Stocks Are Shaky After Strong Quarter

Stocks continued to gain in the second quarter, but talk of a downturn grows. Some analysts say a shift toward value-oriented funds is in order.

A few summer squalls are hitting the US stock market. Equity mutual funds did enjoy a good performance in the second quarter of 1996, and piles of new money poured in. But in recent weeks, a number of once-bright sectors - including small-company and high-tech stocks - have dimmed. And even the Dow Jones industrial average has taken some hits, including a 2 percent dive July 5.

The rain on the parade comes from a variety of sources: concerns about the pace of future corporate earnings, high stock prices, and possible hikes in interest rates by the Federal Reserve later this summer or early fall.

Stock mutual funds are up almost 11 percent for the year's first half and 4.8 percent in the most recent quarter. Now a number of top market strategists forecast a downturn later this year or in 1997.

Byron Wien, an investment strategist for Morgan Stanley & Co., says the Dow might drop 1,000 points in the months ahead, losing 15 to 20 percent of its value. Technicians at such firms as Merrill Lynch and Hancock Institutional Equity also forecast a major correction around the corner.

One sign of an overheated market: For much of the second quarter, a major factor boosting equities was "momentum" investing. Funds poured money into soaring sectors, from technology to small companies, no matter how high valuations might be.

The investing fervor became so intense that one fund family is moving to close two funds to new money, though it only opened at the beginning of the year. The Van Wagoner Emerging Growth Fund plans to close its doors when assets reach about $1.2 billion; the Van Wagoner Micro-Cap Fund's expected limit is $250 million.

The excitement generated on Wall Street by new public stock offerings and momentum players may be troubling to analysts, but it helped make the second quarter a happy one for many investors. Small-company, European, and emerging-market funds did particularly well. So did communications and natural-resource sector funds. Even funds specializing in large companies, dominated by industrial firms, have gained. Technology stocks were hot for most of the first half of 1996, but have been slightly colder than warmer of late. The technology-rich Nasdaq composite index fell 7 percent in mid-June.

Investors slowed new-money inflows sharply in June. Still, the estimated $139.4 billion entering stock funds so far this year exceeds 1993's full-year record of $130 billion.

Given market concerns, Standard & Poor's Corp., a financial-research firm, has reduced the proportion of its model portfolio invested in equities to 55 percent from a more typical 60 percent, says David Blitzer, S&P's chief economist in New York.

"We're a little more cautious about stocks than usual, but we know that anyone who ran to the hills [from equities] in the past year lost some money," Mr. Blitzer says.

"Even if there were to be a market correction," he adds, "if you are investing for the long haul, you can probably ride it out." That is what investors learned from past downturns, such as the market crash of October 1987, and the two-year bear market of 1973-75, Blitzer says. "Those who stayed put" eventually came out OK, although sticking out the bear market of the early 1970s took considerably longer than in late 1987.

Different from 1987

While wary, he does not see the current investing scenario as resembling the summer of 1987, when stocks were rocketing upward prior to the October slump, the worst downturn since the 1929 crash that ushered in the Great Depression. (In terms of single-day downturns, the crash of 1987 was more severe than any single day in the 1929 downturn.)

Stock valuations today are "somewhat excessive," Blitzer says. The price-earnings ratio on the S&P 500 stock index is a lofty 19.5, and the dividend yield, at 2.2 percent, is near a record low.

What makes the current situation different from 1987, he says, are "background" elements. Inflation is currently near 2.5 percent, half 1987 levels. Moreover, policymakers are not under severe pressure to boost a weak US dollar, as they were in 1987.

Just how can buyers of stock mutual funds assess the durability - the safety - of this market? Some strategists and analysts for major investment houses, after all, have been known to tout the market to win sales for their companies, even when they have private doubts.

One safeguard, experts say, is to talk to an expert who doesn't work at a mutual fund or traditional investment house.

Near end of cycle?

Consider Michael Jamison, chief investment officer of the individual investment program at Brandywine Asset Management, Wilmington, Del., with $5 billion under management. His clients are generally "high net-worth" individuals, with at least $500,000 in net worth. They are usually keen on preserving their wealth. To Mr. Jamison, various economic statistics "look like we are closer to the end than to the beginning" of the economic cycle. He adds: "The [stock] market makes me very nervous at the moment."

Some experts recommend that individuals think in terms of committing at least a portion of their overall equity portfolio to contrarian or defensive funds or to overseas markets.

Jamison, for example, sees himself as a "value investor," seeking intrinsic worth in companies. He looks for stocks with low ratios of share price to earnings, book value, or cash flow. These low ratios suggest these firms may gain in market value irrespective of gyrations in the overall market.

Another value-based strategy: buying funds that are linked to financial-service firms, utilities, or basic-industry firms such as aluminum, steel, paper. These sectors have been so "beaten up" from prior downturns, some analysts reckon, that they are unlikely to drop much lower.

Some analysts recommend, as a defensive strategy, buying funds linked to the consumer retail sector, which often performs well in down markets. Examples would be food and beverage companies, both of which did well in the first half of this year.

Some remain bullish

Still, not all analysts see the end of the current bull market.

Larry Wachtel, an analyst at Prudential Securities Inc. in New York, sees nothing on the economic or political horizon that could curtail the long-range advance of the Dow, including the coming presidential election. The 1996 election, he says, has been largely discounted by the investment community, with Wall Street "assuming that Clinton will be reelected along with a Republican Congress."

Mr. Wachtel does not rule out a modest correction, saying the current investing environment is one of "rolling corrections," with different market segments, such as high-tech or smaller companies, being tugged downward at times.

Who will be right about what happens in 1996? Stay tuned.

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