Forget about bulls and bears, friends, it's those sheep you have to keep your eyes on, because they could power the stock market to another explosive rally over the next few weeks. Those sheep I'm talking about - some of whom have moved into the market with vigor in recent days - are those many cash-rich institutional investors who thus far have refused to participate actively in the spirited buying spree in equities that got under way in mid-April. Their fear is that the seven-week, 115-point run-up in the Dow Jones Industrials was little more than a not entirely unexpected rebound (after a fifteen-month, 260-point drop in the DJI) in a continuing bear market. Over the longer run, of course, these sheep may prove right. But for now, at least, some savvy investment pros think the sheep will be hard pressed to remain on the fence should the market continue to display robust behavior on brisk trading volume.
Robert Stovall, the vocal investment policy chief of Dean Witter Reynolds, perhaps diagnoses the case best. He raises the question of how many U.S. money managers will have the courage to remain as cash-heavy as they are right now and then try to explain to their pension fund clients, at the end of the second quarter, that they missed the best rally in years because they didn't believe it. The answer, says Stovall, is that "not too many will have the guts to stay out . . . and so the best may be yet to be."
I hear similar talk from Egyptian-born Fayez Sarofim, the well-respected head of a Houston-based investment counseling firm bearing his name, and his manager of some $32 billion of pension and endowment assets. "We should see continued strength in June because many institutions will be under heavy pressure to run down their cash reserves," he says. Sarofim doubts the market will experience any major setback following its recent runup because, as he sees it, "everybody would like to see a correction so they can buy . . . which means any correction is likely to be a small one."
Sarofim tosses out someintriguing statistics to back his bullish case. His figure - if his market premise is right - indicate the June strength he talks about is potentially enormous. He points out that the $250-billion-plus pension fund industry, the single biggest buyer of common stocks, had 60 to 65 percent of its assets in equities at the end of 1976 and a substantially lesser amount, 50 to 53 percent, in stocks at the end of 1977. A declining market in early 1978, coupled with new cash flows, dropped the equity ratio to below 50 percent at the end of this year's first quarter (the remainer being in fixed-income securities and cash). However, by the end of this month, Sarofim expects equities to be back at the 60 percent level.
If he's right - and that's a big IF - pension funds would have to put $25 billion into equities, assuming the market average remain at current levels. Sarofim, though, thinks the 60 percent equity commitment will be achieved through a combination of rising stock pries and stepped up institutional purchases. In any event, it would still mean considerable equity buying.
Sarofim emphasizes that he's not oblivious to inflation, rising interest rates, and the prospects of a slowing economy. Nonetheless, he thinks the market has enough going for it to move onto higher ground. For one thing, he expects 1978 to produce a sharply higher level of merger activity - equivalent to about $25 billion in equity purchases. Last year, domestic and foreign buyers bought $10 billion of common stocks in their acquisition efforts. Another major plus: Sarofim thinks the abundance of cheap stocks is likely to cause many companies to continue to buy in a substantial amount of their own shares: He puts this figure at slightly below 1977's corporate purchase of $8.5 billion of their own shares.
Sarofim has reputation as a big-name "value" buyer and that's precisely what he's buying now. Recent purchases include Aetna Life, Connecticut General, Ford, IBM, McDonnell! Douglas, Texas Eastern Transmission, Atlantic Richfield, Pennzoil Halliburton, Royal Dutch Petroleum, and Exxon.
Some people rate the public's buying and selling patterns as one of the best barometers for judging the market's direction. Their theory: Just do the opposite. Well, we should all be as dumb as the small investor. Merrill Lynch, which accounts for about 10 percent of the Big Board's retail round-lot volume (100 shares or more), tells me its retail cash customers did their heaviest amount of net buying of equities in three years in the first quarter of 1978. And when the rally got under way in mid-April, they turned net sellers. In other words, the little man was quicker on his feet than the pros.
What's Merrill's current view? "We're still in a bull market," says Merrill's market analysis chief, Robert Farrell. "The market has momentum and should carry higher between now and the summer, probably topping 900 (in the DJI) in the process." In the late summer or fall, though. Farrell looks for a market correction - but with the DJI holding between 775 and 800. "I think we've seen the lows," he says. Farrell, however, sees considerable vulnerability - a potential 20 per cent decline -- in those sizzling secondary or junior growthstocks.
Remember the "niffy fifty" - those high-flying quality growth stocks (such as Xerox, Avon, IBM, and Johnson & Johnson) that dominated leading bank portfolios in the early 1970's and then collapsed in price? Well, Farrell, for one, thinks these heavily capitalized quality securities could provide the market with new leadership over the next one to three years.
"I think the five-year bear market in growth stocks has ended." he says.
Apparently, Morgan Guaranty Trust may have similar thoughts despite its public pronouncements that its major interest is smaller and medium-sized companies. Morgan, I'm told, was an aggressive equity buyer during the recent rally, reportedly purchasing such stocks as Texas instruments, Eli Lilly. Merck, Hewlett-Packard, Disney, Avon, Digital Equipment, K mart, J. C. Penney, and Data General. I picked up unconfirmed reports that this buying may have been done for Arab investors. With assets of $242.2 billion under its management. Morgan obviously made its weight felt.
While Morgan is bullish, another banking giant. Bankers Trust, is bearish - at least for now. "We're negative for the balance of 1978," investment policy chairman Kent Atkins tells me. What bothers Bankers Trust is its expectation that interest rates (both short and long-term) will rise for the next few quarters: also, that the widely expected economic slowdown will continue well into 1979 - into the third quarter in fact. Accordingly, Atkins believes the market could test new lows - but hold at 700 to 750 - before year's end. And so, Bankers trust is neither a net buyer nor net seller.
Still, in the course of running its clients' portfolios, Bankers Trust - which has about 12 to 13 percent of its $26 billion of investment assets in cash or cash equivalents - has been a recent purchaser of some stocks. Medium-sized industrial and diversified companies are favored, such as Emhart, Studebaker-Worthington, Pitney-Bowes, Ex-Cell-O, Timkin, and NL Industries.
One well-publicized reason for the market's mid-April boom was aggressive foreign buying. Foreigners poured about $2.7 billion into U.S. equities last year, and sources estimate they may have put roughly $1 billion into the U.S. stock market in the second quarter alone.
Where the market goes from here is anybody's guess. One would think, though, that after the breaktaking rally some caution is called for. But while there are strong convictions in both the bullish and bearish camps, those fat institutional cash reserves are clearly a market plus. And since a sizable chunk of those reserves are held by sheep, our wooly friends may well turn out to be bulls in sheep's clothing.