Market volatility? No big deal
The recent 400-point plunge is no reason to panic. But it's a good excuse to tweak your portfolio, says Fortune's Nelson D. Schwartz.
(Fortune Magazine) -- For ordinary investors, the market's recent heart-stopping plunge and only modestly reassuring rebound seemed to come out of nowhere.
Sure, there were explanations - a selloff in Shanghai, rising defaults in risky mortgage debt, a recession warning from former Fed chairman Alan Greenspan - but as Citigroup strategist Tobias Levkovich says, the speed of the decline "made people feel unglued."
Maybe so, but for the institutional types whose portfolios are measured in the billions, the drop simply wasn't that scary. "I wouldn't say the world has changed much," says Ben Inker, director of asset allocation for Boston-based money-management firm GMO. Adds Westwood Holdings chief investment officer Susan Byrne: "Everybody's been through crises much worse, and we've been waiting for this for two years."
Individual investors would do well to strive for such sang-froid.
Maybe a few numbers will help put things in perspective.
While the 416-point decline on Feb. 27 - the seventh-biggest ever - wiped out about $600 billion in market value, in percentage terms the decline was only 3.3 percent, not big enough to make the top 20. Even after the carnage, the Dow was less than 5 percent below its all-time closing high of 12,787 (set on Feb. 20). And by March 9, the Dow was back at 12,276.
Of course, seasoned managers like Byrne and Inker can afford to be blasť. Because what pros like them have been doing over the past month is to weatherproof their portfolios - laying off the riskiest bets, taking profits in the markets that have run up the most and stepping back from the groups that will be the most exposed if Greenspan's worries about a recession prove prescient.
Now, says Inker, individual investors should think about doing the same. That doesn't mean a wholesale revamping of your portfolio. Instead, it's about selecting stocks and sectors that are likely to hold up best if the market does decline further - or that will keep pace if it rebounds. Just as important is identifying areas priced for perfection - expensive names that will fall the hardest if a deeper correction comes.
Inker likes big blue chips with steady growth prospects and not much debt - names like Wal-Mart (Charts), AT&T (Charts), Coca-Cola (Charts), and Microsoft (Charts). "You may not get rich off them, but you have a decent chance of staying rich with them," he says. "And that's not true of other sectors. These companies don't really need to borrow, so they're less sensitive if credit spreads widen."
Jim Margard, co-manager of $12 billion Seattle-based Rainier Investment Management, is also sweet on Coke. "It hasn't done much in recent years, but it's predictable, it's diversified, and as a megacap, it's less volatile." What's more, Coke has a 3 percent dividend yield, the same payout as more risky REITs (more on their dangers later).
Margard favors other blue chips like GE (Charts) as well as cheaper, non-U.S. oil giants like Shell and France's Total. All three, which are megacaps like Coke, also boast dividends of well over 3 percent. Byrne, another GE fan, adds that once GE completes the sale of its huge plastics division now on the block (it's expected to fetch at least $10 billion), "they will do something shareholder-friendly with that money" - like a dividend hike, a share buyback, or both.
Another argument for megacaps is that they are much cheaper than their smaller brethren. The top 100 U.S. stocks by market capitalization are trading at a reasonable 14 times operating earnings, Inker notes. Companies that rank in size from 501 to 1,000 trade at a steeper 21 times operating earnings, while the ones ranked from 1,001 to 3,000 go for a whopping multiple of 28.
"That's quite high by historical standards," says Inker. "Normally you get bribed to own small caps in the form of lower P/Es, but these stocks have been on a tear." So if earnings growth does slow, there's not much room for the inevitable earnings disappointments among small caps.
What else should prudent investors avoid? Margard is steering clear of REITs, or real estate investment trusts, which have boomed with the commercial-property market and also fetched huge buyouts from private-equity players like Blackstone.
"Valuations are at a lofty level," he says. "I just think if we see vacancies go up or any other problems, these stocks will correct sharply." Although Inker likes the megacaps, he is cautious about big financials like Citigroup (Charts), J.P. Morgan (Charts) and Bank of America (Charts). "It's not that they're expensive or there is something definitely wrong, like subprime debt," he says. "It's just so hard to figure out what's going on below the surface, so by the time you know about a problem, it's too late. It's much easier to understand Coke than Citigroup."
Other groups to be cautious about include mining and commodity stocks, which have ridden the Asia boom but are vulnerable if the Chinese economy cools. "We're not keen on them," says London-based Ian Scott, global equity strategist for Lehman Brothers. "We're not heading into a recession, but growth looks like it's slowing, and they've benefited enormously from the growth of the past few years."
Speaking of Asia, cautious investors who have profited from the rise in Chinese and Indian stocks might also think about taking some money off the table. "You've got to watch what will happen in world markets," says Westwood's Byrne. If credit or global liquidity tightens, markets like Brazil, South Africa, India and other emerging investing locales will be the first to feel it. On a recent visit to India, Byrne noted that with CNBC broadcasting in both English and Hindi, an incredibly hot real estate market, and tons of new investors, "everyone was in the game." In volatile emerging markets, that's often as loud a sell signal as you can find.
Corey Hajim contributed to this article.