You Must Remember This: A Slide Is Still a Slide
By BRIDGET O'BRIAN
Staff Reporter of THE WALL STREET JOURNAL
Nasdaq, down 60%. The Dow Jones Industrial Average, down 45%. The Standard & Poor's 500-stock index, down 48%.
Believe it or not, the stock market has been in worse straits than it is now. Those numbers describe the last major, sustained downturn in the market, from early 1973 until late 1974, peak to trough. After that market debacle it took until 1982 for stocks to match their earlier highs. And the recession of 1973 to 1975 was the economy's worst performance of the century, save for the Great Depression.
Today, a generation of investors and portfolio managers that has never experienced anything except the irrational exuberance of recent years is learning a difficult lesson: how to invest when the indicators aren't going up. The typical manager of a stock mutual fund today has an average of 5.7 years of experience at the helm, according to data from Morningstar Inc. Bond-fund managers have slightly more, 6.6 years, the Chicago fund-data firm says.
Unfamiliar as this terrain may be for today's less-experienced fund managers, a previous generation of investing professionals is finding this scenario quite recognizable. For some of them, the last year or so has been a triumph of experience over hope and a testament to the power of patience. For others, having survived earlier wars in the market trenches has proved to be no guarantee of investing success in today's difficult climate.
Here is what some fund veterans who lived through the 1973-74 turmoil -- and who today are still in the game -- have to say about then, and now.
In the early 1970s, recalls John Goode, portfolio manager of the $3.3 billion Smith Barney Fundamental Value Fund, "You had a thin market, with a few stocks that were going up but those happened to be important in the leading indexes of the day." Most stocks "were in their own private bear market," he says.
The hot stocks of the day were the so-called Nifty Fifty, a collection of 50 large-cap issues with high price-to-earnings ratios, and whose prospects were deemed golden. Pension funds and other institutional investors were fueling much of the frenzy then; the folks on Main Street weren't much into Wall Street.
For a manager with a value bent like Mr. Goode, then research director for Davis Skaggs in San Francisco, a regional brokerage firm now part of Citigroup, it was a particularly difficult time. He would buy out-of-favor stocks with prices seven times their earnings, figuring they were a bargain, then watch them go to five times. Prices of other stocks -- not the ones he wanted -- would jump to 20, 30, even 40 times earnings.
"It was one of those periods of time where your reason was assaulted by facts that didn't make any sense," Mr. Goode says.
Flash forward 25 years: "The same was true here in 1999 and in the early part of 2000," Mr. Goode says. "Valuation and relative valuation certainly meant nothing, and the similarities, the concentration, characterized the periods both times."
Of course, those Nifty Fifty stocks didn't live up to their name, with most of them falling to earth by late 1974. There were many factors that helped bring stocks down with a thud -- inflation, a huge spike in the price of oil, a federal budget deficit wildly out of balance -- but it was the inability of the Nifty Fifty to maintain their high price-to-earnings ratios that fueled the devastating decline.
As stocks soared this time around, those problems seemed remote. Instead, there was all that talk about the New Economy, the new valuations, the new rules of investing. And it was individual investors who were fueling much of the speculation. Mr. Goode was underperforming his investment benchmark, the S&P 500, and watching fellow value managers Robert Sanborn at Oakmark and George Vanderheiden of Fidelity Investments stop managing money.
"I've got to tell you, being 56 years old, you scratch your head and wonder if it is different this time," he says. So he went looking for something to confirm what he deeply believed -- that the market was in a speculative frenzy. He found it in a piece of research put together with the help of analysts at Sanford C. Bernstein, a Wall Street firm that specializes in researching and investing in value stocks.
Using publicly available data, they looked at the amount of money raised in initial public offerings and calculated how much stock owned by insiders might be coming into the market once the "lockups," or the amount of time such officers and directors must hold onto their stock, expired. As much as $150 billion in insider shares could be freed up from March 30 to June 30 of 2000, they determined.
Mr. Goode got the report March 16, a week after the Nasdaq hit what would prove to be its all-time high. The findings -- what Mr. Goode saw as a "tsunami" of stocks available to come to market -- were all he needed to put his fund on what he calls a "technology-free diet," thus missing the bloodbath that ensued.
"It was basic Economics 101," he says. And he passed with flying colors: In a year in which the average diversified stock fund dropped 4.51%, his fund was up 16.28%, giving him a 10th-consecutive year of positive returns.
In February 1973, Edson Bridges II sat down and wrote a letter to the shareholders of Bridges Investment Fund, the small fund he had started 10 years before. "The sharpness of this correction has taken many investors by surprise, including this investment adviser," he wrote. "The recent deterioration in equity-market conditions is serious, and the causes should be examined for possible new actions in your securities portfolio."
All these years later and Mr. Bridges's missive could easily be describing the events of the past 12 months. Indeed, the 68-year-old Mr. Bridges sees many parallels: High valuations, and a feeling that certain stocks were cheap at any price, particularly large-cap, well-known names.
"People justified buying them [in the early '70s] and paying high multiples by expecting that if you opened up a lockbox 10 years later, the individual stocks would have done well," he says. By the time the market reached its bottom in 1974, "events wound up totally trashing that concept."
Having lived through that once, Mr. Bridges saw a similar phenomenon bubbling in the Nasdaq, starting in 1997 and reaching its peak in late 1999 and the first quarter of last year. But compared with the early '70s, there was something missing that made the latest runup even less sustainable: "The difference is the Nifty Fifty had earnings power that was reportable," he says.
Mr. Bridges's mutual fund is an offshoot of the financial-management business his father founded in Omaha, Neb., in 1946. The firm now has $1.41 billion under management. The mutual fund is a tiny piece of that, with $67 million in assets, and was designed to appeal to the smaller investor.
In all his financial-management businesses, Mr. Bridges has long had a buy-and-hold philosophy. It is shared by his 42-year-old son, Edson III, who took over day-to-day management of the fund in 1997, although the elder Mr. Bridges is still chairman and chief executive. Both stress the importance of company management in their investment decisions and try to visit executives of many companies in the fund, particularly new holdings.
Such an attitude bred an unbroken 22-year string of positive returns starting in 1977. But last year, the fund dropped 14.1%, as many of its stocks -- and by no means just the technology companies -- had sharp declines. While certainly disappointed in last year's return, Mr. Bridges remains sanguine. Age and experience, he says, give you a belief in the future.
"In the investment river, there's always water in that river," he says. "Sometimes you're on the higher, best side of the curve of the river, sometimes not. Once you have the realism of that, you have less concern about the current market selloff."
Karen McGrath, manager of the $459 million Strong Blue Chip 100 Fund, is no aficionado of the buy-and-hold philosophy. "There will always be change," says the 62-year-old portfolio manager.
This current slowdown is just one of a number of periods she has seen with continuing bad economic news and a trend toward lower interest rates. The Milwaukee-based manager counts eight such corrections over the past 20 years, but she says that despite those bumps in the road the past two decades have presented terrific opportunities to invest. "The people who bought or held common stocks during those periods were generally rewarded over the following 12 months," she says.
Ms. McGrath watches the inflation rate like a hawk, saying it is what made managing money in the '70s so difficult. At the time, when she was managing money for Newton, a small Milwaukee firm, it wasn't uncommon for funds to avoid problems in the market by going to cash, sometimes as much as 25% to 50% of the fund.
"Whenever you would have a correction, it was important to have cash, because the same stocks would not recover in the same economic cycle," she says. "That's why we were suspicious of buy and hold." These days fund managers tend to stay fully invested in stocks, relying on sector rotation to stay out of harm's way.
That is what worked for her, as she was early in technology stocks, and in 1998 and 1999 her fund was up 44% and 39%, respectively. She lowered her exposure to tech stocks in 2000, but not early enough to avoid the tech massacre. A string of earnings disappointments starting in the third quarter also whacked her nontech holdings, leaving her fund down 18.6% for last year.
"I can't say I called this one to perfection," she says dryly. "We all have our battle scars."
Even so, in December Strong Capital Management gave her another fund to manage, the Dow Value 30 Fund. It is down 1.48%, year-to-date through February, less than the decline of the S&P 500 in the same period. The Blue-Chip fund is down 10.14%. Although she feels stocks are much closer to the bottom now, she says, "I'm still suffering."
Write to Bridget O'Brian at bridget.o'brian@wsj.com |
