Midyear Investment Review and Outlook : Fund Investors Seeing Red
Americans are likely to find it hard to correlate their increasingly joyous economic mood with their sinking stock portfolios.
Markets worldwide have been battered this year, as the apparent acceleration of the global economy has pushed interest rates up and diverted more money away from financial investment and into real things--houses, cars, appliances, etc.
For the typical stock mutual fund investor, whose ranks have swelled to record levels over the past three years, the first two quarters of 1994 saw the biggest back-to-back quarterly losses in 10 years.
The average general U.S. stock fund fell 2.7% in the second quarter after falling 3.3% in the first quarter, for a year-to-date decline of nearly 6%, according to fund tracker Lipper Analytical Services Inc. in New York.
While that hardly rates as an earth-shaking loss, it has nonetheless fueled widespread fear that a bear market in stocks is under way.
And indeed, Americans may be taking the bear market talk to heart. Inflows into stock mutual funds, which continued to run strong in winter and spring even as markets sputtered, appear to have declined significantly in June, many fund companies say.
What may be troubling to many fund investors isn’t the size of the first-half losses, but the slow, painful way they occurred: Stocks were never able to find their feet again after the Federal Reserve Board raised short-term interest rates on Feb. 4 for the first time in five years, in an attempt to moderate the economy’s growth.
The Dow Jones industrial average reached its all-time high of 3,978.36 on Jan. 31, and it closed on Friday at 3,646.65, for a decline of 331.71 points, or 8.3%.
Don Phillips, publisher of fund newsletter Morningstar Mutual Funds in Chicago, says investors have been taken aback not only by the markets’ steady decline but also by the large, unexpected losses in certain types of investments.
“What’s been so cruel about the first half is that many of those investments that promised greater stability got hit hardest,” Phillips says.
Utility stock funds, for example, plunged 10% on average in the first half, according to Lipper, as rising bond yields made utility dividends less attractive (and as states began to move to increase competition in the electric utility business).
“Balanced” funds, which own a mix of stocks and bonds and are generally considered conservative investments, dropped 4.5% on average in the half, which was worse than the 3.6% loss of funds that buy only blue chip stocks in the Standard & Poor’s 500 index.
Indeed, many pure bond mutual funds endured bigger percentage losses for the half than did stock funds, as higher interest rates devalued older bonds.
Meanwhile, losses in most overseas stock markets were a blow to U.S. investors who had jumped into the foreign-investing game last year, partly on the expectation that other world markets could continue to boom even if U.S. stocks stumbled.
Instead, except for the Japanese market and a handful of others, most world markets fell with the U.S. market in the first half.
Stock funds that specialize in Latin American markets dropped 10.6% on average in the second quarter and 13.2% in the half. Diversified international funds ended the half with a minor 0.1% loss, but that was only because the weak dollar offset much of the decline that occurred in most European markets.
The few big winners among stock fund categories included Japanese funds, up 28.6% in the half as that market rallied out of a four-year bear phase, and financial services funds, which gained 6% in the second quarter and 2.8% for the half as bank stocks rebounded from a selloff that hit last fall and winter.
Except for those categories, however, 21 of the 23 other stock fund categories tracked by Lipper all finished in the red for the half.
For many fund investors, the great worry isn’t over what they may have lost in the first half, but whether much larger losses lie ahead. History shows that bear market declines of 15% or more can strike Wall Street even as the economy advances. In other words, it doesn’t take a recession to cause a market slump--it just requires that stocks have gotten ahead of themselves and that people begin to find other investments (or uses for their cash) more attractive.
Does that mean it’s time to sell out of stock funds? Naturally, most fund experts advise against wholesale dumping of funds, for a simple reason: If you bought stocks for the long haul, trying to time major bull and bear swings isn’t necessary.
And besides, most people would get it wrong, says John Markese, director of the American Assn. of Individual Investors in Chicago. “Every bear market ends when people least expect it,” he says, and most timers fail to get back into the market in time.
Still, there are ways to reduce your risk of loss in a bear market, and to reduce the risk that you’ll panic and bail out completely even when your heart tells you to stay .
Michael Stolper, a San Diego investment adviser, says people who have been invested in stock funds for a long time, but now can’t sleep for fear of further losses, ought to take a chunk of their profits out--perhaps 30%--while leaving the bulk intact.
Others who feel they should be buying into this decline--but who also worry that they don’t have enough of a cash cushion in place to offset a major bear market loss--might consider deferring new investment in stocks until they build up a decent cash hoard again.
And while he’s generally against the idea of trying to “hedge” a stock portfolio with investments in gold or other hard assets, Stolper says buying a hedge now with 5% to 10% of your portfolio may have value if it makes you feel more diversified and thus stops you from panicking later should the market tank.
“There’s enormous value in the placebo effect” of hedges, Stolper concedes.
