Mutual Funds Can Minimize Risks
The stock market’s surprisingly strong rally to post-crash highs makes a jump back into the market look tempting.
But common sense suggests that--as during the summer rally preceding the 1987 crash--much of the easy money has already been made. The best advice for small investors is to avoid getting overly caught up in the euphoria. Invest, but with caution.
Fortunately, there are ways through mutual funds that you can still cash in on any further rally while minimizing risks should it fizzle out. Some funds have done better than the market in good times and not as poorly in bad times.
A look at bullish and bearish arguments from analysts shows why a stock investment now should be approached with caution.
On the bullish side, the rally has triggered a positive shift in psychology as more and more institutional investors want to get a piece of the action. Many market watchers are dropping caution and proclaiming an eventual move past the Dow’s record high of 2,722.42 set in August, 1987.
Much of the rally’s strength has hinged on a belief that the economy is due for a “soft landing.” Under that scenario, slower economic growth will push interest rates lower as the Federal Reserve eases monetary policy. But instead of skidding into recession, the economy will ease into a period of slow but sustainable growth without high inflation.
Even if recession comes, it may be limited to certain industries and geographic regions. “We may be in a new era where the economy is so enormous and so strong that a problem in one area won’t necessarily push the whole country into the tank,” suggests Burton Berry, editor of NoLoad Fund X, a San Francisco mutual fund newsletter.
Other factors are also fueling the rally. They include an influx of foreign money, large amounts of cash still held by pension funds and other institutions, and continued merger and leveraged buyout activity that has reduced the supply of stocks.
Also bullish: The price-earnings ratio--the multiple of stock price over earnings per share--is about 13 for issues in the Standard & Poor’s 500-stock index. That is far from the 20 multiple that has marked past market tops.
Also, individual investors are still largely on the sidelines. Market rallies rarely peak when the small guys are playing it safe. Recent declines in interest rates, if sustained, will entice small investors to shift some money from certificates of deposit and money market mutual funds into equities, bullish forecasters say.
“This market could really surprise people on the upside,” suggests Kurt Brouwer of Brouwer & Janachowski, a San Francisco investment firm that manages mutual fund portfolios. A 3,000 Dow is quite possible, he suggests.
But bearish observers say danger signs abound, prompting them to characterize recent gains as merely a rally in a bear market.
The “soft landing” scenario could really turn into a full-blown recession, these bears say. Interest rates are still high and inflation is still a threat, as shown by this week’s latest government report showing sharp rises in energy prices.
So-called technical market indicators are not convincingly positive, bears add. Daily trading volume, while improved, has not consistently shown the massive strength characteristic of bull market rallies. The number of stocks hitting new highs is not as extensive as should be expected in a full-blown bull market, indicating that only some stocks are enjoying the full force of the rally.
The dividend yield--payouts as a percent of share price--is about 3.5% for stocks in the Dow industrials. That’s close to the 3% level that typically signals that a market peak is near.
Bearish prognosticators conclude that investors should view the current market similar to the spring and summer before the 1987 crash. While this market can keep going higher, there is considerable downside risk once the party is over, they say.
Indeed, two of the nation’s most successful and well-respected managers of stock mutual funds, Michael Price of Mutual Shares and John Neff of Windsor Fund, have recently announced plans to close their funds to new investors because they can’t find good values in the market.
“When a guy like Price says he has a hard time finding values, it doesn’t say the party’s over, but it does mean there is significant risk in this market,” investment adviser Brouwer says. “But there is always risk in the market. That doesn’t mean stay away, you just need a prudent way of approaching it.”
One way to prudently invest is to pick lower-risk, no-load mutual funds that have outperformed the market during recent good times but held up well in the crash. Here are some:
- Lindner Dividend (314-727-5305). This 15-year-old fund invests in unrecognized companies, uses preferred stocks and is “quick to pounce” on opportunities, says Donald J. Phillips, editor of Mutual Fund Values, a Chicago-based investment advisory service. It lost only 7% during the fourth quarter of 1987--the quarter of the crash--compared to a 22.5% decline in the S&P; 500 with dividends reinvested. For the past 10 years, it has boasted an average annual return of 20.6% against 16.7% for the S&P; 500 with dividends reinvested.
- Gabelli Asset Fund (800-422-3554). Its manager, Mario Gabelli, has an excellent track record for finding hidden values. In the crash quarter, it fell only 14%. Its three-year average annual return totals 23.2%, compared to 13.2% for the S&P; 500.
- Clipper Fund (213-278-5033). This Los Angeles-based fund is “the best general equity fund on the market,” Phillips contends. It looks for underpriced stocks in out-of-favor industries. In the crash quarter, it fell only 7.6%. Its five-year average annual return totals 20.1%, compared to 18.3% for the S&P; 500. One drawback: You need a minimum $25,000 to invest initially (only $1,000 if it’s for an individual retirement account.)
- T. Rowe Price Equity Income (800-638-5660). This fund invests in companies with good dividend yields, which will serve as a cushion against falling prices. It lost 13.9% during the crash quarter. For the past three years, it has posted an average annual return of 16.8%, compared to 13.2% for the S&P; 500.
- Gradison Established Growth (800-543-1818). Its portfolio is picked by computer using strict criteria that emphasizes undervalued stocks. It lost 13.6% during the crash quarter but has gained an average of 19.6% in the past five years, compared to 18.3% for the S&P; 500.
Other lower-risk funds garnering frequent recommendations include Evergreen Total Return (800-235-0064), Nicholas (414-272-6133), Janus Fund (800-525-3713), Windsor II (800-662-7447) and Vanguard Equity Income (800-662-7447).
