Skittish investing persists

Investors are staying on
the defensive so far this year

NEW YORK » Investors have plenty of reason to be out of the stock market right now: mixed earnings news, anxiety over inflation, worries about interest rates and climbing oil prices.

With many analysts forecasting slower growth, investors seem uncertain about what to do with their money. The Standard & Poor's 500 has lost more than 3.6 percent this month as buyers huddled on the sidelines. And an estimated $2.9 billion flowed out of U.S. equity funds as of Jan. 20, according to TrimTabs Investment Research Inc. That's a stark contrast to the $31.5 billion that flowed into domestic stock funds in January 2004.

The only place investors are showing any interest is overseas, but those gains are tenuous at best. TrimTabs estimates $2.3 billion has flowed into global international equities so far this year. At the end of January last year, the figure came to $11.49 billion. Bond and hybrid funds are flat, or posting small outflows.

Further reflecting caution in the market, the strongest areas are those that historically have been most defensive: consumer staples, energy and utilities. The weakest sector is technology.

Since the year began, investors have shown a distinct preference for higher-quality issues, especially those that pay dividends, said Jack Ablin, chief investment officer at Harris Private Bank in Chicago. His analysis of the S&P 500 showed that over the past week, stocks with the highest equity quality rating gained 0.2 percent, while those with the lowest rating lost 2.5 percent. Companies that don't pay dividends saw their shares decline 1.5 percent for the week.

"We are back to the quality trade. Investors are skittish about risk taking, and this is after two years of being rewarded for risk taking, so it's a reversal," Ablin said. "Everyone is liquidating positions in the growthier areas, and gravitating toward the more predictable toilet paper and toothpaste companies."

Some analysts say investors are worried about climbing interest rates, because ultimately, higher borrowing costs will drag down corporate profits. The Federal Reserve's Open Market Committee is poised to raise short-term rates another 0.25 percentage point at its next meeting, Feb. 1-2. But while Fed governors have hinted they might become more aggressive with their policy, inflation remains in check, and the market seems to have already taken the upcoming hike into account.

One indicator that suggests investors are not overly alarmed about what the Fed might do is the performance of the financial sector, widely considered to be more rate sensitive than other parts of the market. But rather than leading Wall Street lower, the financial stocks in the S&P 500 are in line with the rest of the market, down about 3.2 percent for the year.

There's little doubt that earnings have caused deep disappointment so far. While results have been far from bad, fewer companies are beating expectations than in past seasons, underscoring the idea that 2005 will be a year of more humble returns.

Some earnings season jitters are normal, but most analysts agree that something else is at work in the market. After the fourth quarter's robust performance, some lull was to be expected. But the idea that the market is in a transition, and that investors are not yet sure how to cope with it, persists.

"The bottom line is, you don't have the continuation of a lot of the themes from last year ... and you're at the edge of the cliff looking over," said Margie Patel, senior vice president of Pioneer Investment Management and manager of four fund portfolios. "When people sort through the earnings and outlooks, I think we'll have more clarity about what the themes will be in 2005, and we'll get a sense of where the market's going."

In the face of rising rates and higher prices for commodities, corporate earnings growth is bound to slow. But most analysts agree returns are likely to stay positive in 2005. With yields on bonds still low and valuations in Europe looking stretched, perhaps more modest returns on U.S. stocks don't look so bad.

"There isn't a really good alternative place to put your money. ... Long bonds look terribly risky. And overseas, Europe isn't looking gangbusters now either," said Janna Sampson, director of portfolio management at Oakbrook Investments. "Outside of taking great risks, where are you going to go? I think you wind up back in the U.S. stock market."