Even top fund managers wonder: How deep is this hole?
John Waggoner / USA Today / Feb 24, 2003
USA TODAY's All-Star mutual fund managers lost only 19% on average the past 12 months, beating the average stock mutual fund and the Standard & Poor's 500-stock index. Feel better now?
Probably not. Even top performers in USA TODAY's annual ranking of All-Star funds are staring up from a hole the bear market has dug. ''I don't feel much like an All-Star,'' says Brian Rogers, whose T. Rowe Price Equity-Income fund fell 18% the past 12 months -- but still beat three-quarters of all equity-income funds.
Most investors are looking up from far deeper holes. The bear market that began nearly three years ago has been a soul-searing event for the average investor. The S&P 500 is down more than 40%. The Nasdaq composite has plunged more than 70%. Most people who bought stocks five years ago are sitting on losses -- and waiting for a good rally to get out. That's a trend that will continue for years to come, if history is a guide.
But when fund investors are fleeing, it's often a terrific time to buy -- just one reason you shouldn't give up on stocks now. Stocks often give their best gains when investors feel the bleakest. ''To the extent that you look at history, the worse things get, the more you should put in,'' says Rogers. And investing in a USA TODAY All-Star fund, which has seasoned management and a solid track record, can help you recover from the bear market's mauling.
Overhang could prolong pain
The bull market pulled in billions of dollars to stock mutual funds in the late 1990s -- a record $188 billion in 1999 alone. Many popular funds have been clobbered. That money, once viewed as rocket fuel for further gains, could now be a vast reservoir of selling pressure -- called overhang -- that is muting many of the market's recent rallies.
Some experts claim that panicky mutual fund investors sell into downdrafts, making losses worse. In fact, very few fund investors sell during a downturn. They added money to stock funds from 2000 through 2001, when the S&P 500 fell 19.9%. In 2002, when the S&P 500 plunged a further 22.1%, they sold just $27 billion.
Instead, fund investors wait to recoup losses before they sell. After the 1987 stock market meltdown, stock mutual funds saw net outflows for the next year as the market continued to rise. After the 1973-1974 bear market, investors yanked money from funds four of the next five years.
Overhang typically blunts early rallies. The market rallied sharply after its July lows, only to fall to new lows in October. And the rally that started in October has lost steam. Joe Keating, chief investment officer for the AmSouth funds, estimates that the S&P 500 was about 20% undervalued at its October low. Normally, stocks zoom from undervalued to overvalued before dropping again. But the S&P 500 was still 10% undervalued when it started falling again. ''My hunch is that it will stay undervalued for a long time,'' he says.
One reason: The mutual fund overhang today may be considerably larger than it was in the 1970s. Investors have lost more money in this bear market than the 1973-1974 bear market. From its top on March 24, 2000, to its most recent bottom on Oct. 9, 2002, the S&P 500 plunged 49%, second only to the 1929-1932 drop that ushered in the Great Depression. ''It's worse than the 1973-1974 market,'' says Robert Torray, manager of the Torray fund.
Worse still, many investors piled in at the top. Investors flooded 25 of the period's hottest growth funds with $163 billion in the 12 months before the bear market began, more than they invested in the entire industry in 1998. Those 25 funds have lost an average 65% since March 2000. Fidelity Aggressive Growth, the most popular of those 25 funds, is down 81%.
But long-term investors should cheer at the sight of fleeing mutual fund owners. Contrarians -- those brave souls who try to run against the Wall Street herd -- see mutual fund redemptions as a signal that the stock market has started to bottom out. Fund investors do tend to be patient, long-term investors. When even they capitulate, it's often a good time to start buying. In 1975, for example, investors yanked about 4.4% of the industry's assets from stock funds. The S&P 500 rose 37% that year and 24% the next. In 1979, investors pulled nearly 12% of the industry's assets from stock funds. The S&P 500 rose 18.6% that year and 32% the next.
Stargazing
Despite the fear among fund investors, few All-Star managers are willing to say that the bear market has ended. For one thing, bargains typically litter the floor of the New York Stock Exchange (news - web sites) at a market low, and that's not true now. But many stocks are cheap, says Torray, whose fund has the best 10-year record among all value funds, which look for beaten-up, unloved large-company stocks. ''We're finding a substantial number of large companies selling for five to 11 times their past 12 months' earnings,'' Torray says. The cheaper the stock, the lower its price is when compared with earnings.
One reason stocks are getting cheaper is the war on terror, in general, and the potential for war with Iraq. Both make it harder to put a price on the value of a company's future earnings, which is the heart of stock analysis.
''The simple analogy is when General Motors workers went on strike in the 1950s,'' says Mario Gabelli, whose Gabelli Equity-Income fund ranks fourth out of 191 equity-income funds the past 12 months -- despite its 9% loss. GM, a blue-chip growth stock in the 1950s, had never endured a strike before. Suddenly normally predictable GM was unpredictable, and its price tumbled.
But, Gabelli says, investors adjust, just as they did with GM stock. And uncertainty certainly isn't new. ''When I was growing up in the 1950s, we had atomic bomb shelters; in the 1960s, when I started my career, we had the Vietnam War,'' he says. During the 1973-74 bear market, the Vietnam War was still being fought, the nation was embroiled in the Watergate scandals, and oil prices were soaring from an OPEC (news - web sites) embargo. ''The world was a scarier place,'' says Brian Rogers of T. Rowe Price Equity Income.
Top performers
The top-performing All-Stars this year are value managers. ''We're seeing a lot of new stock ideas, more so than last year,'' says Scott Moore, co-manager of American Century Equity Income, which ranks third among 131 equity-income funds the past five years.
Moore, for example, likes British Petroleum, which has raised its dividend -- now 4.1% -- and ratcheted up its growth and production targets. ''They're doing a lot of the right things,'' he says.
Torray sticks with fewer than 40 high-quality large-company stocks, but he recently nibbled at some fallen growth stocks, such as EMC, maker of computer-storage systems, and Intel, the computer-chip maker. ''They don't fit our usual description, but on the basis of their performance in better times, it's conceivable they could do well in the future,'' he says.
John Rogers, manager of the Ariel fund, is finding bargains among financial services companies -- even among the stocks of publicly traded mutual fund companies. ''They've just gotten so beaten up,'' he says. ''If you look back 10 years from now, you'll see that it was a great opportunity to buy stocks.''
What to do
Most investors, like most fund managers, are trying to dig out from their losses. But fleeing to money market funds or bond funds could just make the recovery period longer. The average money market fund yields 0.78%. At that rate, you'll double your money in 90 years.
And even though the average U.S. government bond fund has gained 29% the past three years, moving to bonds now could be like jumping into stocks in 1999, albeit not as exquisitely painful. Consider this: Long-term government bonds have gained an average 5.5% a year since 1926, says Ibbotson Associates, a Chicago research firm. They're up an average 14.1% a year the past three years.
So what should you do? First, check your overall asset allocation. Don't put all your money into stock funds unless you have 15 years or more before you'll need it.
If you have already set a target allocation -- say, 60% stocks and 40% bonds -- check your portfolio to see if you still have the same allocation. Odds are good that you're light on stocks and heavy on bonds. Take a deep breath, sell some of your bond funds and reinvest in stocks.
Finally, diversify among funds -- even All-Stars. We don't pick these funds because we think they will shoot the lights out every year. We choose them because they consistently beat other funds with the same investment goals.
If you're a conservative investor, pick more sedate All-Stars, such as American Century Equity-Income. If you're aggressive, try Northern Select Equity, which looks for a few red-hot growth stocks. If you're somewhere in the middle, try a moderate fund, like Davis New York Venture.
No one knows what the stock market will do, even after three consecutive down years. But it helps to have an experienced manager at your side.
''Markets have cycles,'' T. Rowe Price's Rogers says. ''We've had our down ebb, and we'll have our up flow.'' |
