Stocks Took a Sur­pris­ing Dive, And More Jolts May Be Com­ing

The Washington Post Sunday - - Business - By To­moeh Mu­rakami Tse

BNEW YORK uckle up, in­vestors: Tur­bu­lence is back in the stock mar­ket, and an­a­lysts say it’s go­ing to stick around for a while. The on­go­ing tur­moil ar­rived abruptly in late Fe­bru­ary, when a sell-off in the Chi­nese stock mar­ket jolted in­vestors around the world, trig­ger­ing the big­gest one­day drop in the Dow Jones in­dus­trial av­er­age in four years and end­ing sev­eral months of steady gains. Since then, stocks have see­sawed sharply, as in­vestors sift through mixed sig­nals on the econ­omy. Mort­gage in­dus­try prob­lems, a sput­ter­ing hous­ing mar­ket and un­cer­tainty about the di­rec­tion of in­ter­est rates are all fu­el­ing mar­ket jit­ters. How­ever, while eco­nomic growth has slowed con­sid­er­ably, un­em­ploy­ment re­mains low and cor­po­rate deal­mak­ing con­tin­ues at a record pace.

“If you’re re­ally just look­ing to make a call on the macro-eco­nomic fac­tors, your vis­i­bil­ity is pretty poor right now,” said Brian Anger­ame, a port­fo­lio man­ager at ClearBridge Ad­vi­sors, which is owned by Legg Ma­son. He noted that other wild­cards are lurk­ing, such as the re­cent rise in oil prices and on­go­ing geopo­lit­i­cal ten­sions in the Mid­dle East.

By the end of the first quar­ter, stocks had climbed back close to where they be­gan the year. The Dow fin­ished down nearly 1 per­cent, but the blue-chip in­dex had been off as much as 3 per­cent in early March. The broader Stan­dard & Poor’s 500-stock in­dex gained 0.2

per­cent, while the Nas­daq com­pos­ite in­dex rose 0.3 per­cent. The Rus­sell 2000 in­dex of small com­pa­nies fared bet­ter, gain­ing 1.7 per­cent.

Most mar­ket watch­ers do not ex­pect stocks to take off in the sec­ond quar­ter. Robert Doll, global chief in­vest­ment of­fi­cer of eq­ui­ties at Black­Rock, said he an­tic­i­pates that the eco­nomic slow­down will crimp cor­po­rate earn­ings and that this might make share prices less stable.

“We’re in a pe­riod of growth scare for the U.S. econ­omy,” he said. “We’re go­ing to have more volatil­ity in both di­rec­tions.”

Doll thinks profit growth, which had been in the dou­ble dig­its for the past four years, will slow to 5 per­cent this year. He said the broader stock mar­ket can still re­turn up to 10 per­cent for the year — pro­vided in­fla­tion­ary pres­sures ease and the Fed­eral Re­serve low­ers in­ter­est rates.

“It’ll be a bumpier ride to get there,” he said.

In re­cent weeks, the Fed­eral Re­serve has sent mixed mes­sages about where its bench­mark short-term in­ter­est rate is headed. Af­ter a mone­tary pol­icy meet­ing March 21, the cen­tral bank is­sued a state­ment omit­ting lan­guage it had pre­vi­ously used to in­di­cate the like­li­hood of in­ter­est rate in­creases. In­vestors pounced on the change as a sign of a pend­ing rate cut and sent stocks soar­ing.

But a week later, in tes­ti­mony to Congress, Fed Chair­man Ben S. Ber­nanke said fight­ing in­fla­tion was still a pri­or­ity, dous­ing Wall Street’s hopes for a rate cut. Stocks tum­bled on the news.

Many in­vestors have been root­ing for a break on in­ter­est rates to help snap the hous­ing mar­ket out of its pro­longed slump and spark broader eco­nomic growth. A re­cent sur­vey of in­vest­ment man­agers by the Rus­sell In­vest­ment Group showed that their con­cern about the hous­ing mar­ket rose af­ter stocks plunged Feb. 27, join­ing in­fla­tion as a chief risk fac­tor.

Wor­ries about the real es­tate slow­down have been height­ened by mount­ing trou­bles in the mort­gage in­dus­try, where a re­cent spike in de­faults on subprime loans has put more than two dozen lend­ing com­pa­nies out of busi­ness. Last week, New Cen­tury Fi­nan­cial, the na­tion’s sec­ond-largest is­suer of high-risk mort­gages, filed for bank­ruptcy pro­tec­tion, the largest such lender to fall so far.

The subprime tur­moil has dragged down many fi­nan­cial stocks, an­a­lysts say. Of the S&P 500’s 10 sec­tors, fi­nan­cials was the worst per­former in the quar­ter, los­ing 3.4 per­cent. Com­pa­nies in that sec­tor’s thrift and mort­gage cat­e­gory suf­fered par­tic­u­larly, drop­ping 10.8 per­cent, ac­cord­ing to S&P.

“Just about any­body who was in the fi­nance in­dus­try got crushed,” said Tom Roseen, se­nior re­search an­a­lyst at Lip­per, a fund-re­search firm.

The S&P’s best per­form­ers in the first quar­ter were util­i­ties and ma­te­ri­als, which both rose more than 8 per­cent, and telecom­mu­ni­ca­tions, which gained more than 6 per­cent.

Not sur­pris­ingly, mu­tual fund per­for­mance slipped com­pared with the first quar­ter last year, with all fund types gen­er­at­ing sin­gle-digit re­turns, ac­cord­ing to Lip­per.

Funds that in­vest mostly in mid-size com­pa­nies gained more than 4 per­cent on av­er­age, while those spe­cial­iz­ing in small com­pa­nies re­turned about 3 per­cent, ac­cord­ing to Lip­per. Funds that fo­cus on large com­pa­nies were once again the lag­gards, with an av­er­age gain of less than 1 per­cent.

Once-lofty emerg­ing-mar­ket funds were hit by the global sell-off, re­turn­ing an av­er­age of 2.2 per­cent for the quar­ter, com­pared with 12.2 per­cent a year ago. Funds fo­cused on Latin Amer­ica gained an av­er­age 4.8 per­cent, com­pared with a 16.7 per­cent gain a year ago.

“There is a large and rapid de­cline in some of the riskier as­sets,” said Dun­can W. Richard­son, chief eq­uity in­vest­ment of­fi­cer at Ea­ton Vance.

In­vest­ment strate­gists say this may be a good time for in­di­vid­ual in­vestors to read­just their port­fo­lios, par­tic­u­larly for those who had a good run bet­ting on some­what riskier, small­er­com­pany or emerg­ing-mar­ket stocks, strate­gists say.

Doll rec­om­mends in­vest­ing in large, multi­na­tional cor­po­ra­tions with sig­nif­i­cant ex­po­sure to over­seas mar­kets, where the eco­nomic out­look re­mains stronger than in the United States. He said his firm has been in­creas­ing its funds’ stakes in Hewlet­tPackard and Cisco Sys­tems in the tech­nol­ogy sec­tor, Pfizer and Merck in health care, and Exxon Mo­bil and Chevron in the en­ergy arena in the past year.

Craig Hester, chief in­vest­ment of­fi­cer of Hester Cap­i­tal Man­age­ment, said large-cap stocks rep­re­sent 75 per­cent of the eq­ui­ties it man­ages for clients, com­pared with 50 per­cent three years ago. The firm, which has $1.45 bil­lion un­der man­age­ment, has pared its hold­ings of smaller com­pa­nies to 1 per­cent from 15 per­cent.

Among the large com­pa­nies it holds, Hester said, are U.S. Ban­corp, which gets a chunk of its earn­ings through fees, and Joy Global, a min­ing-equip­ment man­u­fac­turer that de­rives about half its rev­enue abroad. “Our port­fo­lios to­day have a more qual­ity bias — com­pa­nies with strong cash flows, strong bal­ance sheets,” he said, adding that they hold up bet­ter in mar­ket down­turns.

But the key, money man­agers said, is di­ver­si­fi­ca­tion. Anger­ame of ClearBridge, who man­ages mid-cap funds, said the in­vest­ing en­vi­ron­ment re­mains fa­vor­able to mid-size com­pa­nies, in part be­cause they are of­ten tar­gets for cor­po­rate ac­qui­si­tions.

“Mid-caps make tasty lit­tle morsels for private-eq­uity shops to ac­quire,” he said. Anger­ame noted that two firms in his port­fo­lio — Ser­viceMaster, a lawn care and pest con­trol com­pany, and Spirit Fi­nance, a real es­tate in­vest­ment trust — re­cently ac­cepted takeover bids from buy­out firms that of­fered a pre­mium over their cur­rent stock prices.

An un­re­lent­ing stream of merg­ers and ac­qui­si­tions has helped boost U.S. stocks, an­a­lysts say. Ac­cord­ing to Thom­son Fi­nan­cial, $451 bil­lion in cor­po­rate deals were an­nounced dur­ing the first three months of the year, up 35 per­cent from a year ago. Lever­aged buy­outs led by private-eq­uity firms ac­counted for a quar­ter of the deal vol­ume.

To some on Wall Street, those cor­po­rate deals say a lot about how in­vestors are han­dling the latest stretch of mar­ket volatil­ity.

“Clearly, some risk aver­sion has crept back into the mar­ket,” Anger­ame said. “I don’t get the feel­ing that in­vestors have com­pletely changed their mind-sets, though. I think we woke up one morn­ing and heard that a for­eign mar­ket had sold off . . . and not many peo­ple knew how to in­ter­pret it.”

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