Catharsis brings relief. But it doesn’t necessarily bring good tidings. Despite the tidy finish, the stock market is still top-heavy and overvalued. Even after the blow-off the Dow is up 21 percent, the Standard & Poor’s 500 up 20.5 percent and the technology-stuffed Nasdaq up 27.7 percent. The most telling indicator: stock prices are so high that the dividend yield of the 500 stocks in the S&P index has fallen to 2.5 percent. The market has a history of peaking once dividends fall below 2.8 percent. “Profit margins are the highest they’ve been in 25 years,” says Jeff Everett, a senior vice president of Templeton Worldwide. “Something tells me returns in this market are not going to be as good as they have been recently.”
Investors have two choices: stick with the high fliers and hope it will be different this time. Or search for out-of-favor investments that are still reasonably priced. It’s tempting to think that hot stocks will never cool off. But history shows that they do. Instead of running with the crowd, the smartest investors sniff out opportunities that the fast money won’t even look at.
There’s no question that you can make a bundle on stock-market darlings like the technology stocks. But Wall Street has proven time and again that it knows how to lose it with the same stocks. In the early 1980s oil stocks were the sure thing. Demand for the black stuff was growing like crazy, but the world wasn’t making any more of it. Oil prices were going to hit $60 a barrel. They never did. In 1989 it was Japan’s market that would grow to the sky. The Nikkei has yet to surpass its peak. In 1991 biotechnology stocks mesmerized investors. A three-year bear market followed.
Where were the bargains in those markets? When all eyes were on Japan, investors could have doubled their money in two years with companies like Colgate-Palmolive and Gillette, who were quietly turning their products into global brands. In 1991 when biotech stocks were the rage, you could have bought discount broker Charles Schwab for $5 per share and sold it two years later for $38.
Betting against the crowd isn’t nearly as risky as betting with it today. For stocks to muscle their way higher, economic conditions have to be picture perfect. Inflation, already remarkably low, must fall further. The dollar must stay weak. Extraordinarily high corporate profits must grow larger. And, oh yes, Windows 95, Microsoft’s breathlessly awaited software program, must beat expectations. “We’ve been in one of those nice euphoric stretches where expectations just get higher and higher,” says John Rekenthaler, editor of 5 Star Investor, a Chicago mutual-fund newsletter.
The only sensible strategy is to reevaluate your portfolio’s exposure to this frothy market. Check your mutual fund’s quarterly reports to see how much exposure you have to the market’s raciest sector-technology stocks. Look also at your gains. You don’t have to dump your current holdings. But you might want to siphon off profits from the best performers and redeploy them, as well as fresh cash, in undervalued havens. Bottom-fishing for bargains requires a contrarian bent. You have to be gutsy enough to move against the prevailing wisdom. But you can pick your level of risk. Here are three ways to do it:
Aggressive: Remember 1993? That’s when another never-fail group was taking off like a rocket ship: emerging-markets stocks. Equities in Latin America, Eastern Europe and other fast-growing economies tanked when U.S. interest rates began rising early last year-and got clobbered again by the Tequila Effect, the aftermath of Mexico’s surprise peso devaluation last December. Some investors are happily wading back into Mexican stocks, but it’s far too early. A better choice: Indonesia, the Philippines, Hong Kong and other Southeast Asian countries. Mutual-fund managers say it’s not hard to find companies growing at 15 percent to 30 percent a year. “Earnings have been accelerating, but stock prices aren’t even back to their 1993 peak,” says Joyce Cornell, a portfolio manager for Scudder. There’s little risk of losing money from an unexpected rise in the dollar because most of these countries have pegged their currencies to ours. One of the premier funds focusing on these countries is Colonial Newport Tiger A, which has a 5.75 percent sales charge. Fund manager Jack Mussey rarely strays from blue-chip companies growing at double-digit rates. Morgan Stanley Asian Growth is run by Eau Wah Chin and James Cheng, who have established a stellar four-year record managing an institutional version of the same fund. You have a choice of buying the fund’s A share, for a 4.75 percent fee, or its C shares, which require you to pay a 1 percent redemption fee if you sell within a year.
Moderate: Municipal bonds would nor-really be a pretty sleepy recommendation. But they’re a dicier proposition these days because of the flat-tax proposals afloat in Washington. The fear: a flat tax will strip munis of their tax-advantaged status. It’s overdone. Even if a flat tax does pass, which is highly unlikely, it won’t begin to take effect until 1997. And there’s a good chance it won’t look remotely like the blueprints now on the table. So many investors have deserted munis that yields have soared to more than 90 percent of what a Treasury security pays out. Pam Hunter, a vice president at Chase Asset Management, hasn’t seen values this attractive in a decade. Top bracket investors should buy prerefunded munis, whose payments are guaranteed by Treasuries in an escrow account. Stick with maturities of 5 to 10 years. If you invest in a fund, you’ll be able to collect a tax-free yield for a few years and get out easily when you want. Because it buys munis with maturities between three and five years, Vanguard Municipal Limited-Term pays a yield that’s higher than a municipal-money-market fund but is still protected from large interest-rate moves. It’s currently yielding 4.4 percent. Another conservative choice: USAA Tax-Exempt Intermediate-Term, which holds securities maturing within 10 years and yields 5.3 percent.
Conservative: Real-estate investment trusts’ (REITs) most attractive feature is something that almost no one pays attention to these days: dividends. In addition, the stocks of these companies, which buy and manage apartments, office buildings and other property, have risen only 9.7 percent, against the overall market’s 21 percent.“You get a healthy yield and the potential for appreciation, too,” says Templeton’s Everett. Cohen & Steers Realty, a mutual fund that invests in REITs, is run by industry veterans Marty Cohen and Bob Steers, who are known for their adroit timing. It’s currently paying out 4.5 percent. Fidelity Real Estate Investment, one of the oldest and most conservative REIT funds, is yielding 5.4 percent.
Are these investments to brag about? Not yet. But that’s the beauty of bottom fishing: someday you’ll be able to say you picked them up for a song.
A frothy market calls for a shrewd investor’s eye. Here are three pockets of good value:
Emerging Markets: Mexico’s still too dicey, but Southeast Asia is a good value. Economies are growing and corporate profits are rising, but prices are still reasonable. A key feature: there’s little currency risk.
Municipal Bonds: Flat-tax fears are overblown. It won’t arrive until 1997, flit ever does. But the scare is making munis unusually cheap. Buy now and you’ll land a pretax yield that’s close to a Treasury note’s.
REITs: Hardly anyone’s touched these real-estate investment trusts since they fell out of favor last year. That’s good because their low stock prices mean healthy dividends and the chance for appreciation. Stable interest rates also boost profits.
