Is There Life After The Crash? Sure He Says : Q & A : William E. Donoghue

Nationally known investment authority William E. Donoghue was meeting with subscribers of his money market newsletter in Boston on Oct. 19 and hadn’t heard that the stock market had plunged a record 508 points until several television news crews rushed into the room and pressed him to provide an instant analysis.

The 45-year-old mutual fund guru, a resident of Corona del Mar since July, repeated the same advice he had been offering for months: Investors need to diversify, but they should not abandon stocks altogether.

Donoghue publishes a money market fund newsletter for institutional investors and a mutual fund newsletter for individual investors. He has written five best-selling financial books, speaks at dozens of investment seminars annually and appears weekly on the Financial News Network as mutual fund commentator. In his spare time, Donoghue collects fine wines and is writing a book on the subject.

As the stock market continued to careen last week, Times Staff Writer John Tighe caught up with Donoghue in San Francisco as he prepared to speak before a group of corporate pension fund managers. In a freewheeling interview, Donoghue assessed the damage caused by the stock market collapse and offered his advice on post-crash investment strategies.

Question: This market has been the most volatile in history, yet you’re recommending stock market mutual funds?

Answer: Absolutely. If I were a long-term, informed investor I would have to look at today’s prices of stocks and say, “These aren’t bad.”

If you liked stocks two months ago, you gotta love ‘em at 65 cents on the dollar.

Q: But what if the market’s collapse continues?

A: This has been a correction. So at some point, the market will be correct--meaning it will be correctly priced. We just had the fastest bear market in history.

At this point we’re approaching a bottom. If we don’t buy stocks, the rest of the world will. The prices of U.S. stocks have got to be bargains now or very soon.

One would have to look at the prices of stocks and say that from here, the major trend is likely to be up. But it’s going to be volatile. It’s going to be a very difficult market to invest in.

If the market were to go up 300 points, people would sell. They wouldn’t stay in. They wouldn’t say, this is a trend. What we’re going to have is a lot of volatility. But I think the trend will be gradually up.

Q: How can anyone know that the market has bottomed?

A: Well I don’t think that anyone will know exactly when it has bottomed.

When someone gets out at the top or anywhere near there, they are rarely satisfied with their timing, so no one will be satisfied with their timing in getting in at the bottom of this market.

This market is not going to rebound dramatically in a very short time. It’s going to move up slowly and be extremely volatile. A new investor should learn from that, look to where the trends are and where the best performing no-load stock funds are, and get into them.

An investor who cannot deal with that risk should probably sit on the sidelines in a money market mutual fund.

Q: If it’s so scary, why would anyone want to be in the stock market?

A: Because if the trend is up, that’s where you want to be. You want to be earning long-term capital gains. For the conservative investor, it might be wise to buy in the next couple of days and then take a two-month vacation. Don’t even watch it for a while.

Q: Meanwhile, what’s going to happen to the economy?

A: A lot of people who didn’t even lose money in the markets are scared today. They’re demoralized; their confidence has been bruised. I don’t expect this to be a very exciting Christmas for retailers.

I don’t expect people to be enthusiastically buying cars over the next year or so. They’re not buying cars right now. They weren’t buying cars last month. And I wouldn’t think that companies would be planning major expansions.

Q: What’s going to happen to small companies, particularly in Orange County?

A: I think the smaller companies are going to have a rougher time. Certainly as money goes back into this market, it’s going into blue chips.

I would not be real optimistic about retailers. We don’t have a lot of heavy capital goods industries in Orange County, with the exception of the computer industry, and who knows what’s going to happen there.

You realize that what has happened in the past two weeks is that all the gains that have come since the first of the year have been eliminated. We’re back to where we were a year ago. We have a weaker economy. We have higher interest rates. We have bruised consumer confidence. And we have a volatile market.

Q: Could those things take us into a recession?

A: They run a very high risk of pushing us into a recession . . . a 40% or 50% probability.

Q: But you don’t see any reason to run for cover?

A: I don’t think this is time to have your gardener be your banker--to bury your money in your backyard. This is a time to look at the fact that interest rates are slowly rising.

Q: You pride yourself on what you call a “Slyc” investment approach emphasizing safety, liquidity, yield and protection from catastrophe. How has that approach worked in this market?

A: Well, it’s actually done very well. It stands for safety, which means we choose to invest in mutual funds that are regulated by the Securities and Exchange Commission. Liquidity means you can get your money in 24 hours or switch your money into another fund simply over a telephone exchange.

With yield, you focus on preserving your capital as much as possible while getting as consistent a yield as you can.

And catastrophe-proofing means having a portion of your money in gold funds so that you’ve got the upside potential if we get really high-interest rates. And with low-interest rates, you get opportunity, and you’ve got both sides covered.

Q: So, have you been covered over the last month?

A: What happened was that we were not totally exposed to the decline because of our diversified portfolio.

Q: You did have losses, though?

A: We experienced losses, as I think everyone did because I don’t think anyone expected the magnitude or severity of the decline. But we experienced losses that were much less than the Dow Jones industrials.

And as we got into it, we began to decrease our exposure to the market by selling off some of our domestic positions and getting into gold and international funds, which have helped us reduce some of the losses.

It also puts us into a position for the rest of this movement. I think that the gold funds will pick up a bit. And certainly the international fund will pick up as the markets stabilize and the dollar declines.

Of course, we have a significant part of our investment in money market funds on the sidelines, and also in international bond funds that have fared very well.

Q: What are you telling people now?

A: Well, at this point I’m not trying to be daring. We’re recommending that people put no new money in the market right now. They should wait a few weeks until the dust settles so that we can see what types of mutual funds and which specific mutual funds are beginning to form an upward trend.

Talking today, I think it’s really easy to sit back and tell you what the possibilities are. But when we start investing, we have to deal with probabilities. I don’t think we have enough information currently to assign probabilities to what’s going on.

Q: When the information is there, where should we be with our money?

A: I think the places to be would be in defensive stocks. PepsiCo, or Coca-Cola, or utilities that have been pretty stable. Those kind of stocks look to me like the place where we’ll see some growth.

When foreigners come in to buy America at bargain prices, as will certainly be happening in the next few months, that’s what they’ll be looking for--blue-chip, defensive stocks.

Q: Foreign investors might drive prices up?

A: That’s right. Well, foreign investors and U.S. investors. I think that there are a lot of people who did have the discipline to sell. Although I saw recently in a survey that only 7% of the people interviewed had actually gotten around to changing anything in their portfolio.

Q: Why are you so interested in international investments now?

A: Well, I would want to be in international investments at any time because there are good opportunities in the other equity markets around the world. Certainly half the capitalization of the world is outside of the U.S.

Plus, as the dollar has been declining in recent years, you’ve had a really double whammy working for you. You’ve had good investments in international markets, and as the money invested in foreign currencies is repatriated to America it buys more dollars because the dollar has been declining. So you’ve got both things working for you.

I think many of us have already begun to diversify our assets internationally. Look at the people driving Hondas and BMWs and Mercedes.

Q: Can you be specific about good international investments?

A: What I like is investing in an international stock market or bond fund that is diversified among many markets.

An international fund is typically in 30 or 40 different stock markets and in individual stocks carefully chosen within those.

And, they’ve been more stable for the last 18 months. Until recently they were not only the highest yielding mutual funds around, but they were also the safest ones to be in.

Q: But if the U.S. market is difficult to predict, how can an investor pick international investments?

A: It’s not confusing to the managers of the funds. And certainly when you have regular and totally comparable performance data on these funds, who cares what they do with the money if you can monitor the success of that manager’s performance?

Q: And the risks aren’t necessarily greater?

A: The risks are different. If the dollar were to strengthen, that would reduce some of the attractiveness of international stock market funds. And if there were problems as there are now in international markets, that would certainly be a reason for concern.

But because these are funds, you can call up on an 800 number and move your money out on very short notice, you can minimize your risk. They are U.S. funds that are regulated under U.S. laws that are operating in foreign markets.

It’s interesting that they have been among the most successful investments over the past two years. And yet, investments in gold and international funds comprise only about 2.5% of the mutual fund market.

Q: Why so little if they are such good investments?

A: Stockbrokers were selling bond funds and income funds instead.

More people have lost money in U.S. government bond funds than have lost money in international stock market funds. There’s almost $60 billion worth of bond funds held by Southern Californians. And all of those people have been losing money steadily since the first of the year, thinking they had a safe investment and paying their broker 4% to 6% to get into that fund or to get out of it.

Q: So how are money funds going to do?

A: People who are in money funds are earning higher and higher yields as interest rates rise. That’s a healthy place to be.

Q: What kind of income can people expect?

A: Maybe 20% is not a realistic goal for the next year or the next two years, but I think over the next five or 10 years that an average 20% annual compounded rate of return is a realistic expectation from a relatively assertive mutual fund market timing strategy.

Q: Why did you move to California from the East Coast?

A: I’ve been a Californian for about 15 years. I just lived in the wrong state. It’s amazing that there are still some neighborhoods like Corona del Mar left. Corona del Mar has that small town kind of feel that I really like. Where else can you live, be a half a block from the beach, be within walking distance of three good jazz clubs, half a dozen fine restaurants and one of the top 10 wine lists in America?

Q: Orange County’s affluence seems to be based more on land than on the stock market. Do you plan to get into real estate?

A: Buying land in California has got to be tempered as much by the earthquakes as the market. There are tremors both ways. I’m renting, and I intend to keep renting.

Q: You’re serious?

A: I’m serious. Maybe as a new Californian I’m taking that more seriously than old Californians, but I’m serious.