1st Quarter Hints at a Mood Shift

Like many financial advisors, Joel Framson has a lot of nervous clients.

Fearful about the economy and the stock market, some are reluctant to shift their portfolios away from what has held up well for the last three years -- such as high-quality bonds, money market funds and “value”-oriented stocks.

Yet the West Los Angeles financial planner thinks this is a logical time to be buying more of what’s down rather than what’s up. He just has to convince his clients.

“It’s going to be a tough discussion with some,” Framson said.

After three awful years for stocks, no one can say for certain that the bear market that began in March 2000 has finally run its course. But there were signs in the first quarter that investors’ mood has begun to shift toward a belief that the worst is over, for Wall Street and for the economy.

If that’s the case, then many of the investments that have been pummeled severely since 2000 -- “growth”-oriented stocks, for example -- could take over as market leaders in the near term. And the sectors that have provided security for investors during the long slump could turn into also-rans, or worse.

The history of financial markets is one of cycles. Even if the immediate outlook for investing is hazy because of the uncertainties generated by the war in Iraq, many professionals are focused on whether the next three years are likely to look substantially different than the last three.

If a shift is underway, it could be troublesome for portfolios that remain heavily dependent on the patterns of 2000, 2001 and 2002 continuing.

“I think all of the bear-market trades are in the process of being reversed,” said Joe Keating, who oversees $25 billion as chief investment officer of AmSouth Bancorp’s investment management arm in Birmingham, Ala.

“People are beginning to position themselves for a cyclical rebound in the economy,” he said.

Despite the war-related gloom that pervaded Wall Street for most of the first quarter, major market indexes such as the Standard & Poor’s 500 remained above the five-year lows they reached in October. That sent an upbeat message about investors’ outlook, market bulls say.

What’s more, the stock sectors that held up the best in the quarter ended March 31 were those that would be expected to gain the most from an improving economy -- technology stocks, for example, as well as other classic growth industries that could post hefty gains in corporate earnings if business improves.

The average technology stock mutual fund slipped 0.5% in the quarter, according to fund tracker Morningstar Inc. in Chicago. That compared with a 3.4% decline for the average domestic stock fund.

Funds that own large-capitalization growth stocks fell 1.5% in the quarter. By contrast, funds that own large-capitalization value stocks -- shares that usually sell for lower price-to-earnings ratios and thus are considered safer in bear-market periods -- dropped 5.2%.

The disparity between the growth and value categories suggested that some big investors were shifting money out of value and into growth, analysts say.

Likewise, precious metals funds, which typically own gold-mining companies’ shares, were the biggest losers among stock funds overall in the quarter. The average precious metals fund sank 12% in the period, according to Morningstar.

Gold’s price soared from 2000 until February of this year, as many investors turned to the metal as a haven.

The average precious metals fund gained 18.6% a year in the three years ended March 31. In the same period, the average technology stock fund plunged 41.2% a year.

But gold has been sliding since February as investors have gained more confidence in the stock market. The S&P; 500 index is up 9.8% since March 11. Gold’s price has fallen 7.2% in the same period.

Still, one quarter’s worth of trends doesn’t offer proof that the bear market has ended. Many pessimists see the recent shift as a hiccup at best.

“Any rally should be sold,” said David Tice, a Dallas-based money manager who runs the Prudent Bear fund.

He says that the economy still is struggling with the hangover from the late-1990s boom and isn’t likely to improve significantly soon.

Tice also says that most stocks, despite their heavy losses since 2000, still aren’t cheap enough relative to earnings or dividend payments to justify jumping back into the market.

Like Tice, Christopher Wolfe, equity strategist at J.P. Morgan Private Bank in New York, views the economy’s fundamentals as troubling. The outlook for consumer and business spending isn’t upbeat even if the war ends soon, he said. That will restrain any pickup in corporate earnings, in his view.

Given the economic backdrop and the recent run-up in stock prices, “The stew that’s being brewed is one for disappointment,” Wolfe said.

Many big investors, however, say they aren’t willing to take the chance of missing out on a stock market turnaround. They say the bears have been right for three years, but they won’t be right forever.

Preston Athey, who manages the T. Rowe Price Small Cap Value stock fund in Baltimore, has generated a 10% average annual gain for his shareholders over the last three years, while the bear market decimated many other stock funds.

But looking at the market today, Athey said, the near term probably favors growth stocks rather than value stocks.

“Small-cap growth stocks just got blasted” in the bear market, he said. “If the market is going to be up, I think growth stocks will outperform.”

Value stocks may continue to look attractive for the long run, but in the shorter term they may take a back seat to growth as returns in the two market sectors move closer to their longer-term averages, said John Park, a value manager who runs the Liberty Acorn Twenty fund in Chicago.

“That ‘reversion to the mean’ is a powerful phenomenon in markets,” he said.

Some analysts say the investors who may be most resistant to buying growth stocks and other beaten-down sectors today may be the same ones who were overloaded with those stocks three years ago amid the Internet mania -- when they should have been more cautious.

Now, the risk is that they’re too cautious, and too willing to accept paltry returns on money market funds and government bonds, market pros say.

In other words, just as investors early in 2000 were buying what had performed well for more than three years, many today are buying bond funds and value stock funds largely because those sectors have led for the last three years.

“The urge to move money into the perceived safety of fixed income may be a strong one for investors after three years of disappointment, but we believe that this trade will likely prove as unprofitable as over-weighting equities in March 2000,” said Richard Nash, chief market strategist for Victory Capital Management in Cleveland.

Framson, a principal at Glowacki Framson Financial Advisors in West L.A., said the issue isn’t that investors should sell all of their bonds or all of their value stocks to buy higher-risk stocks. It’s just a question of adding some of the latter to the mix, or increasing their weighting in a portfolio by “rebalancing” the mix, he said.

Rebalancing is something investors ought to do yearly, Framson said. But as growth stocks have slumped for three years, many investors who have declined to buy more of those shares have felt vindicated, he said. The question is how much longer the bet against growth will be the right bet, he said.

Some investors who have built up large cash balances since 2000 may feel that buying stocks today is sheer speculation, given the risk that the economy could slump anew instead of recovering.

If a recession is imminent, virtually every stock market sector may be headed lower.

“But by saying you’re going to wait to buy, that also is a speculation of sorts,” said Ron Kahn, head of active equities at Barclays Global Investors in San Francisco.

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Tom Petruno can be reached at tom.petruno@latimes.com.