Practical analysis for investment professionals
20 February 2012

Equities Roundup: Major Indices Rally, But Asset Managers Take a Defensive Posture

Posted In: Equity Investments

Risk on! This has been the investor battle cry since stocks bottomed out in the fall of 2011, and global equities have been on a tear ever since, with many major indices rallying 20% or more. Investors seem to be discounting signs of a resurgent U.S. economy, indications that the crisis in Europe may be contained, and a soft landing in China. Or maybe they are just fed up with the paltry yields offered by bonds. Alliance Bernstein captures the dilemma facing investors in “The Risk in De-Risking Now.”

Here are some other important stories of the past month:

  • Despite the recent surge in stocks, asset managers, on balance, have taken a more defensive posture, according to the article “Reuters surveys of leading investors in the U.S., Europe and Japan.” While U.S. and Japanese managers cut exposure to stocks in favor of bonds, their cautiousness was not shared by European managers, who added to their equity holdings. Separately, Warren Buffett shared his views on the relative attractiveness of bonds, stocks, and gold in this adaptation from his upcoming letter to shareholders. Noting that current low rates do not compensate investors for inflation risk, Buffett says, “Right now bonds should come with a warning label.” Implying that the case for gold rests on the greater fool theory, Buffett favors investment in “productive assets,” including real estate, farms, and stocks.
  • As investors reached for yield in 2011, high-dividend-paying stocks were among the best-performing groups. And, as a recent Barron’s article pointed out, strong cash positions, record profits, and relatively low payout ratios leave many firms in a position to raise (and in some cases initiate) their dividends. Berkshire Hathaway, Google, and Apple are just a few firms with huge cash stockpiles but no dividend. And while Berkshire and Google have rebuffed calls for a dividend, Apple, under new CEO Tim Cook, has been less definitive, fueling speculation that a dividend may be in Apple’s future. The call for an Apple dividend is not unanimous, however, and this Forbes article makes a case for reinvesting the company’s $100 billion in cash.
  • On the subject of record profits, a few years back Jeremy Grantham said that “profit margins are probably the most mean-reverting series in finance.” This Wall Street Journal article points out that over the past three years revenues for the S&P 500 Index companies have increased by 20% while per share profits have risen fivefold. And while profit margins may stay at a high level, they did begin to roll over in the fourth quarter of 2011, raising concerns in the blogosphere.
  • On the U.S. political scene, Mitt Romney’s campaign for the Republican presidential nomination brought the spotlight on, and considerable criticism of, the private equity business. The Financial Times neatly summarizes the argument against private equity’s favorable tax treatment. And political opponents of Romney have also pointed to private equity investors as “job killers.” Separately, as the New York Times reports, the Securities and Exchange Commission has begun an “informal inquiry” into the business practices of the private equity industry. On his blog, Aswath Damodaran offers a strong defense of the private equity business, arguing that by targeting underperforming businesses and making them more competitive, private equity investors can create value for investors and customers; and if successful, jobs will follow.
  • Finally, the much anticipated news that Facebook would sell shares to the public was met with media frenzy and a range of opinions. Blogger Jeff Matthews sees Facebook as the next Google, and there no doubt will be huge demand for its shares — the initial public float is expected to be less than 10% of the outstanding shares. But, as this Financial Times article points out, it may be a bumpy ride, as short sellers have been targeting social networking stocks with small public floats. Finally, this Los Angeles Times article warning of the pitfalls of diving into the “vast pool of dumb money” that is public ownership, and this Financial Times piece questioning Facebook’s decision to go public, are both worthwhile reads.

For more news and trends, visit the Equity Investments Community of Practice.

About the Author(s)
David Larrabee, CFA

David Larrabee, CFA, was director of member and corporate products at CFA Institute and served as the subject matter expert in portfolio management and equity investments. Previously, he spent two decades in the asset management industry as a portfolio manager and analyst. He holds a BA in economics from Colgate University and an MBA in finance from Fordham University. Topical Expertise: Equity Investments · Portfolio Management

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