Investors Are Looking on the Sunny Side of a Downturn(NYTimes, 6/24/06)

June 24, 2006
Investors Are Looking on the Sunny Side of a Downturn
By VIKAS BAJAJ and JEREMY W. PETERS
As his investments in the stock markets of developing countries were hitting record highs in early May, Tristram Millard had a nagging feeling that things were about to turn down.
He resisted the temptation to cash out, believing that his investments still had more bang left in them.
But things did turn down and the recent swoon left him with a 15 percent loss in a Latin American fund and reduced his profits in a broader emerging market fund.
But he is not panicking.
"As gut wrenching as it is when the market shakes out like this, I tend to see it as a buying opportunity," Mr. Millard, 29, said. "It's not like all those companies are going to go out of business."
Like Mr. Millard, most investors — professionals and amateurs, individuals and institutions — have reacted with relative calm to the recent downdraft in global financial markets.
Certainly, they have taken money out of developing countries and fast-growing American companies, but they have not, at least so far, sold out of the market as they did during the technology crash of 2000 or the 1997 Asian financial crisis.
They have reinvested some of the money in more conservative areas like bigger American companies, money market accounts and certificates of deposit.
The contraction in markets and investor confidence, as a result, is slow and small by recent standards. Since April of this year, the Standard & Poor's 500-stock index is down 5 percent and the Nasdaq composite index is down 8.7 percent. By contrast, in the two months after they peaked in March 2000, the S.& P. dropped 8.4 percent and the Nasdaq fell 33 percent.
Most individual investors are making only minor adjustments in their portfolios, according to one study. Transfer activity in the 401(k) accounts of 1.6 million employees studied by Hewitt Associates has increased only slightly and most of the transfers were out of emerging market funds.
The investor pullback is a natural outgrowth of higher interest rates and tighter monetary policies worldwide, experts say. "The punch bowl is being taken away everywhere you look," said Liz Ann Sonders, chief investment strategist at Charles Schwab.
The Federal Reserve is expected to raise short-term interest rates next week by a quarter point for the 17th time in two years, to 5.25 percent. The Bank of Japan has been removing cash from banks as it prepares to raise rates that have been close to zero for more than five years. The European Central Bank has raised interest rates modestly and expects to increase them further. Money flow could ease even in the white-hot Chinese economy as the government tightens lending standards.
Ms. Sonders has been advising Schwab's clients to take a conservative, though not bearish, position by increasing the allocation of cash in their portfolios by 10 percentage points and reducing their stocks by an equal amount. Investors are heeding those recommendations, Ms. Sonders said, but the change has been gradual.
"People are trying to hunker down and ride through this and hope that the correction is over," she said.
Since the start of May, more than $84.2 billion has flowed into money market funds, according to AMG Data Services, a research firm. By contrast, investors took $21.6 billion out of money market funds in the first four months of the year and took $290 billion out from 2002 to 2005.
Some experts say that the tightening of monetary spigots is only now starting to be felt by investors, who became more aggressive with their investments in recent years.
But by historical standards, money remains relatively cheap. The Fed's interest rate for interbank loans is below its 50-year average. Japanese rates are not expected to move much higher than zero and not until the end of the year, and in Europe those costs are still below 3 percent.
Though concern about the United States trade deficit and housing market worry economists at the World Bank, the organization expects the global economy to grow 3.7 percent this year and 3.5 percent in 2007 after expanding by an estimated 3.6 percent last year.
"The comfort that we can take right now is a global economy that is on more solid ground than it was in 1997 or 2000," said Jerry Webman, the chief economist at Oppenheimer Funds.
Fund managers, meanwhile, see opportunities. Shares of large American companies, which languished relative to international stocks and commodities in recent years, may come back in favor as investors look for stable growth, said Michael E. Schroer, managing partner at Renaissance Investment Management in Cincinnati. His fund recently invested in Coca-Cola and Colgate-Palmolive and sold Apple.
Most of the fallout in the spring retreat occurred in developing countries and in commodities.
For developing countries like Brazil, the contraction could put a damper on stock prices, though probably not their economies, experts say. That is so, they said, because investors have been borrowing at low rates in developed countries to invest in developing markets with, until recently, expectations of a higher return.
Such returns are needed to entice investors into those markets because as interest rates rise similar returns are available in money markets and bonds with less risk.
Brazil's main stock index, for instance, has fallen 17.4 percent after rising 25.5 percent from January until May 9, when it peaked.
"Brazil was benefiting from a series of trends that will no longer exist if interest rates get much higher in more developed countries," said Armínio Fraga, a former president of Brazil's central bank who is now a partner at Gávea Investimentos, an asset management company in Rio de Janeiro.
In the last five weeks, investors pulled $4.7 billion from emerging market funds, after putting in $16 billion during the first four months of the year. The Morgan Stanley capital international emerging markets index of stocks in 25 countries has fallen 16.5 percent since April.
The sell-off was accentuated by the increasing popularity of exchange-traded funds, which can be bought and sold like a stock, rather than just once a day with mutual funds. Many of these newly popular funds track indexes of stocks by country, region or sector and maintain no cash. So, when investors redeem them, the funds sell shares in local markets to raise cash, said Robert L. Adler, president of AMG Data. "They are simply hitting the market at the same time," he said.
In India, the selling from these funds dumped more shares on markets than local demand could absorb, said Shriram Iyer, head of research at Edelweiss Securities in Mumbai. "When the global funds started selling," he said, "this acted as a trigger and led to a downward spiral."
India's Nifty index of 50 stocks is down 19 percent since May 10, after climbing 32.4 percent for the year until then.
Markets for commodities like gold, silver and platinum have had similar trajectories.
In Chicago, Jay R. Feuerstein, a futures trader, unwound his firm's holdings in gold after his computer models suggested the price had crossed an important threshold at $690 an ounce. He now has a short position on gold, which hit a 26-year high at $721.50 on May 11 and closed yesterday at $584.80. "We were very fortunate," he said.
But even in those volatile markets, a few of the faithful are standing pat.
Jim Brownold, a retired actor, bought more gold coins when the price fell. After losing money on technology stocks like Yahoo in 2001, Mr. Brownold believes he has become more conservative with his investments.
"I prefer to invest in something and let it roll until it develops some kind of problem," he said.
Ira Scott, a psychiatrist based in Manhattan, is staying with the stock market. He trades stocks every day, but recently has taken a more conservative approach and is making fewer trades but he said he remained confident in his investments, even if the volatility was nerve-racking.
"I've been a little more on the safe side lately," he said. "I'm trading smaller but more confidently."
Paulo Prada and Saritha Rai contributed reporting for this article.