Strategic Responses: Facing Hard Task, Fund Managers Ready Trading Plans
Throughout history, markets have had to reflect the effects of war, famine and disaster.
There's one thing fund managers agree on: They are ready to exploit overreaction. They'll pounce on any stock that looks like it's fallen too much or risen too high.
There is no consensus regarding the actual direction the market will move on Monday and over the next few weeks. The optimists see the attacks as the sort of massive cathartic event that creates a bottom in a market that has long been sliding. And an enormous injection of funds by the Federal Reserve and other central banks will help stocks climb higher, they say. However, others believe the bear market will deepen, due to global instability, a more sluggish economy and depressed company earnings.
The Task at Hand
All of the investors this columnist spoke to find trading on appalling events like these to be a distasteful task. But the world is a markedly different place after Tuesday's assaults. No market can ignore that. Naturally, some people will profit and some lose money as a result of the atrocities. How can it be any different in a market? The only alternative is to shut down trading altogether, something the attackers would no doubt relish.
"As difficult as it is, we have a responsibility to preserve our funds' capital," says the head of financial sector research at a large mutual fund firm in San Francisco.
Many money management firms spent the latter part of last week gazing nervously at the sliding markets in Europe and Asia to gain advance notice on what may happen in the U.S.
They've been calibrating central bank actions and speaking to brokers to get a feel for whether retail investors are withdrawing large sums from mutual funds. Some managers are projecting long-term geopolitical scenarios that attempt to weigh the possibility of massive strikes against Muslim states. Then there's the chance that certain hedge funds could get into trouble, forcing a selling wave.
"Over the past few days we've spent a lot of time strategizing," says Tom Brown, head of the Second Curve Capital financial services fund in New York. Brown says his fund is ready to reduce its holdings in some stocks if it feels it's necessary. But he adds, "Of course, what happens Monday could be a lot different from what we've been expecting."
The San Francisco mutual fund analyst comments, "We have no positions that we want to liquidate at any price."
The invigorating thing about a market is that there are usually two starkly opposed views.
Take the airline sector. Most investors have written this off, fearing huge losses from reduced traffic, higher security costs and potential lawsuits. But one West Coast hedge fund manager comments, "There's no way the government's going to let the airlines go bankrupt. It's an integral part of our infrastructure." He's not thinking of buying airline stocks at this point, but, clearly if they fall too far, investors will be tempted to buy them if government money is available to keep them afloat.
The same thinking applies to the brokerages, many of which have large operations in the area devastated by the destruction of the World Trade Center. "The brokerages aren't going to zero. If Monday's bids look good, we'll take them," says the San Francisco mutual fund analyst.
That said, the nasty drops in the stock prices of European banks with large brokerage operations don't bode well for America's financial sector. For example, CS Group, the parent of global investment bank CS First Boston, lost 28% last week, while the U.K.'s HSBC (HBC) and Germany's Deutsche Bank have shed 13% and 12%, respectively, since the attacks. Elsewhere in finance, one investor notes that General Motors' (GM) lending and insurance company GMAC lent more than $500 million in August to Silverstein Properties to buy the lease to the World Trade Center. GMAC said Friday that insurance in connection with its financing "does not exclude coverage for acts of terrorism."
Leisure and tourism stocks could also drop. "We're long Royal Caribbean (RCL) and I am sure that's headed down," says the West Coast hedge fund manager, referring to the cruise company. "We'll sell that into any rally." This person thinks companies will now organize fewer conventions. This means hotel firms, casino companies and gaming-machine makers like International Game Technology (IGT) and WMS Industries (WMS) look vulnerable.
A big, longer-term debate is taking place over the direction of oil prices, and, as a result, the fate of oil, gas and power stocks. Here, much depends on the sort of retaliatory actions that the U.S. government makes. Oil and gas prices could decline after any rally if President Bush looks able to surgically target its response and execute it without causing major instability in the Middle East or sparking terrorist counterattacks. However, if he's perceived to have used too much force, particularly against a Middle Eastern state, any support he now has among OPEC countries could soon dissipate, and oil prices could move higher.
However, if Bush fails to get at the perpetrators effectively, support among Americans could drop, sparking domestic political instability, which would affect all sectors by putting upward pressure on interest rates.
Of course, any further attacks against the U.S., Israel or any of America's allies in Europe would likely deal a severe blow to economic confidence and stock prices, as it would show terrorists evading the massive efforts that governments have been making to capture and neutralize them since Tuesday.
Market Question MarksThen, there's the possibility that the market itself will be a source of problems. Efficient settlement will be tough for a while, according to a senior risk manager at a New York-based brokerage interviewed Friday evening. As a result, liquidity may be curtailed, which may exacerbate price swings. And big question marks hover over the trillion-dollar over-the-counter derivatives markets. Hedge funds that have attempted to hedge risk with complex models may have failed to cover themselves against something as large and terrible as Tuesday's attacks. "How many of the rash of hedge funds sprung up this year to undertake sophisticated, model-based strategies in arbitraging between stock, bond hybrid instrument returns and volatilities had run a scenario incorporating terror, war and market shutdown?" asks Sean Corrigan at Capital Insight, a financial consultancy based in the U.K. These are the questions people are asking. Monday's market is when they get answered.
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