Stock, Bond Slumps Signal Worse Than '94 as Inflation Says '74

By Michael Patterson

June 30 (Bloomberg) -- It's been 14 years since investors suffered as big a retreat in stocks and bonds and some of the largest money managers say the losses may have more in common with the 1974 bear market before the worst is over.

The Standard & Poor's 500 Index dropped 3.4 percent since March and investors in Treasuries lost 2.88 percent, the steepest combined plunge in 14 years, according to data compiled by Merrill Lynch & Co. and Bloomberg. Equity and debt markets fell in tandem for only the sixth time since the savings and loan crisis of the 1990s as oil closed at a record 19 times and concern grew that inflation will cut the value of bond payments.

Dreman Value Management LLC, BlackRock Inc. and Cambiar Investors LLC, which together oversee $1.38 trillion, are buying banks, phone companies and oil producers to weather more declines in benchmark indexes. David Dreman, whose DWS Dreman Small Cap Value Fund beat 90 percent of its peers over five years, bought Cleveland-based KeyCorp as financial firms fell to a 10-year low last week. BlackRock added AT&T Inc. for the best dividend yield since 2006. Cambiar says Marathon Oil Corp. is inexpensive.

``Between inflation and the liquidity crisis, this is one of the toughest markets I've seen,'' said Dreman, who oversees about $15 billion in Jersey City, New Jersey. ``But it's not a market you sell into. Any losses you take by being too early will be more than offset by buying cheaply.''

Coordinated Plunge

Dreman founded his firm in 1977, three years after the S&P 500 fell 30 percent for its worst annual loss in the last 60 years. Stocks plunged as the Arab oil embargo pushed up U.S. consumer prices as much as 12.3 percent, at the time the biggest annual advance since 1947.

Consumer prices climbed 4.2 percent in the 12 months to May. The Reuters/Jefferies CRB Index, a gauge of 19 commodities, added 49 percent in the past year, exceeding the record 48 percent annual gain in 1973.

Investors were whipsawed this month by the Dow Jones Industrial Average's worst June since 1930 and the biggest losses in Treasuries in four years. Bets that the Federal Reserve will increase interest rates helped spur a 1,292-point tumble in the Dow average this month on concern higher borrowing costs will prolong the worst profit slump in six years.

Just two of 10 industries in the S&P 500 rose this year. Energy producers gained 6.3 percent and a group of mining and chemical companies added 0.5 percent. Massey Energy Co., the fourth-biggest U.S. coal producer, advanced 155 percent for the index's biggest rally after the Richmond, Virginia-based company's first-quarter profit topped analysts' forecasts.

Bear Market

The drop in the Dow to its lowest level since September 2006 is part of a ``secular bear market'' that may last 10 to 15 years as home prices fall, consumers default and tighter credit slows economic growth, says Ryan Atkinson of Balestra Capital Ltd., which manages $550 million including last year's fourth-best performing U.S. hedge fund and is wagering equities will fall.

``The vast majority of investors are long-only investors and they would like nothing more than for stocks to always move to the upside,'' said Atkinson after the Dow came within 15 points of a 20 percent retreat from its October record. ``History shows we have bull markets and we have bear markets, and this is a bear market. That's what they're missing.''

Global stocks are poised for their worst monthly decline since September 2002. The MSCI World Index retreated 8.4 percent in June, while China's CSI 300 Index lost 22 percent for the steepest slide among the 20 biggest markets. An 11 percent retreat in Brazil's Bovespa index cut its year-to-date return to 0.7 percent, leaving Canada as the world's best performer in 2008. The S&P/Toronto Stock Exchange Composite Index climbed 3.8 percent this year.

Credit Losses

The Balestra Capital Partners fund rose about 130 percent in nine months last year after betting mortgage bonds would default, according to a letter sent to investors. Almost $400 billion of bank credit losses and writedowns sent financial stocks in the S&P 500 down 44 percent since the beginning of 2007, the worst performance among 10 industries.

Citigroup Inc. fell 19 percent this quarter and is trading at a decade low. Goldman Sachs Group Inc. added the biggest U.S. lender by assets to its ``conviction sell'' list last week and cut its recommendation on U.S. brokerages, saying losses in the industry will be ``far worse'' than it originally anticipated.

KeyCorp shares decreased 49 percent this quarter, the fifth- steepest drop among 90 financial companies in the S&P 500, after it said it would sell new stock and reduce its dividend to cover a tax ruling. Only one of the 21 analysts following the shares rate it a ``buy,'' according to data compiled by Bloomberg.

Speculation that the Fed will lift its target rate for overnight loans between banks pushed the Merrill Lynch Treasury Master Index down 2.88 percent this quarter, the biggest loss since 2004. The index has averaged a total return of about 1.75 percent in quarters when the S&P 500 fell over the last two decades, data compiled by Bloomberg show.

Dividend Yields

Dennis Stattman, who helps manage about $46 billion in asset allocation funds for BlackRock, owns fewer stocks and bonds than are represented in his benchmark in part because oil's rise is spurring inflation even as the outlook for economic growth deteriorates. He likes AT&T, the biggest U.S. phone company, because a 21 percent drop this year pushed its dividend to 4.88 percent of the share price, the highest yield since July 2006.

``We're buying pretty carefully and we're able to get some attractive stocks,'' Stattman, whose BlackRock Global Allocation Fund outperformed 86 percent of peers last year, said in a phone interview from Chicago. Still, ``there's some risk now that inflation is damaging the value of all financial assets, stocks and bonds included,'' he said.

`Very Treacherous'

Laszlo Birinyi, president of Westport, Connecticut-based research and money-management firm Birinyi Associates Inc., says it's ``very treacherous'' to make long-term bets on stock markets now because equities are swinging too much and there's ``very few historical parallels'' to gauge when they will stop.

The S&P 500 alternated between gains and losses for six days before ending last week with the steepest two-day plunge in four months. The Chicago Board Options Exchange Volatility Index, a gauge of expected swings in the S&P 500, almost doubled in 2007 and surged 13 percent on June 26.

Birinyi is purchasing companies such as Paris-based handbag maker Hermes International, which has no ``buy'' ratings and 17 ``sells'' from Wall Street analysts, according to Bloomberg data. He also owns stocks that outperformed peers such as U.S. Steel Corp., the country's largest steelmaker by revenue.

Hermes rose 16 percent in 2008, helped by takeover speculation and first-quarter revenue that topped analysts' estimates. U.S. Steel rallied 55 percent since December after hot-rolled steel-sheet prices jumped about 86 percent in the year through May.

Stock Picking

``We want to look for individual stocks,'' said Birinyi, who oversees more than $300 million. ``That's probably the toughest part of the process but it's the most rewarding. It's where the opportunities are.''

Cambiar's Brian Barish beat his peers this year by purchasing energy and raw-materials producers. He's betting Houston-based Marathon Oil, the fourth-largest U.S. oil company, and Newmont Mining Corp., the world's third-largest gold producer, will advance because they haven't caught up with a 102 percent surge in oil and 45 percent gain in gold over the past year.

Marathon's stock fetches 7.4 times analysts' average 2008 profit estimate, 30 percent less than the average for energy companies in the S&P 500, according to Bloomberg data. Newmont's 7.9 percent gain this year is the eighth-best in the Philadelphia Stock Exchange Gold & Silver Index, which rose 12 percent.

Barish is shunning any company that relies on low energy costs and a surging economy to boost earnings.

``You're winding up with a handful of winners and a whole lot of losers,'' said Barish, who outperformed 98 percent of his peers this year running the Cambiar Aggressive Value Fund and the Cambiar Opportunity Fund. ``It's painful, but we're trying to concentrate our positions around the areas of the market where you don't have these ferocious headwinds.''

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Last Updated: June 29, 2008 19:04 EDT