California Bank Stocks’ Run-Up Made No Sense
A few words about the “efficient” stock market:
When California bank stocks were soaring in May, a lot of investors and traders hopped on board, because they assumed that the market knew what it was doing. It appeared to some otherwise-rational people that Wells Fargo, Security Pacific, First Interstate and other leading California banks had escaped serious loan problems in the recession.
That assumption made little sense on the face of it. California’s unemployment rate is above the national average in this business slump. And commercial and residential real estate markets are far more overbuilt here (and in neighboring Western states) than in most places. So how could it be that, when other banks across the country were facing rising loan losses, California’s banks would somehow come through unscathed? Do we really have smarter bankers than everyone else?
Anybody who knew anything about California’s economic pain in this recession should have realized that Wells Fargo didn’t deserve to be a $98 stock. But that’s where buyers pushed it in early June. Now, Wells is at $65.375, down 33% from its peak. First Interstate has plunged from a high of $42.50 to $26.625 now. Security Pacific has slumped from $33.125 to $21.125. All three in recent weeks have announced major new loan writeoffs, stunning Wall Street.
On May 24 in this column, Morgan Stanley & Co. banking analyst Arthur Soter expressed the view that many investors were badly deceiving themselves if they believed that banks’ troubles were behind them. History was clear on that subject, Soter pointed out: Banks’ problem loans typically rise for a full year after a recession ends, because it takes time for all of the corporate and individual deadbeats to fess up. Nobody likes to say they screwed up, right? You delay that admission for as long as you can.
The much debated “efficient market” theory of investing says that, at any given point, stock prices reflect all the knowledge and expectations of astute investors. Therefore, stocks are supposed to be fairly priced at all times.
The truth is, there was nothing efficient about the prices of California bank stocks a month ago. A better way to explain those stock prices is the “mass-hysteria market” theory, which holds that, at any given point, stocks can soar to absurd heights based on the misguided assumptions of a rapidly multiplying herd of uninformed buyers.
In the long run, stock prices may indeed be efficient and fair. But in the short run, the illogic that pushed California bank stocks so high tells you that temporary inefficiencies occur every day in the market. Learning to recognize and exploit them is one key to successful investing.
Betting on Bond Funds: OK, so bonds bore you. But making money isn’t boring. Would you guess that stocks or bonds made more money for investors over the past 12 months?
The answer is bonds, hands down. Mutual fund tracker Lipper Analytical Services in New York, tallying up bond and stock fund performance as of June 30, reports that:
* The average taxable bond fund--those that own U.S. government, corporate or foreign bonds--posted a return of 8.91% in the 12 months ended June 30. That figure counts interest income plus or minus any change in the bonds’ prices.
* In contrast, the average stock mutual fund rose 5.17% in that period.
So you made 72% more in bonds than in stocks in that time frame, which encompasses the stock market’s summer-1990 peak, the bear market brought on by the Persian Gulf conflict and the new bull market born last winter.
Bonds have always been the slow-but-(mostly)-sure investment. You buy them for the interest income, and hope that they’ll rise in value as well--which they can, if yields on new bonds drop, making older, higher-yielding ones more attractive.
Over any long period of time, bond returns typically have lagged stock returns. And that’s been true in some very short periods as well--for example, the first six months of this year, when the average stock fund leaped 16.2%, versus a 6.6% return on the average bond fund.
However, the question more investors are asking is whether bond and stock returns might run much more in sync during the 1990s than in previous decades, when there was no debate that stocks were the better bet.
Why would bonds give stocks more of a race? During the past 10 years, interest rates have been deregulated in this country, and the bond market has become a much more volatile place. It reacts quicker to news. And because of that volatility, bond market traders have tended to keep interest rates high (relative to inflation) to protect themselves from crazy market swings.
If you assume that long-term (10- to 30-year) Treasury bond yields stay in the same 7.5% to 9.5% range that they’ve been in since 1986 (they’re now around 8.3%), it’s conceivable that the return on the average bond fund over the next five years could be comparable to the return over the last five.
From June, 1986, to now, the average taxable bond fund returned 40.4%. In the same period, the average stock fund rose 49.1%, according to Lipper Analytical.
So the advantage still went to stocks. But for conservative investors who value income and security more than the bigger gamble that stocks represent, stocks’ premium of nine percentage points over five years may not be enough of a draw. Bonds may make more sense.
Some investors who study the five-year return figures in the accompanying chart might note that the real surprise was money market funds. Those short-term, virtually risk-free funds returned 41% over five years, slightly better than bonds.
Who needs bonds when money funds pay that well? Good point--except that for the past year, the Federal Reserve has pushed short-term interest rates dramatically lower, and is likely to keep them low well into 1992 to keep the economy on track. Money funds have had a great run since 1986 (since 1979, for that matter), but there’s no excitement there anymore.
How Income-Fund Investors Fared
Here are fixed-income (bond and money market) mutual fund performance figures for the first half, one year and five years ended June 30.
Average total return Income fund type/term 1st half 1 yr. 5 yrs. Corp. junk bond +21.62% +8.3% +24.9% Corp. bond (lower-quality, 10 yrs.+) +4.62% +9.8% +46.4% Corp. bond (5-10 yrs.) +4.48% +9.2% +44.0% Corp. bond (high-quality, 10 yrs.+) +4.42% +9.5% +44.2% Corp. bond (1-5 yrs.) +4.26% +9.2% +45.0% GNMA +4.12% +10.7% +52.2% U.S. govt. (1-5 yrs.) +3.73% +9.2% +43.9% U.S. govt. (5-10 yrs.) +3.33% +9.4% +40.2% Money market +3.10% +6.9% +41.0% U.S. govt. (10 yrs.+) +2.98% +8.8% +42.3% Global bond -0.11% +9.0% +73.3% Avg. taxable bond fund +6.59% +8.9% +40.4% Avg. stock fund +16.17% +5.2% +49.1%
Source: Lipper Analytical Services Inc.
