WILL MUTUAL FUNDS SURVIVE
A SEVERE BEAR MARKET?
This writer's considered answer is that some will and some will not. Starting in the late 40's and early 50's, my
fund investing experiences have covered the Go-Go years and the 1972-75 bear market. Now, via computer, I
follow the daily performance of 32 quite varied mutual funds. The list comprises stock funds both long and
short, plus bond and blend funds ranging in size from small to large. I currently have high confidence in the
bear market survival for only a few of them. That's why I check them all daily.
MUTUAL FUND HISTORY
In the 1960's, there was a mini-bubble (Go-Go mania) in which several highly exploited new funds rose quickly
to prominence and then crashed with heavy investor losses. In the nearly 3 year bear market of the 1970's, the
major averages dropped 48 and 50%. These numbers are still quoted today on CNBC but are quite
misleading. The Indicator Digest unweighted average of all NYSE stocks fell from a peak of 59 in the Spring of
1972 to a low of 21 in December 1975 - a drop of 64%. Many popular funds fell in price by 70%, 80% or more.
There were net mutual fund redemptions for the next 9 years.
In the early years, the fund industry grew slowly in number of funds and total assets. The number of no-load
funds increased. There were bad funds and good ones but the performance information available to investors
was quite limited. The practice of merging bad funds with stronger performers was being used to improve the
averages. This practice has been developed into a fine art in recent decades with very few investors aware of
their fund's burial. The dark side of mutual funds is carefully hidden from view.
During the 1970's, few tools were available to aid investors in their selection and timing decisions. One of my
treasured possessions today is a large hand-plotted chart of the Indicator Digest Average from 1970 thru 1975
with two simple moving averages I hand calculated on my slide rule. This broad average was available weekly
and I plotted it on the chart every week end during the 5 years. It is a scary chart and it kept me continually
aware of the severe nature of the bear market. The nearly 3 year decline was interrupted by 3 major bear rallies.
The final low in December 1975 went unrecognized until the 1976 bull market rally was well underway. At the
bottom, the atmosphere was complete Gloom and Doom but we now know it was a minor bear compared to
our present mania. Young readers can be assured that the current almost daily calls of a bottom are wildly
wrong.
Alan Newman has published fascinating charts on www/crosss-currents.net that permit a valid comparison of
the 1929 and 1999 Manias. For example, the 1999 trading volume normalized for GDP was nearly 3 times that
of 1929. And, importantly, the level during the 1970’s did not exceed the very low level of "normal" times
which was about 1/9 that of 1929. This gives me a clear personal measure of the very huge bubble height from
which we are now falling. It must be at least ten-fold that of 1972-75.
CURRENT MUTUAL FUND PROBLEMS
An informed observer can readily detect glaring examples of common situations such as:
1. The huge number of very large funds.
2. The very few funds stressing and delivering capital preservation.
3. The very low cash position of nearly all funds.
4. Excessive % ownership of volatile stocks in a single fund.
5. The large number of managers lacking bear market experience.
6. The prevalent criticism of managers holding large cash positions.
7. The competitive urge for funds to be fully invested.
8. Fund performance comparisons on a relative rather than absolute basis.
9. Fund performance comparisons to a weighted, not unweighted, average.
10. Lack of adequate supervision by regulatory bodies.
11. Advertising hype to keep investors fully invested at all times.
12. Inflexible management - failure to conserve assets in a major decline.
13. Inability to sell huge positions when cash is needed for redemptions.
14. Lack of recognition that we are in a major bear market.
GENERAL DISCUSSION
I subscribe fully to the view expressed on the internet by objective experts that "mutual funds are, currently, an
accident waiting to happen!" The present situation has been described as a game of "musical chairs," where
there are ten investors and only one chair, not the usual nine. Only a few investors will get out in a panic
situation.
Particularly egregious is the hype coming from Wall Street and its advertisers that is aimed at keeping poorly
informed investors in their growth vehicles. In the same vein is the advertising that "all you need is a few bonds
and a little bit of cash." What we are now facing is not like some recent small bear markets but the biggest one
of all times.
I place the blame for the present dire predicament squarely on the shoulders of the mutual fund industry's
senior managers. Young or old, they should have become informed about the dangers presented by bear
markets, small and large. Both directly and indirectly they have induced tens of millions of new investors, to
throw their savings into a huge stock mania near its very top.
Of course we cannot excuse Al Greenspan for his failure to quench the "irrational exhuberance" when he first
made the words public. Nor can we forgive the SEC for their years of neglect in checking the industry excesses.
Both the Fed and SEC have played a big role in urging or permitting our stock bubble to grow to its huge size.
What the future hold at this writing is unprecedented and unknown. The present small trickle of mutual fund
redemptions is probably coming from retirees or those nearing retirement. Meanwhile, the much larger group
of young investors are being taught daily in fund advertising and by analysts on CNBC to "hold the course."
Will there be a major investor panic induced by market action or some external cause? The history of other
manias tells us this is very possible and that it can come with little or no warning since crowd emotion is
unpredictable. It must be clear to well informed observers, that many mutual funds, certainly the largest, will not
be able to liquidate their large positions to meet massive redemption requests. Since this danger will not be
widely known before the event, it behooves each reader of this article to take what steps are needed to put his
own house and that of their friends and relatives in good order.
Robert B. Gordon Sc.D.
Sun City West AZ
rgordon145@aol.com
September 3, 2001 |
