Nothing about investing seems easy now.
And, as is common in a bear market, even the best and brightest investing professionals are hard-pressed to read the near-term tea leaves for either the economy or stock market.
If we are in an average bear market, it will last at least another three months, with the Dow Jones industrial average losing 27 percent, compared with the 20 percent lost between early October and Wednesday, according to Ned Davis Research.
But professional investors are reluctant to call this market typical. They have been humbled by their own inability to foresee the current economic issues unfolding. They have been taken aback by the credit crisis that neither the Federal Reserve nor the Treasury Department seemed to anticipate until homes were plunging in value and Wall Street’s mortgage-bond creations were poisoning the financial system at home and abroad.
In the last few months, the most powerful street in the world, Wall Street, has had to turn to developing areas of the globe, including Singapore and South Korea, for the capital needed to withstand the mess.
U.S. home values have plunged 15 percent, according to the widely watched Case-Shiller index, and Lehman Brothers, for one, is predicting another 15 percent drop. U.S. households have lost more than $2 trillion in net worth in the housing and stock market. The world’s financial system has not yet determined a replacement for the multitrillion-dollar structured finance market that has gone dormant in the aftermath of Wall Street’s failed mortgage-bond alchemy. Foreign stocks dropped 13 percent.
“The financial crisis looks to be extending into the global economy in a more serious way,” Citigroup global strategist Robert Buckland said in a report Thursday.
Few sectors gain
The 13 percent decline in the MSCI World Total Return Index during the first half of the year was the worst in the 38 years of data history, said Tim Hayes, chief investment strategist for Ned Davis.
Among sectors, only oil and gas and natural resources gained during the first half of the year. And, he said, among countries, the gains were only enjoyed by resource-based, commodity exporters — South Africa, Canada, Chile and Brazil.
“It’s hard to believe what’s happened over the last year,” said Mohamed El-Erian, the co-chief executive of Pimco, one of the world’s most powerful bond investing firms. “The unthinkable has become the thinkable. The market is telling you something.”
Exactly what that is remains unclear, however.
At a Morningstar conference in Chicago recently, financial advisers from throughout the nation asked some of the industry’s most respected fund managers to help them see the future. None of the managers would venture a guess for the near term, expressing confusion about the confluence of unusual factors — soaring energy costs, hundreds of billions in bank write-offs that apparently are still not over, a newly integrated world in which wealth is shared and destroyed globally like never before, and the U.S. consumer hobbled by too much debt and skyrocketing food and energy costs.
“This is a highly unusual cycle,” said Loomis Sayles bond fund manager Dan Fuss.
Bargains tough to see
While the fund managers admit frustration as they search history for insight into today’s economy and market conditions, they say they are confident that in a few years, investors will look back at this period the same way they look back at other scary periods.
“Sentiment is so horrible, you can’t help but make money if you take a three- to five-year time horizon,” said T. Rowe Price Chairman Brian Rogers.
Although he said he doesn’t know “where the last $40 in oil came from,” and many of the stocks in the funds he manages “are performance-challenged, meaning they have gone down,” he thinks the recent period is like 2000, a period in which euphoria over young Internet companies drove stocks to extremes and then collapsed.
As the stock market declined 49 percent, companies failed and investors lost faith in stocks in general, he said there were bargains to buy.
“There are a lot of great ways to make money now, but it doesn’t feel that way,” Rogers said.
The difficult part is figuring out those great ways. Rogers thinks there are probably opportunities in financial services but said investors must be picky.
And having the ability to pick them properly is probably beyond most individuals and professionals.
“Financials are one of the most confusing areas of the market,” says Susan Byrne, Westwood Holdings Group chief investment officer. “How do you value them? There’s no transparency and never was.”
Sovereign wealth funds, loaded with newfound wealth in booming emerging markets, lost money after plopping it into troubled U.S. financial companies earlier this year.
During the last quarter, financial companies as a group dropped 24 percent, despite a relief rally after the Federal Reserve organized the sale of Bear Stearns to JPMorgan Chase in March. The exchange-traded fund that invests in financial companies, the Financial Select Sector SPDR (XLF) has declined 43 percent during the last 12 months.
With lending institutions under pressure, businesses and consumers are feeling the impact as they struggle to obtain affordable loans and deal with the rising costs of energy.
“Measures of commercial bank lending have turned down sharply in recent weeks,” said Goldman Sachs economist Andrew Tilton. “This will have adverse effects on investment hiring and consumer spending. Tighter credit, not just gasoline prices, helps explain why auto sales have been so weak in recent months.”
Manufacturing and labor market reports recently make it “clear that the fundamentals of the economy are weakening,” he said.
Consumer weakness
The stock market often turns up about halfway through a recession, but analysts warn that there is still weakness ahead.
“Although the American consumer has remained fairly resilient, consumer spending should take a hit in the fourth quarter as the impact of the tax rebates wanes,” said Diane Vazza, Standard & Poor managing director and a global bond analyst. “We expect consumer spending to grow at 1.9 percent in the third quarter before retreating 1.5 percent.”
With further shocks in food or oil prices, she said, the decline will be worse.
As financial institutions remain under stress and consumer spending weakens, Vazza is warning investors to be cautious about investing in high-yield bonds.
Yet Jack Ablin, the chief investment officer for Harris Private Bank, said that as an alternative to stocks, high-yield bonds may make sense for investors willing to take on the risk. Although they decline along with the stock market, he said, they do not decline as severely. Then, when stocks start to climb, high-yield bonds historically have climbed almost as much as stocks.
Think internationally
Another defensive move is to buy companies with high international sales, said Goldman Sachs strategist David Kostin.
Despite the slowdown globally, countries such as China, India, Russia and Brazil are likely to continue to grow significantly more than the U.S. economy. China’s real gross domestic product growth in 2009 should be about 10 percent, while the U.S. will grow at 1.1 percent, Kostin said.
Meanwhile, he said investors will continue to be disappointed in U.S. stocks as corporate profits turn out weaker than expected.
“We believe consensus earnings per share estimates are far too optimistic,” Kostin said. Bruce Berkowitz, founder of Fairholme Capital Management, said the best way for investors to protect themselves is to select companies generating significant free cash flow.
“I’m strictly about smelling the cash,” he said. “I want to see what’s in the bank at the beginning of the year and what’s in at the end of the year. Don’t play Russian roulette. If you have to guess, move on.”
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gmarksjarvis@tribune.com
To our readers: This report on 2nd-quarter mutual fund and stock performance replaces the usual Monday Business section. The regular Monday news and features will return next week.
