago-based Keeley Small-Cap Value Fund and another member of the Tribune’s mutual fund panel, explained: “The problem is you don’t know if the opportunity (to buy stocks) will become a greater opportunity, so you take every day as it comes. We’ve got a pretty good cash position, and we’re still waiting.”
Panel member Gloria Santella, co-manager of the Stein Roe Capital Opportunities Fund, said current market sentiment is similar to that of 1990, when the U.S. economy was in a slump and war was erupting in the Middle East.
“That was a very psychologically driven market,” she said. “This market has shades of that kind.”
With the average Nasdaq stock off 45 percent since July, losses are at levels not seen since the bear market of 1974. “We’re at extreme levels,” Santella said.
“I think we’re going to continue to see major earnings disappointments for the rest of this year, and that’s going to make the market a difficult place to be,” said panel member John Rogers, manager of Chicago-based Ariel Growth Fund. “I think that the big blue-chip stocks are only 50 percent of the way into this correction. They still have a good way to go.”
Our stock pickers reflect the gloom in their third-quarter results. Only two of the 12 stocks selected by the four panelists as attractive prospects for the latest quarter managed to post a gain: contract research organization Parexel International, selected by Stein Roe’s Santella, rose 7.2 percent, and South Korean-based Woongjin Publishing, a Herro pick, gained 7.8 percent in terms of the Korean won.
The others lost ground, led by a 54 percent drop in Brazilian banking leader Unibanco, a stock picked by Herro.
The quarter was bad for their four funds as well, with percentage declines ranging from 15.6 percent at Keeley Small-Cap Value to 25.1 percent at Capital Opportunities Fund.
For comparison purposes, here is how market benchmarks performed: the Dow Jones industrial average fell 12.4 percent; the Standard & Poor’s 500 index lost 10.3 percent; the S&P 400 mid-cap index lost 14.7 percent; the Nasdaq composite index dropped 10.6 percent, and the Russell 2000 index of small-company stocks sank 20.5 percent–all on a price basis, or without reinvested dividends.
Stock pickers who look beyond the big-name blue chips typically compare their performance to the Russell 2000 index or the S&P mid-cap index.
“When you have a liquidity crisis like this, the smaller companies get hurt worse than the larger ones, and that was no exception this time,” Keeley said.
“On an optimistic note, small stocks are probably 90 percent through their correction,” Rogers said. “They have been in a bear market a lot longer than most people recognize.”
The panelists noted numerous reasons why they felt stock prices may continue to fall: President Clinton’s problems and their effect on world leadership concerns; the weakening corporate profit picture, which probably will become clearer as third-quarter results are released in the next few weeks; anger and worry over the excesses and costly errors by private investment pools known as hedge funds, and selling by investors to lock in losses for tax purposes.
What will it take to turn things around?
The market needs leadership by a prominent sector of stocks. In September, the market “had a lead by technology, and that’s important because that will give a flavor for the rest of the market,” Keeley said.
He generally avoids technology stocks in his value-oriented portfolio but said he hopes technology leadership can turn around overall market sentiment.
Herro, with 35 percent of his fund still invested in emerging-market stocks, needs even more help and is looking primarily to his own optimistic convictions.
“What the market seems to see is a massive downturn in earnings,” he said. “However, when you talk to the companies, they’re not really seeing that. It’s almost like the dog that didn’t bark. No one is seeing a meltdown in earnings. Two-thirds of the global economy is doing quite well, but the market is obsessed with the part that’s not doing quite as well.
“I remain undeterred in believing that fundamentals are far better than prices of equities, and the more they drop, the more bullish I get,” Herro said. “We have been doing some buying.”
Similarly, Rogers, who was the earliest among the Tribune panelists to turn negative on stocks, is seeing daylight.
“Small stocks are so cheap relative to blue-chip stocks that I’m pushing our customers and saying put more money into small companies and mid-size companies and avoid the big, large-caps at all costs,” he said.
“At these levels, we’re near the bottom,” Santella said. “It’s a good time to start investing over the next six months. She and the other panelists said they believe opportunities may lie in the likelihood that the stock market has discounted for a recession in the United States that will not occur any time soon.
For example, Santella chose for one of her fourth-quarter selections Chancellor Media, a radio-station holding company that has sold off along with other media stocks as analysts fear a recession. Even with an economic slowdown, radio advertising revenues tend to be more stable than newspaper or television ad revenues, she said.
She also ventured into a restaurant stock, one of the more speculative sectors of the market at any time. She likes Papa John’s International, a fast-growing delivery and take-out pizza chain that recently told Wall Street it would trim its growth targets in return for higher profit margins. The stock has bounced off a low of $26.25 to close Wednesday at $33.
One of Keeley’s picks is Chicago Title, the giant title insurance firm that continues to benefit from home sales and mortgage refinancings spawned by record-low interest rates.
Rogers is confident enough to stick with the three stocks he chose for the third quarter, two of which–Specialty Equipment and First Brands–continue to benefit from relatively strong consumer spending. Interface, a maker of carpet tiles for office buildings, was hammered in the third quarter by fears that a recession would halt office construction and remodeling.
Herro remains enthusiastic about Unibanco, the Brazilian banking firm that has been a long-term holding in his fund. Based on the book, or net asset, value of the company, the stock at $13.12 Wednesday remains a compelling bargain, he said. Shares have bounced from their recent low of $7.25 despite continuing worries about the Brazilian economy.
