Fund Managers Scared Witless!

The latest market mayhem–as many financial writers are labeling it–reminds me, to an extent, of my first brush with fire when the tech bubble burst in 1999. I was still at TD Evergreen’s retail desk, babysitting a portfolio of about CDN$100 million in clients’ assets. For days, all I could see was red across the board. The phone would not stop ringing. The first question on every client’s lips was, “What are we to do?”

At the time, there wasn’t much anyone could do. If a company had a “dot-com” in its name, investors were ready to dump indiscriminately loads of money, even when there was no business plan and no profits in sight. Most of my clients would phone about their own picks. Expressing my concerns about their investing strategies mattered little. Eventually, this illogical state in the markets reached the boiling point. The events that followed are history.

Granted, no one is comparing the recent bloodbath with dot-com fiasco of the late 1990s because it would be as if comparing apples and oranges. Yet, the question on everyone’s lips remained the same, “What are we to do?”

Believe it or not, answering such a simple question is not easy, particularly when those who should be able to keep their cool better than anyone are running scared witless. Basically, within only four short weeks, fund managers started hating the outlook for the global economy. In April, no one cared about macroeconomic factors because equity markets were on fire. In May, their half-full glasses turned half-empty on concerns that the world’s central banks might try to engineer below average economic growth just to keep inflation in check.

Moreover, in a May survey of fund managers conducted by Merrill Lynch, 57% of interviewees expected the world economy to slow down in the next year or so. In April, that number stood at 41%. By the same token, those forecasting that the world economy would grow declined from 33% in April to 27% in May and finally to 12% during the first week of June. Finally, about 54% of those surveyed expected corporate profits to deteriorate in the next 12 months.

What are fund managers doing to offset the heat? For starters, they are increasing the cash component in their portfolios. Obviously, their line of reasoning is that inflation fears can be offset by increased liquidity.

In contrast, only a smaller percentage of interviewed managers, just about six percent, are putting more weight on bonds. Stocks are still the preferred weapon of choice for 54% of fund managers. However, this percentage is down from 60% in May. In terms of sector preferences, fund managers still like energy, pharmaceutical, industrial, and insurance stocks. Off the buy lists are consumer discretionary, utilities, telecoms and technology stocks.

Returning to the question, “What are we to do,” (‘we’ being ordinary investors), some of the ideas put forward by fund managers could be useful. For example, if you have a “bleeder” in your portfolio, adjust your stop limits accordingly and close the position. You may do so at cost, but at least you’ll have some liquidity to work with.

I agree that changing portfolio weightings to favor bonds is not a good move. Stocks are still the way to go, but keep with the sectors that fund managers like. Chances are, these sectors will be the ones with increasing buying pressures.

Although it seems logical to short sell stocks, do so cautiously. When the market is down-trending as fast as this, finding the right entry point could be an exercise in futility. By all means, close the shorts that you may have opened before mid-May. But, when and if you are initiating new shorts, choose your entry points carefully. In the past couple of weeks, bottom pickers got badly burned.

Finally, I disagree with the majority of interviewed fund managers that it may take 12 months for market imbalances to correct themselves. I believe we will see slight improvements during summer months and another sell off in the fall. Once that is out of the way, the traditional year-end rally should ensue. I’m not reinventing the wheel here; the market is such an addict to cycles, including business and seasonal cycles.