Weak economy weighing down market

It's no surprise that advisers are worried about a multitude of economic problems

It’s no surprise that advisers are worried about a multitude of economic problems. Forget the fact that stock and bond markets around the world are holding up relatively well; many observers believe that a weak picture for jobs and housing will weigh on the stock market until clear improvement is seen.

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“Until we get evidence that housing and jobs are recovering, the market is really going to be under pressure,” said Vahan Janjigian, chief investment officer at Greenwich Wealth Management LLC, which has about $650 million under management.

“I think we’re likely [to see] a slowdown in spending in the fourth quarter [and] a new recession in the first quarter [of 2011],” triggered by tax hikes, said Robert Arnott, chairman of Research Affiliates LLC and manager of the Pimco All Assets Fund (PALPX).

GLOBAL SLOWDOWN

The International Monetary Fund said this month that global economic growth will slow more than expected next year due to fiscal-austerity moves by developed nations and worries over sovereign debt.

“The economy could be in slow-growth mode for the next two to three years,” said Bruce Bittles, chief investment strategist at Robert W. Baird & Co. Inc. — slow growth being defined as increases in gross domestic product of no more than 2%.

More advisers are worried about the risk of deflation that could come from tepid growth.

InvestmentNews’ 2010 Industry Attitudes survey found that 59.5% of responding advisers are either “somewhat concerned” or “very concerned” about deflation, up from 45.5% in 2009.

“There’s no inkling of inflation anywhere,” said Jim Biddle, founder of The Securities Center Inc. “The jobless [problem] is just sucking the life out of everything.”

In an odd development, the bond market is priced for deflation, but the stock market is not, Mr. Arnott said.

“In fact, growth stocks are priced for renewed organic growth,” he said. “If that doesn’t happen, growth stocks could get hammered.”

A flood of liquidity is temporarily propping up stock prices, Mr. Bittles said.

Central banks have made it clear in the past several weeks that they’ll engage in more quantitative easing, which creates money, he said.

“That’s a backstop for the stock market,” Mr. Bittles said. “It’s why stocks are doing as well as they are,” especially commodities-related stocks.

NOT ALL BAD NEWS

That said, the market does have some things going for it, Mr. Bittles said.

November through May tends to be the best period for stocks, and the third year of a presidential cycle also tends to be the best, he noted.

“On top of that, no one is optimistic, certainly at the extreme,” he said. “But we have seen extreme pessimism.”

“The rally since August has been broad-based, and nearly all sectors have participated,” Mr. Bittles said. “That’s healthy.”

Mr. Bittles likes multinational consumer staples stocks that will benefit from a weaker dollar, and emerging markets with growing economies and solid balance sheets.

Mr. Janjigian also likes non-cyclical stocks with growing dividends, such as Johnson & Johnson (JNJ).

Investing in foreign markets with economic freedom, low debt and low deficits “will make a significant difference in returns,” said David Marotta, president of Marotta Wealth Management Inc., which has $170 million under management.

The five biggest markets that meet his criteria are Hong Kong, Singapore, Australia, Switzerland and Canada. Mr. Marotta also gives clients a “healthy dollop of emerging markets” because of superior growth in such regions.

In addition, advisers continue to keep larger-than-normal allocations to fixed income.

“Most of our portfolios are much higher in fixed income than a decade ago, by far,” said Benjamin Valore-Caplan, managing partner at Syntrinsic Investment Counsel LLC, which has $525 million under management.

His model portfolio used for endowments has 25% in bonds, but most clients have more, he said.

“I’ve been buying short-term [corporate] bonds of less than five years’ [maturity] and can get 5% to 7%,” Mr. Biddle said. “If you don’t go too far below investment-grade and [don’t] get too hungry for yield, you can get some pretty decent bonds.”

Mr. Arnott likes some high-yield and floating-rate bonds, and emerging-markets bonds in local currencies, which offer some inflation protection.

“With inflation, the real value of debt tumbles, the debt coverage ratio falls, spreads narrow, and prices improve, along with getting the high yield,” Mr. Arnott said.

Mr. Marotta has shortened bond durations overall in client portfolios, waiting for interest rates to rise.

He also favors foreign bonds and uses the American Century International Bond Fund (BEGBX), the Pimco Foreign Bond Fund (PFBDX) and the Pimco Emerging Markets Bond Fund (PEMDX), none of which hedge currency exposure.

E-mail Dan Jamieson at [email protected].