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Investors' Trust in War Script Drives Rally

March 18, 2003|Tom Petruno | Times Staff Writer

A week ago, big-money investors were panicking to get out of stocks. Now they're panicking to get in.

Meanwhile, many individual investors appear to be hanging back, so far unwilling to commit fresh cash to the market after three years of heavy losses.

Which camp is following the smarter course remains to be seen. For the moment, because of the volume of dollars that big investors such as hedge funds, pension funds and private money managers control -- and the technical trading strategies they employ -- their renewed interest in shares has set a suddenly bullish tone on Wall Street.

The risk is that these institutional investors could just as quickly turn away from the market if an invasion of Iraq doesn't closely follow the 1991 Persian Gulf War script.

Even if investors don't abruptly flee, there is the question of how high they will be willing to push share prices in the near term, given other fundamental concerns besides a U.S.-Iraq conflict. For example, the economic outlook has dimmed in recent weeks, and it isn't clear that is solely because of the war threat, analysts say.

Trust in the 1991 script -- which calls for a fast U.S. victory -- has been the driving force behind the rally that has lifted the Dow industrials 8.2% since last Tuesday.

As in 1991, the latest market rally was preceded by a sell-off: The Dow dropped 15% between Jan. 14 and last Tuesday. In 1991, the prewar sell-off took the Dow down 6% in the two weeks leading up to the war.

The difference this time is that investors have rushed into the market ahead of the outbreak of hostilities.

"This is buying by front-runners trying to emulate the 1991 experience," said Ned Riley, chief investment strategist at money manager State Street Global Advisors in Boston.

Stocks soared Jan. 17, 1991, the day after Western allies launched the air war against Iraq. The Dow rose nearly 115 points, or 4.6%, that day. The market continued to advance in the weeks that followed as victory appeared certain. The Dow was up 15.7% between Jan. 15 and Feb. 28 of that year.

Buyers' eagerness this time in part reflects growing confidence in the outcome of a war, based on memories of the crushing U.S. victory over Iraq in 1991. But it also is a function of the technical strategies many big investors use in managing their portfolios.

For example, pension funds and other investors that balance their portfolios between stocks and bonds have been shifting money out of Treasury bonds and into stocks, said Christopher Wolfe, head of U.S. equities at J.P. Morgan Private Bank in New York.

Once Treasury bond yields reached generational lows March 10, the "asset allocation" trade of moving money from low-yielding bonds to potentially cheap stocks automatically took on a life of its own among institutional investors, analysts say. Those trades also helped turn the stock market around in July and again in October.

Another trading strategy that has helped drive the market in recent days has nothing to do with a belief that stocks may be undervalued: Short sellers -- traders who borrow stock and sell it, hoping to buy it back cheaper at a later date -- have been snapping up shares to close out their bearish bets.

One of those short sellers is Bill Fleckenstein of Fleckenstein Capital in Issaquah, Wash. He said he covered all of his short-sale positions late last week.

"I thought it was certain we would have a rally of some magnitude" ahead of a war, he said.

But he doesn't believe stocks' gains will be sustained. "This has nothing to do with the bear market being over," said Fleckenstein, who contends that stock prices still are "ridiculous" compared with underlying earnings.

Many stock portfolio managers disagree vehemently and see the latest rally as overdue.

"I think it's a great time to buy stocks," said Bill Nygren, manager of the value-oriented Oakmark Fund in Chicago. "I think you could put a portfolio together by throwing darts and you would do better than what the bond market" will provide in coming years, given current low yields, he said.

But for many mutual funds to buy stocks, they will need cash from small investors. The average U.S. stock fund had just 4.4% of assets in cash at the end of January. That was down from 5.4% a year ago and 11.4% at the start of January 1991. By that measure, stock funds overall are low on fuel.

Yet so far there has been no significant surge of interest in stock funds by individuals. "I don't see any evidence of the retail investor storming back in," Nygren said, echoing other fund managers.

Wolfe said the cautious mind-set applies even to some of his wealthiest clients who could afford to put more capital to work in stocks. "They want to wait to buy," he said, until it's clear how Iraq will be resolved and until the market rally builds a bigger head of steam.

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