Heard on the Street
As Profits From '90s Melt Away,
Investors Become Unpredictable
By KEN BROWN
Staff Reporter of THE WALL STREET JOURNAL
The Dow Jones Industrial Average is down 25% from its high, but it still has more than tripled since the start of the last bull market, which began in October 1990. And even though the Nasdaq Composite Index has fallen 70%, it is up 355% in that period.
So, despite the recent market turmoil, investors can at least take comfort in the big profits they racked up in the 1990s. Right?
Not so fast. By one measure, most investor profits in the past decade have been wiped out. That is because so much of investors' money actually was invested in the market shortly before its peak last year. And the disappearance of those profits now raises disturbing questions about how investors will react when they realize how little they are now ahead.
"If you're playing with the house's money, you tend to be a little more reckless with the money, but when you cross that line to zero and you're playing with your own cash, everything changes," says James Bianco, president of Bianco Research LLC, a Barrington, Ill., investment-research firm. "That's why the public has been so calm and so cool, because all they've been losing is unrealized profit. Now we're getting dangerously close to the zero number."
Mr. Bianco has tracked mutual-fund investor profits for more than a decade, and until now has argued, correctly, that small investors would stick with their funds because they hadn't lost their original investment. But "if the market stays down here, then I think you're going to start to see attitudes change, and you might see more consistent outflows from mutual funds," he says.
Others believe that investors may be so convinced that they have got to stay invested in stocks to make money in the long term that they will conclude that selling their mutual funds is more dangerous than holding them.
But their behavior may be hard to predict, because the recent stock market decline is different from the ones that have preceded it. "One time we had a big profit, my wife said, 'Sell, let's cash out,' " says Daniel Shapiro, a lawyer in Montclair, N.J. "We didn't, and here we are today with a lot less money."
The profits have been disappearing steadily since March 2000, but the pace has accelerated recently. In December 1999, for example, investors had $753 billion in unrealized profits in their stock funds, according to Mr. Bianco, who began tracking the data in October 1990, which is generally considered the start of the last bull market. This past July, the profit figure had fallen to $542 billion. At the end of August, it was $452 billion, and today it stands at approximately $199 billion.
How can that be possible after the greatest bull market in history? Simple. Back in October 1990, when the Dow industrials were at 2400, investors bought $684 million worth of U.S.-stock mutual funds, while in January 2000, with the Dow industrials at 11750, they dumped $31.3 billion into the funds.
"Back when the Dow was at 3000 and 4000, they weren't putting $10 or $20 billion into mutual funds, they were doing that when the Dow was at 11000," Mr. Bianco says.
Calculating these investor profits isn't an exact science, Mr. Bianco freely admits, but it captures broad trends. To get the numbers, Mr. Bianco tallies up the total monthly sales of funds that invest in U.S. stocks and then modifies that number based on the market's subsequent performance. So if $10 billion goes into the funds in a given month and the market rises 50% over the next 12 months, the investors' profit on that money is $5 billion.
From October 1990 through the end of this September, mutual-fund investors put $1.46 trillion into U.S. stock funds, and that investment is currently valued at about $1.66 trillion. At the peak in August 2000, the investment was valued at $2.1 trillion.
To replicate mutual-fund returns, Mr. Bianco created an index that is equal parts the Dow Jones Industrial Average, which tracks 30 big-company stocks, and the Russell 2000, an index of small-company stocks, on the theory that funds invest in the whole range of stocks.
To put the numbers in perspective, Mr. Bianco also calculated how investors would have done if they had put their money into three-month Treasury bills, considered a riskless investment, instead of stock funds. For the first time in a decade, investors would have been better off in bonds, with a profit of $202 billion, Mr. Bianco says.
Mutual-fund investors' unrealized profit briefly fell to the current low point in August 1998, during the Asian financial crisis, and fund investors pulled $6 billion out of funds that month. But the market quickly rebounded, and the profits went to new heights.
Besides spurring investors to pull cash out of stocks, the recent market decline could make them feel poorer, which could lead them to cut spending, slowing the economy further. That could push stocks lower, creating a self-perpetuating downward spiral.
This concept is called the wealth effect, the idea that people spend more when they feel richer, and vice versa. Most economists agree that people cut their spending between three cents and five cents for every dollar that their wealth falls.
Given the market downturn, the economic slowdown, the rise in the jobless rate and the low level of household savings in the past year, some economists believe the savings rate will rise sharply, cutting consumer spending, which has been the main engine keeping the economy afloat. "You basically have a lot of negatives coming together for the consumer," says Jan Hatzius, a senior economist at Goldman Sachs Group.
Some analysts question whether hitting the break-even point will spur individual investors to sell. They argue that investors are always moving cash in and out of their mutual funds, so they might not know their break-even points. That is especially true because as funds pay out their capital gains, their share prices change accordingly, making it harder to calculate gains or losses on a fund than on an individual stock.
"I think that there's a lot of people who have no idea," says Mark Cortazzo, an investment adviser with Macro Consulting Group in Parsippany, N.J. Among his clients, many are more conservative with the money they have saved themselves and more willing to take risks with money they have gotten through stock options or their retirement plan at work, he says.
"What they earn as salary and they've saved, they view differently than their stock options or the company portion of their retirement plan, because that was an added gift," Mr. Cortazzo says. He adds, "How people psychologically compartmentalize the pools of wealth they have is very interesting."
Another reason investors might stick with the market is that they have read and heard hundreds of times that stocks are the best long-term investment, and that selling when the market is down is a bad move. Mr. Shapiro, the lawyer in New Jersey, counts himself in this crowd. "They pound into your head this whole long-term concept, so you see this as retirement money," he says.
But few investors have experienced a downturn as sharp and deep as this one. So their reactions could be unpredictable. "The public is getting very close to their uncle point right now," Mr. Bianco says.
Write to Ken Brown at ken.brown@wsj.com1
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