Of Two Minds : Hot Bets Can Tempt Even The Coolest Investor : It’s a Time of Second-Guessing. First-Half Performance Varied More Widely than at Any Other Point in the 1990s.
In the first half of 1993, the model investor struck a delicate balance between two opposing forces: the overriding need to protect one’s nest egg and that hard-to-kill urge to take a gamble.
For those who were content to play it long-term, low-key and conservative with most of their money, stocks and bonds produced respectable--if not flashy--average returns of 3% to 7% from January to June. Chances are the buy-and-hold investor did better in the markets than in a short-term bank account, the usual alternative.
For the investor who let a little of the short-term gambler out, however--and who latched onto the right trends--there were spectacular returns on some very simple bets. Japanese stock mutual funds jumped 35% on average, Canadian stock funds rose 28% and gold funds soared a stunning 59%.
The wide range of first-half returns among investments was dramatic--perhaps more so than at any time thus far in the 1990s. For the average investor, that is at once exciting and aggravating. It means a lot of people will be second-guessing themselves, wondering why they didn’t buy into the hot trends.
And because mutual funds have made it so easy for small investors to play the market sector by sector, everybody knows what they could have, should have, would have earned--if only they’d had the foresight and the conviction.
Of course, it always looks easy in retrospect. And for some investors, there is no happy medium between the conservative and gambler; they’re either one or the other.
Let’s assume, however, that while most stock and bond owners are cautious and long-term investors at heart, they’re also intrigued with the idea of making small bets from time to time on potentially explosive market trends--with all the inherent risk that that involves. Let’s assume that most investors are of two minds.
How should you manage your money in the second half of 1993? What follows are some potential strategies for both the long-term and trend-playing portions of a portfolio.
Long-Term Investor
If the question is “buy, sell or hold?” the answer is hold--and buy on dips.
Sound familiar? That’s because the market pattern of the last two years shows no signs of changing, Wall Street pros say.
In the first half of 1993, U.S. stock and bond markets were spooked repeatedly by concerns about the economy, President Clinton’s rise and fall in the polls, inflation scares, and what the Federal Reserve might or might not do to interest rates.
Yet for the typical long-term investor, sitting patiently through the storms worked quite well:
* The average U.S. stock mutual fund rose 4.6% in the half, according to fund-tracker Lipper Analytical Services. Annualized, that’s a 9.4% return--still dramatically ahead of the 2.6% annualized yield on the typical money market fund.
* The average bond mutual fund gained more than 6% in the half. That figure measures both interest earned for the six months and the bonds’ appreciation as market interest rates dropped. If bonds produced the same results in the second half, the average return for the year would be a very generous 12%-plus.
Many experts foresee a generally dull period for U.S. stock and bond markets over the next few months. Expect the sluggish economy to keep interest rates level or push them lower, making bonds look attractive and supporting stock prices by limiting investors’ alternatives.
The wild card for the markets is the same wild card for the economy--President Clinton’s plan to raise taxes and cut the federal deficit. Almost everyone on Wall Street believes that the Clinton plan, if passed by Congress, will depress the economy further in the fall by sapping the ability of consumers and businesses to spend.
Even so, few Wall Streeters expect another recession, because the real extra tax burden that the Clinton plan would impose on the majority of Americans is minimal.
“The middle class is getting off almost tax-free in the deal,” contends Maury Harris, economist at Paine Webber Group in New York. Most people just don’t know it yet, he says.
With or without the Clinton program, many experts believe that the economy’s ebb-and-flow pattern of the past two years is likely to wear on well into 1994, as consumers and businesses continue to rebuild their finances after the severe 1990-1991 recession. Slow growth abroad also is a drag on our economy.
For the long-term investor, all of this suggests that owning stocks and bonds--but particularly stocks--still makes sense, says Sheldon Jacobs, publisher of No-Load Fund Investor newsletter in Irvington-on-Hudson, N.Y.
Investors are almost universally terrified that stock and bond markets are primed to crash, he notes. But that sentiment has held sway for more than a year. “Some people have been getting out of the markets prematurely, and their investment performance has suffered for it,” Jacobs says.
He advises his 23,000 newsletter clients to stay put--but only if they are well diversified across a broad range of mutual funds, thus lowering their overall risk from any single adverse shift in the economy or the markets.
A diversified portfolio today probably includes at least one fund from each of the following market sectors, investment advisers say:
* Lower-risk, value-oriented stocks: In market parlance, value stocks are those that traditionally sell for lower price-to-earnings ratios than the average stock. Historically, these typically have been larger companies--often industrial firms sensitive to swings in the economy. Banks, utilities and insurers also are in this group.
For the past year, value stocks have ruled the market, in part because investors believe that Industrial America is primed for a big comeback, here and abroad. And, in fact, some industries already are resurging. U.S. auto sales, for example, are strong, even as consumers scrimp on other purchases.
“We think the turn in the auto (stocks) is still a good story,” says J. Richard Walton, investment strategist at Wertheim Schroder Investment Services in New York.
In short, the industrial stocks in many value-oriented fund portfolios are the best way to bet on an economy that is gradually getting better. They also are the stocks most likely to ignore the biggest negative of a stronger economy--rising interest rates.
* Higher-risk, growth-oriented stocks: Wall Street’s classic growth stocks in such fields as health care, packaged foods and retailing have suffered over the past year from the general malaise in consumer spending. Rising competition and an inability to boost prices have trimmed many growth companies’ earnings potential.
Nonetheless, including a good growth-stock mutual fund in your portfolio makes sense, investment advisers say.
For one, even a slow-moving economy produces a decent number of fast-growth companies, and most of those stocks wouldn’t interest value-fund managers. “For many of these companies, even though growth is decelerating, it will still be huge,” argues Martin Sass, head of his own investment firm in New York. He cites Microsoft Corp. as an example.
In addition, should the industrial revival fail to materialize, Wall Street may have little choice but to beat a path back to the growth stocks’ doors. So, these stocks may be a hedge against an economy that gets worse, not better.
* International stocks: Almost anyone who owned an international stock fund in the first half of this year will vouch for the wisdom of global diversification. The average foreign fund soared 14.6% in the half, more than triple the gain of the average U.S. stock fund. A weak dollar helped bolster foreign-stock returns.
While Europe continues to slide into recession and Japan’s economy struggles, their stock prices--like ours--are being supported by lower interest rates. Particularly in Europe, the betting is that rates overseas can drop much further this year, even if U.S. rates begin to creep up. Note Germany’s latest rate cut, last week.
The best way to think about foreign markets, experts say, is that many of them are 18 months or so behind the U.S. market. So as the global economy revives, there may be significantly more money to be made in foreign stocks than in U.S. stocks.
* Bonds: If you knew for certain that interest rates were going sharply higher in the next 12 months, bonds would be the last thing you’d want to own.
But what if rates continue to fall, or stay fairly level? The current 4% to 8% yields on longer-term bonds still would beat 2.6% money-fund yields by a long shot. And if the economy slows more than expected, bonds could outpace stocks in the second half, as they did in the first half.
If you aren’t sure which type of bond fund to choose, there’s an easy option: a mixed fund, which can invest in a wide range of bonds (GNMA, corporate, Treasury, etc.), depending on where the fund manager sees the best opportunities. The T. Rowe Price Spectrum Income fund, for example, owns a mix of shares in six other Price bond funds, thus creating a “fund of funds.” The Spectrum fund now yields 5.9% annually.
While many investors fear that the next move in interest rates is up rather than down, some pros note that the signals pointing to higher rates will come gradually, when they come.
“With bonds, you have some time to react” if the market turns against you, says Jim Haber, who manages the $15-million Infiniti Investment Fund in New York.
“If you’re in the wrong stock, you have only seconds to react to bad news--if that.”
The Trend Player
Hindsight is always easy, but there were some powerful signs at the end of 1992 that a few long-depressed market sectors were primed to rally.
No one, for example, wanted to talk about gold--not after four straight years of losses. Yet the metal’s price was holding up, even in the face of heavy central bank selling of gold reserves.
Likewise, investors worldwide were nearly unanimous that the Tokyo market couldn’t rally this year, because Japanese corporate earnings surely were going down.
As things turned out, gold bullion ended up 14% in the first half and finished the week even higher, at $385.90.
And Japanese stocks surged 16%, which translated into a 35% average gain for Americans in Japanese stock funds, thanks to the added boost from the weak dollar.
It takes a special type of investor to bet on these kinds of sector turns. Most important, you have to be willing to lose money--potentially a lot. Either gold or Japanese stocks, for instance, could just as easily have gone down as up this year.
If the thought of losing 50% of an investment in a short period is abhorrent to you, trend-playing in stocks isn’t your bag.
But if you can handle the risk, betting on narrow market sectors with a small portion of your overall portfolio offers the potential for enhanced gains in an era of otherwise low stock and bond returns.
That’s one reason why Heiko Thieme, manager of the American Heritage stock fund in New York, sets aside 10% of his $85-million fund for aggressive short-term trading.
“You can make money if you’re very, very flexible,” he says.
Legendary investor Peter Lynch, in his book “Beating the Street,” says the “best candidate for investing in sector funds is a person with special knowledge about a commodity or the near-term prospects for a certain kind of business.”
For example, a jewelry store owner might be in perfect position to know the ins and outs of gold price moves, Lynch says.
Barring special knowledge, and assuming you have money that you can afford to lose, you can just play hunches--which is what a lot of trend players obviously do.
Getting into a narrow market sector is the easy part, though; knowing when to get out is tougher. One idea is to set parameters in advance for how much you’re willing to lose--and the point at which you’d take profits.
What’s worth buying now? Some sector-fund ideas from the people who invest other people’s money:
* Gold stock funds: Shares of gold mining companies tend to lead the metal, and that’s what happened in the first half. Yet even with a 59% gain for the average gold stock mutual fund in the period, many Wall Streeters insist that gold--and the mining stocks--are just beginning a powerful rebound after nearly a decade in the doghouse.
“I’m a great believer that when something’s been out of favor for 10 years, you move back in,” says Wertheim Schroder’s Walton.
While many investors assume that gold needs higher inflation to pump it up, the bulls point to a surge in demand--such as from China--that is as much jewelry-related as inflation-related.
Gold also is benefiting from the dollar’s increasing volatility versus other major currencies, says money manager Eric Fry at Marin Capital Management in San Francisco.
Warning: Gold stocks, and gold funds, are among the most volatile of investments.
* Pacific Rim stock funds: While Japan’s stock market has stolen the spotlight this year, in fact much of the Pacific Rim is on fire. Markets in Hong Kong, Australia, Malaysia and Singapore all outpaced the broad U.S. market in the first half.
Some of the excitement stems from the spillover benefits of China’s dramatic growth. But many of the Pacific markets still are climbing back from devastating declines in 1990. All in all, this remains the planet’s fastest-growing economic region.
Michael Howell, global stock strategist at Baring Securities in London, is especially bullish on Tokyo’s prospects. He sees interest rates there dropping further, in part to stop the yen’s advance.
Just as lower rates have fueled U.S. stocks’ advance since 1990, so too will Tokyo stocks get a sharp lift, in spite of their already-high price-to-earnings ratios, Howell contends.
Warning: Before you buy a Pacific Rim fund, check that its assets are allocated among the Asian markets you’re most excited about. If you want to bet solely on Japan, buy a Japan-only fund.
* Global bond funds: If you believe that foreign interest rates are coming down--especially in Europe--these funds could produce hefty returns over the next year. Many are already up 9% or more in value so far this year.
In the near-term, you collect an annualized interest yield that can be two percentage points or more above yields on comparable U.S. bonds.
Warning: The big risk in these funds is currency changes, which are totally unpredictable. If the dollar strengthens significantly in the second half, your foreign bonds would be devalued automatically.
* Health care/biotech stock funds: This is a real contrarian play. Weighed down by rising competition in the medical field and the threat of sweeping federal reform, the average health-care fund lost 8.3% of its value in 1992 and plunged another 8.3% in the first half of this year.
Depending on the shape and timing of the Clinton Administration’s national health-care proposal, medical stocks could rally sometime in the second half of this year over sheer relief that some solid reform ideas are on the table, many analysts say.
Warning: Some pros believe it’s still too early to bottom-fish here--considering that the typical health fund was up 207% in the five years ended last Dec. 31.
* Small-stock funds: As a group, smaller stocks fared OK in the first half. But some funds that are heavy in smaller consumer and health-care companies didn’t participate in the rally. Other laggard funds simply may have had a bout of muffed stock picking. And in general, investors’ heady enthusiasm for small stocks at the end of 1992 has evaporated.
But this sector’s problems often are seasonal. Sector players have learned over the years that the best time to own small stocks is between October and January. This is a group to purchase in early fall.
Warning: Although many Wall Streeters believe that small stocks will produce better returns in the ‘90s than blue chips, any market selloffs along the way will hit small stocks much harder.
First-Half ‘93: Not Bad For Long-Term Investors. . .
Average U.S. stock mutual fund
1992: 8.9%
1st-half ‘93: 4.6%
Average bond mutual fund
1992: 7.9%
1st-half ‘93: 6.2%
Dow Jones Industrials
1992: 7.4%
1st-half ‘93: 8.1%
. . . But Much Better for Trend-Players
Total returns, 1st-half ‘93:
Gold funds: 59.3%
Japanese funds: 34.9%
Canadian funds: 28.4%
Nat. Resources funds: 22.3%
“Junk” bonds: 10.5%
Source: Lipper Analytical Services; Merrill Lynch & Co.
The Long-Term Investor: Covering All the Bases
Experts say the best bet for long-term investors in an increasingly uncertain market is to diversify. It’s not enough to just own a mutual fund, they say. You should own at least one fund in each of four key sectors: value stocks, growth stocks, international stocks and bonds. Here are five fund ideas in each sector. Most are recommended either by Telephone Switch Newsletter, Morningstar Inc. or both. VALUE-ORIENTED U.S. STOCK FUNDS
Total investment return: Fund 1988-1992 1993 800-phone Fidelity Growth & Income +135% +9.9% 544-8888 Main St. Income & Growth +177% +9.3% 548-1225 Lindner Fund* +80% +8.8% ** New York Venture +150% +7.0% 279-0279 Laurel Stock* +114% +4.7% 235-4331
GROWTH-ORIENTED U.S. STOCK FUNDS
Total investment return: Fund 1988-1992 1993 800-phone Columbia Special* +182% +5.8% 547-1707 Scudder Capital Growth* +121% +4.3% 225-2470 Janus Fund* +158% +3.5% 525-3713 20th Century Giftrust* +202% +2.2% 345-2021 Founders Frontier* +181% +0.1% 525-2440
INTERNATIONAL STOCK FUNDS
Total investment return: Fund 1988-1992 1993 800-phone Harbor International* +106% +14.2% 422-1050 Vanguard Intl. Growth* +21% +13.3% 662-7447 Price International Stock* +49% +11.4% 638-5660 Templeton Growth +89% +10.8% 237-0738 Scudder Global* +88% +10.6% 225-5163
BOND FUNDS: MIXED PORTFOLIOS
Total investment return: Fund 1988-1992 1993 800-phone Vanguard Wellesley Income* +88% +9.2% 662-7447 IDS Bond Fund +73% +8.8% 328-8300 Fidelity Asset Mgr. Inc.* N/A +8.6% 544-8888 FPA New Income +74% +6.8% 982-4372 Price Spectrum Income* N/A +6.6% 638-5660
Note: 1993 returns are through June 24
N/A--Not applicable (fund didn’t exist for full five years)
* Denotes no-load (no sales charge) fund
** Phone is 314-727-5305
Sources: Telephone Switch Newsletter; Morningstar Inc.; Lipper Analytical Services
The Short-Term Trader: In Search of Trends
You want to take big risks--for potentially big returns? And you can afford to lose a lot too? Then you might have what it takes to play short-term market trends. Traders often look in one of two directions: at market sectors that have turned hot and may maintain their momentum for the near future, or at depressed market sectors that may be ready to rebound, if only temporarily. Here are some representative funds--chosen unscientifically--in both categories. Your mutual fund company also may have funds in these sectors.
Momentum Plays: What’s Already Hot
GOLD STOCK FUNDS
Total investment return: Fund 1988-1992 1993 800-phone Benham Gold Equity* -23% +56.6% 472-3389 Fidelity Select Amer. Gold -20% +52.0% 544-8888 United Services World Gold* -37% +48.2% 873-8637
PACIFIC RIM STOCK FUNDS
Total investment return: Fund 1988-1992 1993 800-phone Vanguard Index Pacific* N/A +33.6% 662-7447 Nomura Pacific Basin* +18% +26.1% 833-0018 Price New Asia* N/A +14.7% 638-5660
GLOBAL BOND FUNDS
Total investment return: Fund 1988-1992 1993 800-phone GT Global Strategic Inc. +47% +19.1% 824-1580 Fidelity Global Bond* +48% +9.4% 544-8888 Scudder Intl. Bond* +81% +9.2% 225-2470
The Unloved: Ready to Rebound? HEALTH CARE STOCK FUNDS
Total investment return: Fund 1988-1992 1993 800-phone Financial-Invesco Health* +285% -18.5% 525-8085 Fidelity Select Medical +228% -16.1% 544-8888 Putnam Health Sciences A +141% -7.1% 225-2465
SMALL-STOCK FUNDS
Total investment return: Fund 1988-1992 1993 800-phone USAA Aggressive Growth* +84% -6.5% 531-8181 Fidelity OTC +162% -1.8% 544-8888 Vanguard Explorer* +116% -1.7% 662-7447
Note: 1993 returns are through June 24
N/A--Not applicable (fund didn’t exist for full five years)
* Denotes no-load (no sales charge) fund
Sources: Telephone Switch Newsletter; Morningstar Inc.; Lipper Analytical Services
