Real Estate: The fallen angels!

Out of Stocks, and Into …?

Where the Money Travels

Depends on Rival Views

Of What Drop Means

By E.S. BROWNING
March 5, 2007; Page C1

All dressed up with no place to go.

That’s the problem confronting the investment dollar in the wake of last week’s stock slide.

As billions of dollars came out of the world’s stock markets last week, the money didn’t just evaporate. It is trying to decide where
to alight.

The economy continues to grow, generating profits. Market interest rates remain low — in fact they have been falling again — making it cheap to borrow money. So there is no shortage of cash.

The question is where, once the dust settles a bit, the cash will go. Some lately has been heading for safety, to such things as Treasury bonds. In the longer run it is likely to go elsewhere as well, and where you think it will go depends a lot on what you think just happened to the financial markets.

Analysts see at least three ways to view last week’s trouble, which resulted in a 4.2% drop in the Dow Jones Industrial Average. Goldman Sachs economists Ed McKelvey and Andrew Tilton outlined three competing views in a report last week.

1. A much-overdue short-term pullback. The Dow Jones industrials hadn’t fallen as much as 2% from a high in more than seven months, and hadn’t fallen 10% in almost four years. That is an exceptionally long time without a serious hiccup.

If last week’s trouble was just a hiccup, then stocks should rebound in the next few weeks, and the trick is to pick out the stocks likely to rebound the most.

“This does not mark the end of the cyclical bull market,” wrote veteran money manager Steve Leuthold, chairman of Leuthold Weeden Research, in a special report to clients after Tuesday’s 416-point Dow selloff.

“I am extremely doubtful that this big down day marks the start of the market’s widely anticipated 7%-10% correction phase,” Mr. Leuthold wrote. “Why? Because far too many CNBC pundits now expect this to happen.” He said he would be looking for stocks to buy, including adding to his investments in CHINA

Some analysts think that even if the problems are just temporary, they could last a little longer. In this view, hedge funds — large, loosely regulated pools of private capital — had more money invested in stocks than they really wanted, to avoid being left behind by the market’s rampant gains. Now, with the market clearly no longer rampant, hedge funds will take the opportunity to pull back and bet on declines — and while they do so, stocks could remain under pressure.

2. A flight from risky investments. If that is what is going on, then the market shift is more serious.

At least for now, this appears to be happening. Investors suddenly have pulled back from a raft of risky securities, from developing-country stocks and bonds to junk bonds and small stocks in the U.S.

“I would caution people not to say that this is over,” says Marc Stern, chief investment officer at Bessemer Investment Management in New York. His view is that investors had become blasé about risky securities, paid too much for them, and now are seeing the prices of those assets fall back to a more normal level. “One should naturally expect heightened volatility to persist. A healthy correction in this time period wouldn’t surprise us,” he says — meaning he thinks risky investments could fall further.

Mr. Stern, in other words, won’t be following Mr. Leuthold into China anytime soon. He won’t be buying developing-country bonds until their prices have fallen to a level he considers more realistic. Earlier this year, Mr. Stern had built up his cash hoard and has pulled back from risky securities. Once the storm seems to be passing, he says, he likely will buy larger, blue-chip stocks that can withstand the possibility of more stormy weather as the year progresses.

“Some of the easy money that went elsewhere may be coming back to the U.S.,” says Richard Sichel, chief investment officer at Philadelphia Trust, who also thinks the stocks of big U.S. multinational companies could come back into favor. Big-stock bulls have been predicting such a shift for more than a year, and big stocks generally have lagged behind other investments, but the bulls think they will come into their own now.

Nervousness about risk also is evident in the way investors have been using stock options. For months, investors didn’t feel much need to buy and sell stock options to protect themselves from sudden market changes. An index measuring the use of options, called the Vix and tracked by the Chicago Board Options Exchange, has been unusually low for months. Last week it jumped 70%, an almost unheard-of gain in percentage terms. In absolute terms, however, the Vix is still well below its historic average.

3. A sign of a weaker economy to come. This could be the most troubling prognosis. Some investors took former U.S. Federal Reserve Chairman Alan Greenspan at his word last week when he said a recession later this year couldn’t be ruled out. These investors see the flight to bonds as another sign conservative investors are hunkering down for a period of economic trouble.

Until last week, investors who had bet on a softening economy hadn’t done very well. Consumer spending and corporate profits repeatedly have come in stronger than most pundits expected. Reports of the consumer’s demise have been exaggerated.

Despite this, the Goldman economists say in their report that they think economic growth, the housing market and consumer spending all may be softer this year than more bullish analysts are forecasting. They also don’t rule out the possibility that default problems in the lower end of the mortgage market could bleed into other lending markets.

The Goldman economists see a silver lining: They expect the Fed to step in by June and begin cutting its target interest rates.

Early this year, before the U.S. government slashed its once-strong estimate of fourth-quarter economic growth, many investors thought the robust economy would prevent the Fed from cutting interest rates until year’s end, if then. Today, with the economy appearing to be growing more like 2% than 3% annually, bond yields and interest-rate futures suggest many investors think the Fed will cut rates by summer to give the economy a boost.

Lower interest rates support stronger economic growth. They also support home sales because they make it cheaper to invest in land and to take out a mortgage.

And cheap money makes it easier for people to borrow money and invest in financial markets. A big source of support for the stock market over the past four years, and for a wide variety of riskier investments, has been the huge amount of cash sloshing around, looking for a place to go. The availability of cheap money has made investors a lot more comfortable about taking risk.

As long as the Fed is expected to cut rates — rather than raise them, as it was doing in 2000, when the last bear market began — the cheap money can continue supporting stocks. Cheap money would help offset some of the worries these days about slowing economic growth, a credit crunch, a weak housing market and investor exposure to risky assets.

Real Estate: The fallen angels!

1. India”s economic growth is expected to average around 8% till 2020
2. GS projects India”s potential average growth to be an 6.9% for the period 2006-2050
3. India”s GDP is expected to surpass US GDP by 2050, making it second largest economy, next only to China

1. Favorable demography
2. Turnaround in manufacturing sector
3. Re-allocation of land, capital, and especially labor from low-productivity agriculture to high-productivity industry and services
4. Trade openness
5. Cheap credit

1. Political instability
2. Social instability
3. Supply-side constraints in business such as shortfalls in educational attainment
4. Environmental degradation.