Pnc Policy Panel Shuns The Bull For The Bear

Posted: March 09, 1987

Just as the Dow Jones industrial average was roaring to another record high Wednesday afternoon, Malcolm "Skip" Wilson, chief investment officer of Provident National Bank, was convening a decidedly bearish meeting of the PNC

Financial Corp.'s investment policy committee.

Gathered around the desk in his 11th-floor office in a building at 17th and Chestnut Streets were Robert Christian, director of economic research, and Lucinda S. Mezey, director of equity research. Voting members other than Wilson also attended via conference calls to their PNC-affiliated banks in Pittsburgh, Erie, Pa., and Louisville, Ky.

Each month the committee reviews the research generated by the bank's analysts and sets out the strategy that PNC portfolio managers will follow in deploying roughly $40 billion in assets - with about half in money-market mutual funds and half in actively managed accounts that are balanced between stocks, bonds and cash.

Taking a look at the composite performance of the largest trust-division accounts at the bank shows the committee's guidance has been wise.

In the 12 months that ended in September, the trust division's stock accounts posted a 33.4 percent rate of return, versus 31.7 percent by the Standard & Poor's 500-stock average. And, for the three years ended in September, PNC came in with an 18.2 percent average rate of return on stocks, compared with 16.4 percent for the S&P 500.

Meanwhile, the fixed-income portfolio returned 23 percent for the year, versus 20.7 percent for the Shearson Lehman Bros. Government/Corporate Bond Index. And the PNC bond portfolio yielded 17.4 percent average rate of return for the three-year period, compared with 16.7 percent for the Shearson index.

Wilson says that the committee is skeptical that the Dow will continue to reach new highs, and that it believes that the averages are "dangerously overextended" because of deteriorating market fundamentals, such as general economic conditions, and overly optimistic sentiment of the majority of investors.

Dangerously in this case means "a good chance" of a 15 percent to 20 percent "correction" in the Dow - or a drop of roughly 350 to 450 points

from last week's levels - over a six- to nine-month period beginning within a couple of months, Wilson said.

As a result, PNC is moving to rejigger its asset deployment. While still maintaining 60 percent of its total assets in stock portfolios and 40 percent in bond portfolios, the bank is now upping the cash portion of its stock portfolio from 25 percent to 30 percent.

Along the way, the bank is also restructuring its portfolio according to economic sectors. Consumer-durables companies (which make things like appliances) and natural-resources companies (which produce things like lumber or oil) will now comprise a smaller proportion of the total portfolio and capital equipment/services companies (those that make and/or service industrial equipment) and utilities will make up a larger part.

"While numerous fundamental concerns exist as we enter the fifth year of this economic recovery, the market has set caution aside in a sharp upward revaluation triggered by a strong net flow of fund moving into the equity market," concludes the PNC investment policy committee. The comments were made in a note that other institutional investors who pay for PNC's advice should be getting today.

In addition, the committee predicts, "over the next few months, the market is likely to experience continued high levels of volatility as it is buffeted by the crosscurrents of rapid cash-flow swings," caused by stock-based futures and options trading.

So, while conceding that this inflow from retail, institutional and foreign investors should continue to drive the market higher in the near term, Wilson argues that it is not worth sticking entirely with stocks, given their volatility and the growing dangers.

"Just look at the risks and the rewards," he said. "We can guarantee ourselves a 5 percent rate of return on cash investments during a period that could very well include a significant interim correction." He said that even the flow of cash into the stock market that many believe is propping up prices will taper off as contributions to individual retirement accounts end for this tax season.

"The Dow has been up 165 percent over the last 4 1/2 years. Why chance losing a lot trying to get every last little bit?" Wilson said.

Underlying this view is PNC's prediction of GNP growth in the 3 percent to 3.5 percent range this year. However, Wilson says, "All of the good news has already been discounted at current valuation levels."

Quoting the commmittee's statement: "The market could be vulnerable to disappointments over the next few months, as weaker-then-expected earnings trends, increasing inflation and interest rates, the difficulty of deficit reduction, or concern over the dollar causes investors to reassess current valuation levels."

Indeed, PNC says, the market's price-earnings ratio is now approximately 21 times earnings for the last 12 months, and 18 times projected earnings for the coming 12 months, far higher than the average level of 14.7.

"The last time P-Es were at these levels was in 1973, and it took 10 years to build back up after they fell off," Wilson said.

And, he said, the stock market's current dividend yield of roughly 2.5 percent is far below the 3 percent that over the last 45 years has been the typical low during a "rounding" or a beginning of a market top.

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