Will Stocks Stay in a Narrow Range or Is Breakout Near?
When a money manager hears too many peers taking his or her view of the stock market, a queasy feeling sets in. The crowd, after all, is usually wrong. Better to be a contrarian.
That queasy feeling is all over Wall Street today, as the third quarter begins. Many professional investors believe that stocks are likely to continue pulling back in the weeks ahead but that, overall, the market will remain stuck in a narrow “trading range” in the new quarter.
The Dow Jones industrial average, at 2,906.75 Friday, may fall to 2,800 or so, but that will likely be the extent of the damage because investors still believe in an economic recovery ahead. On the upside, meanwhile, a Dow of 3,000 is the most Wall Street can hope for until corporate profits clearly show signs of rebounding.
That’s the crowd view. As Peter Anderson, money manager at Federated Investors in Pittsburgh, puts it, “All you can justify right now is a trading range.”
But Anderson also admits that the wide acceptance of the trading range idea gives him stomach pains. “You know that a trading range isn’t going to continue forever,” he notes. “You have to break out of it, one way or another.”
And the greater the crush of investors betting on a flat market, the greater the likelihood that the market will surprise everyone with a stunning move--up or down--much earlier than expected.
That’s the contrarian case, and it’s a compelling one. Yet it’s also worth noting that there are times when the crowd does guess right:
* Last fall, many investors turned extremely bullish about bonds, figuring that the Federal Reserve was about to slash interest rates. They were right.
* In January, most pros figured that the market would continue falling until the Gulf War began and the allies quickly guaranteed a victory. Right again. (Though most investors wrongly expected that it would take more than one day to gain military superiority.)
* At the end of the first quarter, with stocks up dramatically, a narrow majority of investment advisers polled by Investors Intelligence newsletter felt that the market had reached at least a short-term top. Right once more. Most stock indexes rocked and rolled in the second quarter but ended virtually at the same place they were on March 31. The Dow, up 10.6% in the first quarter, inched down 0.2% in the second.
So when the crowd now says that stocks are headed lower for a couple of months, but not dramatically lower, it isn’t far-fetched to believe that they’re on target.
But after you hear enough of that talk, you also start to realize something else: Big investors’ reluctance to buy stocks now means that they’re piling up tons of cash as they wait. That money will eventually have to be put to work.
Even if the economy weakens again this summer and sends the stock market reeling, the first signs of recovery this fall will bring the herd back to stocks in a major way.
The advantage that individual investors have over institutions is nimbleness--you can play the market without moving it. When the market looks bad, you can spend time identifying stocks or stock mutual funds that you want to own for the inevitable next wave up, and then buy on weakness.
Or, you can just plan to invest a set amount each month for six months, figuring you’ll be buying gradually into a selloff or a rally. Either way, averaging-in beats the queasy feeling that comes from being part of--or out of--the maddening Wall Street crowd.
So, Where to Hunt?We asked five money managers where they expect to make money in the second half of the year, assuming the stock market eventually returns to bullish footing. Here’s what they said:
* Frederick Ruopp, Chelsea Management, Los Angeles: “I think people will make money by avoiding disaster,” Ruopp says, only half-joking. He has been raising the cash portion of his portfolio lately because he doesn’t want to pay the typical share price of three times book value--that is, three times the liquidation value of a company’s assets. Historically, when stocks sell for that high a price relative to book value, it’s time to get out.
But when the market does begin to rally, Ruopp figures that the industrial stocks that charged ahead in the second quarter could again be the leaders, as investors look to a better economy in 1992.
* Ken Heebner, Capital Growth Management, Boston: “I think the surprise of the second half is going to be that business isn’t recovering,” says Heebner. And in that climate, he believes that investors will return to one of his favorite “cheap” stocks--Philip Morris ($63.50, NYSE).
The tobacco and food giant has been in his portfolio for two years, and Heebner still loves it, noting that it sells for about 14 times estimated 1991 earnings per share, versus the average stock’s price-to-earnings ratio of 17. Philip Morris has already dropped 12% from its 1991 high of $71.875.
* Robert Bacarella, Monetta Financial Services, Wheaton, Ill.: “I want to buy, but they’re all too high,” Bacarella moans about stocks. His portfolio is 35% in cash now--a lot of dry powder for future use if prices come down.
But he still believes that Compression Labs ($16, NASDAQ) is going to be a great story. The San Jose company’s video teleconferencing systems for business are on the verge of a major market breakthrough, Bacarella says. Skeptics have questioned the firm’s proprietary technology of squeezing more data into a video signal (which cuts the cost of teleconferencing), but Bacarella has no doubts about its potential. The stock has fallen back 38% from its 1991 peak of $25.875.
* Robert LeFleur, Northern Trust Co., Chicago: We’re coming up on a hefty market pullback here, LeFleur says, but he looks at it merely as “a correction between two nice up-legs.” The war rally was one up-leg, and the rally that LeFleur expects in tandem with a recovering economy in 1992 will be the other. Bet on stable to lower interest rates into 1992, he says, because “the Federal Reserve is not going to be your enemy with a presidential election coming up.”
What about the next six months? The growth stocks in food, health-care and other stable businesses will post better net gains than the industrial companies from here to year’s end, LeFleur figures, because the growth names have already taken steeper drops from their 1991 highs. The industrials could be more vulnerable to a selloff and by year’s end may be just rallying back to their current prices.
* Alan MacGregor, MacGregor-Rodman Investment Management, Westlake Village: MacGregor’s firm plays the market where it sees momentum--in stocks and corporate earnings. “We let the market tell us what to do,” he says. Right now, his accounts hold between 25% and 50% cash, because momentum has clearly flagged.
And when the pullback ends? “We’re leaning toward retailers when we come out of this,” MacGregor says. Such retail stars as Home Depot ($45.125, NYSE), Gap Inc. ($59.875, NYSE) and Charming Shoppes ($20.75, NASDAQ) have what it takes to spearhead the retail sector when the economy is fully back on track, he says.
Quarter’s Best and Worst Stock Groups
Industrial stocks dominated the list of big winners in the second quarter, as investors bet on a revived economy. At the bottom of the pile: computers, energy and insurance. Here are the 10 best and 10 worst industry groups for the quarter, among 87 categories. For comparison, the S&P; 500 stock index fell 1.1% for the quarter, but gained 12.4% for the half.
BEST INDUSTRIES
Avg. change 2nd qtr. 1st half Paper bag/box makers +20.5% +50.3% Auto parts +17.3% +32.5% Can/bottle makers +17.0% +32.1% Chemicals (general) +15.1% +23.8% Specialty apparel retailers +14.6% +65.7% Long-distance phone cos. +14.0% +30.5% Chemicals (diversified) +13.8% +24.3% Communications equipment +13.7% +28.7% Paper/forest products +13.4% +24.3% Railroads +11.9% +20.6%
WORST INDUSTRIES
Avg. change 2nd qtr. 1st half Computer systems -15.8% -8.1% Health care (misc.) -12.8% +10.5% Oil/gas drilling -11.6% -19.1% Natural gas -11.4% -14.5% Insurance (multi-line) -10.5% +13.0% Insurance brokers -10.4% -0.9% Shoemakers -9.8% +27.7% Coal -8.5% -10.1% Grocery store chains -8.0% +19.3% Hospital management cos. -7.8% +13.9%
Data through Thursday close
Source: Smith Barney, Harris Upham & Co., using S&P; indexes
