News Column

An Era of Downsized Expectations


While generally upbeat about investment prospects, Hispanic money managers nonetheless caution against the “irrational exuberance” of years past.

By Mark Egan
January/February 2002

After two years most investors would rather forget, money managers are optimistic that the worst is over. The S&P500 index fell nearly 10 percent and 12 percent in 2000 and 2001, respectively – the first back-to-back declines since the early 1970s. But despite that dismal backdrop – to say nothing of the current recession and the war against terrorism – money managers forecast good times ahead, predicting a rising stock market as the economy shakes off its lethargy. In contrast to the heady Internet bullmarket days when the sky was the limit, however, investment advisors are urging stock market investors to have realistic expectations. Julio Gonzalez, a vice-president of Georgia-based Miramar Securities and Hispanic-owned money management firm Diaz- Verson Capital, sees the Dow Jones Industrial Average at 12,000 and the S&P500 at 1,400 by year’s end. Though many investors pulled money out of the stock market during the past two years, Mr. Gonzalez expects that trend will reverse in 2002. “Investors are anxious to jump back into the market,” says Mr. Gonzalez, who aims for annual gains of 12–15 percent. “We think there could be a big boost to this market.” In fact, Mr. Gonzalez is almost unwavering in his optimism. “The key thing to keep in mind is that this stock market has withstood the Cuban missile crisis, the resignation of President Nixon, the assassination of President Kennedy, the oil embargo, depressions and recessions. It has withstood everything that has ever hit this country and has always gone higher.” Indeed, the market proved that point again last year. After September 11, stocks stumbled to three-year lows, heightening fears of a protracted bear market. But the uncertainty was short-lived, as stocks took just one month to return to pre–September 11 levels. And if optimism is the flavor of the day, the statistics support that view. The stock market has not declined for three consecutive years since the Great Depression, and during the first year of a recovery, stock prices have jumped an average of 38 percent. The S&P500 fell 17 percent and almost 30 percent, respectively, in 1973 and 1974 as a result of the oil crisis and Richard Nixon’s resignation. But in 1975 and 1976, stocks jumped almost 32 percent and 19 percent. Even if gains like those do materialize again, investors should not expect all stocks to rise. Mr. Gonzalez believes that means buying companies with solid earnings prospects. Kroger (NYSE: KR), Walgreen (NYSE: WAG), and Wal-Mart (NYSE: WMT) are among the retailers he likes. He also expects gains from heath-care company Johnson & Johnson (NYSE: JNJ), while among financials he expects that American Express (NYSE: AXP) and the Bank of New York (NYSE: BK) will benefit from higher interest rates in the coming months. Many experts say U.S. stocks are still overvalued, given mixed corporate earnings results. And while most expect the economy to shrug off the recession this year, many economists expect a patchy recovery with some key indicators like unemployment getting worse before they get better. And with the U.S. Federal Reserve at or near the end of its rate-cutting cycle, interest rates will likely rise, adding another challenge for stocks. Jayusia and Alan Bernstein, founders of Miami-based Stratigraphic Asset Management Co., expect equities to enjoy 10 percent returns this year but are skeptical such gains will be sustained. They say the one lesson to be gleaned from recent years is that investors should lower expectations to realistic levels. The Bernsteins manage more than $100 million in assets, with a minimum account size of $500,000. They expect corporate earnings will recover this year, but not enough to match profits seen in 2000. They see bonds as unattractive, given low yields that don’t compensate investors for the pricing risk if interest rates rise. “The bullish story this year is that investor expectations are inflated, a recovery in the economy is anticipated, and low interest rates are making investors more willing to move up the risk curve into common stocks,” the couple wrote in a recent letter to clients. “Over the next few years it is not reasonable to expect the market to sustain double-digit returns because stock valuations are already high and corporate profits are problematic.” Jayusia Bernstein says part of the problem during the Internet stock bubble was that “money managers, in order to keep up with the indexes, were buying companies with price/earnings multiples that didn’t make any sense.” The Peruvian-born Ms. Bernstein takes a traditional approach to investing, with a portfolio of large-cap stocks, investment grade bonds, and no derivatives. She believes annual returns of 7 to 9 percent over the next three to five years are as much as investors should shoot for. Ms. Bernstein says investors should study benchmarks like price/earnings ratios before buying stocks, and cautions against any attempts at market timing. “Investing is counterintuitive. When you are most pessimistic is when you have to be buying, and when you are the most optimistic, you have to pull back,” she says, adding that most investors should buy regularly to average their costs. Among the stocks the Bernsteins like are health insurance firm Cigna (NYSE: CI), life insurance company MetLife (NYSE: MET), and utility Duke Energy (NYSE: DUK), all for their attractive price/earnings ratios. The pair expect property casualty insurance firm Chubb (NYSE: CB) to reverse its recent slump as insurance premiums rise because of heightened terrorism concerns. Among banks, the Bernsteins like Wells Fargo (NYSE: WFC) for its price and excellent management; they also like medical device maker Boston Scientific (NYSE: BSX). First Pacific Advisors’ Robert Rodriguez was named Morningstar’s Fixed Income Mutual Fund Manager of the Year for 2001 after his FPA New Income Fund chalked up gains of 12 percent. Mr. Rodriguez also manages the FPA Capital Fund, which soared 38 percent last year. He buys government, agency, and high-yield bonds and seeks out stocks that are “out of favor, unloved, hated, and selling at large discounts,” he says. Mr. Rodriguez predicts tougher times ahead. “This is not a period where people are going to see big double- digit investment returns like those of the 1990s. That era is probably gone for at least a generation,” Mr. Rodriguez observes. “Investors need to lower their expectations. “Investment returns will average 5 percent or less from common stocks as measured by the S&P500 over the next five years – a very subdued forecast. Stocks and high-quality bonds will probably generate returns approximating each other.” Mr. Rodriguez cautions frustrated investors not to try to boost returns by taking on higher levels of risk. He believes equities are relatively richly priced, and he is a net seller of stocks, expecting turbulence ahead. The women’s clothing retailer Charming Shops (NASDAQ: CHRS) is the one firm Mr. Rodriguez is buying, having already snapped up about 8 percent of the turnaround company. As a long-term strategy, Mr. Rodriguez suggests balancing exposure between a good value fund and a good growth fund. Then every three or four years, the investor should sell the fund that has done well and buy its underperforming counterpart. Mr. Rodriguez calls the strategy “buying weakness and selling strength.” “If investors did something along these lines,” he says, “they would end up with considerably better long-term investment results than by being skewed to any one particular discipline.” Peter Landin is CEO of U.S. Institutional Business for Barclays Global Investors, a firm that manages more than $750 billion in assets, mainly for large pension funds. “Our fundamental belief is that it is hard to pick individual stocks with the intention of hitting home runs,” Mr. Landin says. He believes most individuals should let professionals handle their investments, with the goal of managing a modest return above stock indices. “What is important is not really the overall level of returns as much as the level of returns compared to the alternatives,” he says. “We have a favorable opinion of the stock market relative to the opportunities in fixed income or cash.” Mr. Landin advises individual investors to buy index funds instead of relying on the home-run strategy. “Even most professionals tend to underperform the index,” he says. But for investors who do press ahead with individual stock picks, he cautions against buying companies using aggressive accounting practices, saying such firms are “effectively borrowing from future earnings and setting themselves up for disappointment.” Mr. Landin says his firm is split 65/35 between stocks and bonds and that investors should also seek a balanced portfolio. With that in mind, he says the Enron collapse, which cost thousands of employees their jobs and their life savings, should serve as a lesson. “I hope that this year – and the Enron situation in particular – has been a wakeup call for people to understand that no matter how much they believe in their company, they have to be aware of the significant downside risk of concentrating their investments and their jobs in a single stock,” Mr. Landin says. “Diversification is key,” he advises, adding that holding 20 percent or more of your portfolio in a single stock should raise a red flag. Linda Descano, director and portfolio co-manager of the Private Portfolio Group at Citigroup Asset Management in Stamford, Connecticut, has a different approach to investing. Ms. Descano offers a mutual fund and managed accounts for “social awareness” investing, which enables investors to invest in a manner consistent with their values and beliefs. With accounts ranging from $50,000 to $25 million, Ms. Descano invests mainly in large-cap stocks of U.S.-based multinationals across the economic spectrum. “The majority of our clients are very sensitive to a handful of industries. Tobacco, nuclear power, and weapons are probably the three that there is a lot of concern over, with some concern over alcohol and gambling companies,” she says. Ms. Descano has a positive outlook for the coming year but warns investors not to expect smooth sailing. “Over the next several months we will probably still hear a lot of negative news, and that is going to create more concern and volatility,” she says. She recommends companies such as United Parcel Service (NYSE: UPS) and American Express (NYSE: AXP), which should benefit from an economic recovery, as well as PepsiCo (NYSE: PEP) and the drug company Pfizer (NYSE: PFE), which she expects to do well regardless. For Ms. Descano, asset allocation is key. “The most important thing for an investor to do is work with a financial adviser to establish goals and objectives, develop an asset allocation that will help meet those objectives, implement that strategy, and monitor it and not get caught up in issues of timing and market ups and downs,” she advises.

Source: HISPANIC BUSNESS magazine

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