By David Randall
NEW YORK (Reuters) - As recently as six months ago, Sandy Villere was pushing more of his $1.1 billion fund into U.S. stocks - a good call given the 26 percent gain in the S&P 500 so far this year. But as he looks ahead to 2014, he's starting to question whether it could be downhill from here.
His concerns about rich valuations have prompted him to raise the level of cash he holds in his portfolio to 15 percent of assets, the highest level allowed by the fund's prospectus.
"We're just not finding any new opportunities to put our money to work in stocks," said Villere, whose Villere Balanced Fund mixes stocks and bonds and is one of the best performing balanced funds over the past 10 years, according to fund tracker Morningstar.
Villere is not alone. With stock market indices hitting record highs after gains of nearly 165 percent since the bull market began in March, 2009, some fund managers are starting to question whether the party will fizzle out in 2014.
As a result, the level of cash in actively managed stock portfolios has crept up to 3.5 percent of assets, according to Lipper, a Thomson Reuters company. While low on an absolute level, that figure is the highest percentage of cash held by fund managers since the financial crisis in 2008.
Among portfolio managers' concerns: what will happen when Federal Reserve decides to cut back on its $85 billion a month bond-buying stimulus program that has provided the easy money that has helped to push the stock market higher? Will the bond market suffer another selloff, raising borrowing costs and making bond yields relatively more attractive for investors? And are earnings and revenue growth sustainable enough to support current share prices?
Those concerns were underlined by activist investor Carl Icahn on Monday when he told the Reuters Global Investment Outlook Summit that he could easily see "a big drop" in the stock market because valuations are high and earnings at many companies are artificially fueled by low borrowing costs.
The level of caution as the calendar closes on the year is unusual for a rally of 2013's magnitude, said Sam Stovall, chief equity strategist at S&P Capital IQ.
Since the end of World War Two, the S&P 500 has risen in 10 of the 18 years that followed a year in which the index gained 20 percent plus, with an average rise of 10 percent, Stovall said. The last time the market failed to gain in the wake of such an outsized strong performance was 1990, when the S&P fell 5.5 percent in the year after it jumped 25.2 percent.
"A lot of people are nervous that we are overdue for some sort of decline," he said, citing that the S&P 500 has not fallen by 10 percent or more - a decline known as a correction in market parlance - for more than two years.
Indeed, stocks look neither cheap nor expensive by most measures.
The S&P 500 is expected to earn slightly more than $121 per share in 2014, a roughly 11 percent improvement from this year's estimated earnings, according to estimates from Thomson Reuters I/B/E/S. Based on that estimate, the S&P is currently trading at 14.7 times forward earnings, slightly below its long-term average of 17.
Those prices - along with the strong performance of companies that focus on the U.S. economy - suggest that there are more gains to come, said Dan Veru, chief investment manager at Palisade Capital Management who oversees roughly $4.5 billion in assets and has been moving more of his portfolio into cyclical stocks.
"Small-caps are telling us that the economy is improving and will continue to improve," he said.
Still, portfolio managers are turning to other assets as a hedge against what they see as a volatile market in early 2014. Uri Landesman, who oversees a $1.3 billion hedge fund at Platinum Partners, said that his firm has been trimming back its long positions and buying gold instead in anticipation that the Federal Reserve pulling back on its stimulus program will roil the market. Landesman expects the S&P to fall to 1,550 in early 2014, a roughly 14 percent drop from its current level.
"I think that we're in for a very serious correction from here," he said.
Even fully-invested portfolio managers like Brian Lazorishak, who heads the $37 million Chase Mid-Cap Growth fund, are wary of buying at current prices. That presents a problem for funds like his whose prospectus mandates that he must keep his assets in stocks at all times, he said.
"We don't have the ability to go to cash even if we wanted to," said Lazorishak, who worries that the stock market will become increasingly "frothy" in 2014.
Instead, he has largely been cutting his positions in companies like off-road vehicle marker Polaris Industries, which is up more than 60 percent for the year. He's shying away from companies like streaming video service Netflix and professional social network LinkedIn that he sees as overpriced, and moving instead into shares of companies like medical device maker Hanger Inc, whose forward price to earnings ratio of 14.9 is below its peer average of 19, according to Thomson Reuters data.
"It's certainly harder to find anything that looks like a decent value," he said.
(Reporting by David Randall; Editing by Linda Stern, Martin Howell and Tim Dobbyn)