Wsw/25″/mike1st/mark2nd
BENJAMIN MARK COLE
1998 was yet another year of the bull, at least for those with enough blue-chip stocks in their portfolios to overcome the lagging effects of small-cap stocks. As of the middle of last week, the S & P; 500 was up 26 percent for the year, while the S & P; 100, the bluest of blue chips, surged ahead by a hefty 32 percent.
On the other side of the coin, the Russell 2000, an index of the 2,000 stocks with market capitalizations smaller than those of the 1,000 largest stocks, declined by 7.2 percent in 1998.
So what will 1999 bring?
Many are not looking for another strong bull market.
“I think we will continue in a deflationary mode around the globe, and that will begin to impact earnings here (in the United States), and then in the stock market although right now I am fully invested,” said William Mason, money manager for Woodland Hills-based Cullen Fortier Asset Management Inc., and a professor at Pepperdine University. “It doesn’t pay to get too far ahead of the market.”
Increasingly, U.S. investors are huddling toward the few favored blue-chip stocks, a situation that reminds the veteran Mason of the 1972-1973 market, and the then-fashionable “Nifty Fifty.”
“Back in 1972, we had a divided market. The Nifty-Fifty the big predictable growth stocks were hot, but it really represented a transition to a bear market,” said Mason.
The loss of confidence in the broader market ultimately drove down the Nifty Fifty when a few events broke the wrong way. Today, a nagging problem is the ongoing recession gripping Japan. With Japan stifled, Asia will come back slowly and U.S exports to the region will be weak.
“I don’t see Japan turning the corner,” said Mason. Also, Mason is all but scornful of small-cap stocks. “They may come back, and the buffalo may come back too,” he sniped, pointing out that mutual funds simply buy larger stocks.
Even Scott Leonard, president of Santa Monica-based Leonard Capital Management, and an advocate for putting small caps into an investor portfolio, is chary of small caps.
“The fact is, the large-cap market is doing well, and that has decreased the demand for small caps. If large caps keep going up, I don’t think small caps will do well in 1999,” Leonard said.
A decline in blue-chip values, on the other hand, could be seen by investors as a bad harbinger for all stocks, including small caps, conceded Leonard.
But there are voices of optimism on the small-cap front. Bryant Riley of West Los Angeles-based B. Riley & Co. says that some small caps have become so cheap that sooner or later the market has to take an interest. “There are some good-quality small caps, some of which are trading for below book value,” he said.
One stock Riley likes is Santa Fe Springs-based Vans Inc., the shoe maker, which is now building skateboard parks. Riley projects that Vans, which has a book value of $7 a share, will post earnings of 64 cents a share for the year ending May 1999. “At less than 10 times earnings, that’s a pretty cheap stock,” he said. Stocks which make up the S & P; 500 trade at an average of 25 times earnings, by comparison.
Over in the world of non-investment-grade corporate IOUs, junk-bond mavens are hoping for a more complete recovery from the summer flight to quality, which smashed the values of high-yield bonds.
“In terms of the high-yield market, we haven’t fully recovered from the August-September debacle, certainly not to the extent that the equities markets have recovered,” said Larry Post, president of West Los Angeles-based Post Advisory Group, a junk-bond money management shop.
To Post and other junk-bond traders, the climate is risky but may spell opportunity. “The spreads between U.S. Treasuries and junk bonds are wide and the yields are good. There are many junk bonds issued by companies that the equities market says are good companies, but which offer good yields,” Post said.
But Post is wary about more churning in the equities markets, and what that would mean for junk bonds.
“I have one caveat about 1999. The (junk-bond) market seems to be taking its cue from the equities market to a much greater degree than historically, and to a much greater degree than is warranted,” he said. “And what is going on in the equities markets scares me, with the Internet-stock buying frenzy. Can it go back to reality without affecting everything else?”
The high values of companies, private and public, may cool the mergers market and thus the stock market in 1999, said Bill Doyle of Kerlin Capital in downtown Los Angeles and Larry Hurwitz of West Los Angeles-based Lawrence Financial, both boutique investment bankers.
“The mergers action can’t be sustained at these price levels because the financial buyers (such as leveraged buyout groups) can’t buy anything anymore. If earnings deteriorate, the strategic mergers are going to have to come down in price too,” said Hurwitz.
Added Doyle: “The M & A; frenzy will slow down, as some people digest the acquisitions they have already made, and as buyers get more selective. That will carry over into valuations.”
Short takes
The aggregate net profit of all publicly held Japanese companies for the year through March is expected to fall 11.2 percent from a year earlier, the second straight year of decrease, according to the Nihon Keizai Shimbun, a government agency. The fall in group net profit is attributed to weak Asian economies. It appears as if the Federal Reserve, governor of the nation’s money supply, is easing things a bit, even if it isn’t cutting rates. The money supply, through November, is on pace to expand by 8.8 percent, as measured by M2. The supply grew by 5.7 percent in 1997 and 4.6 percent in 1996, by the same measure. The Fed attributed some of the increase to worried investors moving money into safe and liquid accounts bank deposits.
Contributing Reporter Benjamin Mark Cole writes about the local investment community for the Los Angeles Business Journal. He can be reached at [email protected].
