- The Washington Times - Tuesday, May 25, 2004

If you are feeling a bit wary about the stock market, you are in good company. A recent survey of mutual fund managers shows many professional investors are losing their appetite for risk, too.

Some fund managers are so alarmed about rising inflation, oil prices and the prospect of slower global growth that they have reduced their exposure to equities and substantially raised their cash holdings, according to a survey conducted by Merrill Lynch earlier this month.

Of the 280 fund managers who participated in the monthly survey, 86 percent think inflation will rise over the next year, and two-thirds believe interest rates will go up by August. Fewer than 10 percent expect the world economy to strengthen in 2004; only 26 percent expect improvements in corporate profits, down from 47 percent last month.

Reflecting the interest-rate concerns, the number of managers saying they were overweight in technology and banking stocks fell dramatically during the month. More than a quarter said they were overweight in cash, with average cash holdings at 4.5 percent, up from 3.8 percent in April.

“Isn’t it interesting what a little interest rate fear will do?” said Janna Sampson, co-manager of the AmSouth Select Equity Fund and director of Portfolio Management at Oakbrook Investments. “It’s been ugly this month. There’s no doubt people are scared.”

That interest rates are on the way up is no surprise in a growing economy, Miss Sampson said. But the soaring price of oil has been a worrisome factor.

Higher energy costs are essentially a tax on equities, she said, which creates “kind of a double whammy” when coupled with rising rates. Analysts are growing more concerned that this will eat into corporate profits, making it more difficult for companies to meet earnings expectations in the months ahead.

The bearish sentiments are supported by fund flows, which show asset levels are down at aggressive growth funds, said Carl Wittnebert, director of research at TrimTabs Investment Research Inc.

Still, he noted, flows remain steady into equity income funds, which hold more stable, dividend-paying stocks.

“People are becoming more risk averse, but the continued flow into more conservative funds shows they’re not completely risk averse,” Mr. Wittnebert said. “If you’re in the stock market at all, you’re an optimist.”

Aggressive growth funds, which saw average net inflows of $5.3 billion for the first two months of the year, flattened out somewhat in March, with net outflows of $700 million. That reversal accelerated from the beginning of April through May 14, when net outflows came to an estimated $3.6 billion, Mr. Wittnebert said.

“That [$3.6 billion] is a substantial number by historical standards,” Mr. Wittnebert said. “That indicates substantial fear.”

In comparison, near the lowest point of the bear market in December 2002, net outflows for aggressive growth funds came to about $4 billion.

Small investors should take heed, said Gary Kaltbaum, president of Kaltbaum & Associates, a money management firm in Orlando, Fla. He has recommended that his clients follow the lead of larger investors by focusing on more stable issues, building cash reserves and, most importantly, not “buying on margin” — using borrowed money to purchase securities.

“You should have raised the bar on the type of things you’re buying,” Mr. Kaltbaum said. “You should own more defensive issues, like the Procter & Gambles of the world, that will not be exposed as much as the high-flying names that could get bludgeoned in a market like this.”

Consumer-product makers, such as the Procter & Gamble Co. and General Mills Inc., are considered safer investments because of their predictable long-term performance. The logic is that even in a downturn, people will eat cereal and buy paper towels and diapers. The same has been said of drug stocks, though they have suffered lately because of internal pressure within the pharmaceuticals industry.

If safety is a concern, you might consider a fund with a higher percentage of consumer staples. You can also gauge the amount of risk a manager has taken on by checking a portfolio’s “beta” — a figure that measures the degree to which the fund fluctuates against the total market.

The Standard & Poor’s 500 stock index, considered the best gauge of the broad market, has a beta of 1. A fund with a beta of 0.8, for example, will be less risky; a beta of 1.2 indicates the manager has taken on more risk.

More-bullish market players agree that investing in higher quality stocks is a smart move in the current climate. Trimming back holdings in rate-sensitive technology and banking stocks also makes sense, said David Chalupnik, head of equities at U.S. Bancorp Asset Management in Minneapolis.

Still, Mr. Chalupnik said, it’s important to maintain perspective. Although inflation and interest rates are set to rise and growth seems to be reaching a peak, the economy is strong, and will likely remain solid in 2005. Things are “just not that bad,” he said.

ASSOCIATED PRESS

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