This Time, Pain for the Record Books
By KENNETH N. GILPIN / NY Times - 10/6/02
For the vast majority of mutual fund investors, the third quarter was a period of dismal superlatives.
Major stock market averages posted their biggest three-month declines since the fourth quarter of 1987. To find a worse period for domestic equity mutual funds, you need to go back even further, to the third quarter of 1981.
Investors shifted record amounts of money from stock funds to bond and money market funds. And the decline in stocks during the quarter solidified the current bear market as one of the worst ever.
The cumulative effect of nearly three years of declining prices has made some people question the wisdom of investing in financial assets.
"We are now working on a third horrible year, and that really does scare investors off," said Russel Kinnel, director of fund analysis at Morningstar Inc. "As tough as it is, most people recognize they need to invest, that it is very difficult to reach their goals if they don't. But as we grind along, it exacts a lasting toll."
Bill Nasgovitz, manager of the Heartland Value fund, said, "people are just fed up — retail, institutional and otherwise."
"They are sick and tired of buying losses," he added. "And they are traumatized."
For the record, the average domestic equity fund fell 16.1 percent during the quarter, according to Morningstar. But as bad as that number is, it does not show the breadth of the losses.
Of the more than 8,000 domestic stock funds tracked by Morningstar, only 86 posted positive returns, and the vast majority of those were in so-called bear market funds that bet against a climb in stock market averages.
Going back to 1976, Morningstar could find only one three-month period that was worse: the third quarter of 1981, when only one fund rose in value.
Given the pervasiveness of the decline, it is no surprise that virtually all investment styles suffered.
Large-cap growth funds. Small-cap value funds. Biotech, utilities, financial services and real estate sector funds. It didn't matter: everything lost money.
For investors in domestic funds, there was one bit of good news, if you could call it that: Foreign stock markets did worse. The average international stock fund fell 17.8 percent, according to Morningstar.
Lipper Inc., the fund tracking firm, said that of the six worst-performing equity classifications, four were in foreign stocks.
Declining stock values prompted an exodus from stock funds. According to AMG Data Services, which tracks mutual fund flows, a record $51.1 billion was redeemed from stock funds in the third quarter through Sept. 20, including $40.1 billion in July alone. "Around 2.4 percent of mutual fund assets have been withdrawn from equity mutual funds," said Robert Adler, president of AMG. "It remains to be seen how much follow-through there will be in the fourth quarter."
Still, much money that left stock funds did not end up under mattresses. Rather, investors put $54.3 billion into taxable and municipal bond funds, also a record.
The flow of money into bonds, particularly Treasury securities, helped to drive down interest rates to levels not reached since Dwight D. Eisenhower was president.
The rate decline ensured another quarter of good performance for bond funds. But it also raised serious doubts about whether the bond market rally can continue.
Taxable bond funds had an average gain of 1.8 percent in the quarter, according to Morningstar, their biggest quarterly increase in two years.
United States Treasury funds were the best performers, gaining 7.8 percent. But investors who moved into Treasury bond funds recently may be in for disappointment.
"We are much closer to the end of this bond market rally than we are to the beginning," said William H. Gross, the founder and managing director of the Pacific Investment Management Company. "Bonds go down in price just like stocks do." It seems obvious, but it really isn't obvious to neophyte investors in the bond market. They think that an interest rate is akin to what they get at the bank, and will be able to take their money out whole."
Because interest rates have fallen so low, "there is more risk in the bond market than there has been in a long time," Mr. Gross said.
"It is not an easy game these days," he said. "But the safe-haven game of a 1.25 percent money market rate is very painful. You have to decide which is the bigger risk."
Some analysts view the decline in interest rates, and the pessimism among investors, as a signal that it may be time to buy stocks.
"The fact that there is no competition from Treasuries and other asset classes, and the fact that most of the things people are worried about are well advertised in the market" suggest that the stock market won't reach the lows it hit at the end of July and September, said Bill Miller, manager of the Legg Mason Value Trust, with $9 billion in assets.
However, he added, "a sustained upward move in the market requires that people be more confident about what the future holds."
Mr. Nasgovitz at Heartland Value has been buying stocks. "This is a buyer's, not a seller's, market," he said. "Between now and the end of the year, every month you should dollar-cost average into the stock market, and get ready for a much better 2003. I could be all wet, but I think that is what is going to happen."
Lauriann Kloppenburg, director of equity research at Loomis Sayles, with about $10 billion in equities under management, said that "on an allocation basis we would definitely be tilting toward stocks."
But she added: "The market won't get out of this fog, or this volatile range, until something positive, and sustainable, happens on the economy. In the meantime, we will focus on near-term uncertainties."
Many analysts said stock prices were already reflecting most of those uncertainties. A big unknown, however, is war in Iraq. "There is a lot of uncertainty about how the Middle East will turn out," said Lanny Thorndike, chief investment officer at Century Funds in Boston. It is difficult to assess, he said, whether "it will either lead to a long, drawn-out scenario, like Vietnam, or something like Kuwait."
Thomas McManus, chief investment strategist at Banc of America Securities, raised his stock allocation late last month to 65 percent, from 60 percent, partly because interest rates were so low but also because investor sentiment was so bad.
"We could have a good rally in 2003," he said. "We don't see signs yet that the economy will have a regular cyclical recovery next year, but you can't wait until you see those signs. You put money in when valuations appear to reward you for the risk you are taking."
That said, Mr. McManus acknowledged that the stock market had not come to grips with the possibility that an invasion of Iraq could lead to widespread instability and unrest in the Middle East. "If people thought the Middle East were going to be involved in a huge conflagration, stock prices would probably be down 20 percent from here," he said. |
