Getting Ready for the Next Bear Market
Many mutual fund managers will tell you that stock prices are long overdue for a downturn. But that doesn’t mean the managers are raising a lot of cash to defend against a drop.
If anything, managers generally seem to be abandoning cash as a defensive mechanism, perhaps because they worry about underperforming if the market continues to rally. Stock fund managers, on average, were holding just 5.5% of their assets in Treasury bills and other cash equivalents in December, the most recent month for which figures are available. That’s down from 7.9% one year earlier.
The question of bear market preparedness and the role of cash came to light at a recent investment conference sponsored by discount brokerage Jack White & Co. in La Jolla that several prominent fund managers attended.
One of the most bearish responses came from John Rogers, who runs the Ariel Growth Fund in Chicago.
“‘The odds are pretty good that we’ll have a dire correction within the next 12 to 18 months,” he predicted.
Still, at about 3%, Ariel Growth’s cash level is hardly excessive. Rather, Rogers said he’s preparing for a downdraft by focusing on defensive stocks such as newspaper publishers and companies that make household products.
“‘These are real businesses with real cash flow,” he said. “‘Even in a market crash, people will still buy those products.”
David Katzen, manager of the Zweig Appreciation and Zweig Strategy Funds in New York, said he’s cautious about the market yet still has slightly more than half his portfolio invested in stocks.
On the one hand, Katzen said, it’s easy to paint a bullish scenario for stock prices because the economy continues to grow just fast enough to boost corporate profits without reigniting inflation.
On the other hand, he figures the prolonged stock price rally has raised the market’s risk level.
“What’s particularly worrisome is that mutual fund cash holdings are at their lowest levels since the 1970s,” he said. “So there’s not a ready reservoir of cash that can come into the market if prices drop.”
Robert Sanborn, who runs the Oakmark Fund in Chicago, also thinks stock prices have become lofty. But he also sees many positive factors that justify the higher prices. These range from greater efficiency in the way companies are run to a pro-capitalist business climate at work around the globe.
At any rate, Sanborn doesn’t try to time his stock picks by raising cash, and he continues to find attractively priced companies in which to invest. He predicts Oakmark will hold up relatively well in a bear market because of the preponderance of large value stocks in the portfolio.
In a similar vein, William Nasgovitz of the Heartland Value Fund in Milwaukee hopes to gain a measure of protection by holding small stocks. These companies have not rallied as much as larger firms in recent years, so presumably they would have a shorter distance to fall. “Hopefully, small stocks won’t get pummeled as badly,” Nasgovitz said.
One of the more bearish managers at the conference, Steve Leuthold of the Leuthold Asset Allocation Fund in Minneapolis, said he is holding a relatively hefty cash position, equal to 20% of the fund’s assets, along with 50% in bonds. Of the remaining 30% in stocks, high-dividend real estate investment trusts, or REITs, make up the majority.
Leuthold thinks the market is vulnerable to a correction.
“We are in a new era” of high market valuations, he said. “In the past, all such new eras have been temporary.”
At the other extreme was Garrett Van Wagoner of the Van Wagoner Funds in San Francisco, who continues to invest in small, volatile growth stocks without worrying about market corrections. Should a bear market materialize, Van Wagoner said, he fully expects to get bruised.
“The fund owns a lot of high-P/E [price-to-earnings ratio], high-growth stocks, and it would go down a lot,” he said.
However, Van Wagoner said his funds do have access to a line of credit that they could tap in a slump. The idea would be to borrow money if necessary to meet shareholder redemptions without having to sell stocks at depressed prices.
Perhaps the most interesting response to the possibility of a market drop was voiced by Thomas Kamp, who helps run the New York-based Alliance Premier Growth Fund, which holds relatively little cash. Kamp said he would sell his least favorite stocks during a market decline and buy more of his favorite ones. Such moves make the fund less diversified and more volatile.
“That way, when the market rebounds, we’d get an extra kick,” he said--assuming the right stocks were chosen.
