Beyond Bulls & Bears

Making Sense of Market Sentiment

Remember when you were a kid, and your parents warned you not to blindly jump off a cliff just because everyone else was doing it? The grown-up version of that home-spun adage might also include a warning to not blindly dump assets just because every other investor seems to be. But many risk-averse investors appear to be doing just that. Some recent trading days have seen nearly all stocks – even those of healthy companies — being sold. This is unusual, says Ed Perks, Portfolio Manager of the Franklin Income Fund:

Ed Perks
Ed Perks

“Things like all 500 stocks in the S&P 500 declining on the same day — this is not something we have seen much historically — and that actually happened over the last month. The correlation amongst stocks is rising to near all-time record levels.”

It’s hard to imagine a scenario in which every stock in the S&P 500 is legitimately worth selling. Professional money managers understand that sentiment can often drive markets – and when that sentiment turns negative, investors may not give even healthy assets a fair shake. But this can create opportunities for those willing to take a deep breath and look closer before selling assets. As Perks notes:

“We are very focused on applying our fundamental research – equity and credit research – to identify opportunities, because when you have these mass, correlated movements, there is likely some opportunity to find value within.”

Still, because market sentiment is such a powerful force, it’s probably worth keeping track of. Right now, that sentiment seems to be souring on financial institutions. Perks thinks there’s still a lot of uncertainty around financials that might be driving some of these stocks’ volatility:

“In many regards, the financials sector is still hurt somewhat by the uncertainty – the uncertainty in terms of regulation, the uncertainty in terms of any single financial institution’s exposures. When I look at US financials, I feel like they are in a much stronger place today in terms of capital and exposures than they were, say, coming out of the financial crisis. That said, there are still concerns with some financials in terms of litigation around mortgage-backed securities, in particular. And I think that lack of comfort with what the ultimate exposures would be has driven a lot of this volatility.”

 And the uncertainty in the US and Europe has sent many investors rushing out of stocks and into what they perceive as “low risk” assets –such as US Treasuries. This has led to an increase in the value of Treasuries – despite the recent S&P downgrade ofUS sovereign debt. Although some investors may be scratching their heads at this, Perks thinks it’s related to the continuing uncertainty:

 “I think the initial response to the US Treasury downgrade was somewhat counterintuitive in that we have actually seen long-term interest rates decline substantially in the US. I think that is reflective of the broader market concerns around the European sovereign debt crisis, the European financial institutions, and more broadly, the uncertainty and challenges that global economies are facing.”   

This uncertainty is having other interesting effects, such as the decline in equities as Treasuries increase in value. Hybrid strategies, such as those employed by the Franklin Income Fund may be attractive for investors who are seeking exposure to more than one single asset class. Still, one thing’s for certain: In investing, as in life, look before you leap. Your parents’ warning about jumping off cliffs is probably still good advice.

Until next week, Beyond Bulls & Bears leaves you with a quote from the late Sir John Templeton:

“To buy when others are despondently selling and to sell when others are avidly buying requires the greatest fortitude and pays the greatest ultimate rewards.”



 

IMPORTANT LEGAL INFORMATION

The fund’s share price and yield will be affected by interest rate movements. Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds in the fund adjust to a rise in interest rates, the fund’s share price may decline. The fund’s portfolio includes a substantial portion of higher yielding, lower-rated corporate bonds because of the relatively higher yields they offer. Floating-rate loans are lower-rated, higher-yielding instruments, which are subject to increased risk of default and can potentially result in loss of principal. These securities carry agreater degree of credit risk relative to investment grade securities. While stocks have historically outperformed other asset classes over the long term, they tend to fluctuate more dramatically over the shorter term. Changes in the financial strength of a bond issuer or in a bond’s credit rating may affect its value. The Fund is actively managed but there is no guarantee that the manager’s investment decisions will produce the desired results. These and other risk considerations are discussed in the fund’s prospectus.

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