Early chill in the fall season

Times Staff Writer

Let’s face it: Opening your third-quarter mutual fund or 401(k) statement will be like dropping a bowling ball on your toe. And let’s not even think about the fourth quarter.

As the very stability of the global financial system has been called into question, stock fund investors have had almost nowhere to hide.

If there’s a glimmer of good news, it’s that many fund managers think, wishfully perhaps, that the market decline could soon burn itself out.

The average U.S. equity fund skidded 10% in the third quarter -- and the damage was minor compared with the brutalization in the eight trading days since the period ended. So far in October, the Standard & Poor’s 500 index is down a stunning 23%.

Even foreign stock funds, whose strong gains in recent years provided a much-needed counterbalance to meandering domestic stock performance, were pounded, sinking on average 20.5%.


The brunt of the third-quarter losses came in September as fallout from the subprime mortgage crisis and credit crunch brought down Lehman Bros. Holdings Inc. and the federal government scrambled to prop up other financial heavyweights such as Fannie Mae, Freddie Mac and American International Group Inc.

Concern over the fate of the financial system may have eased a bit at the end of the quarter, but by then the stock market was overtaken by worries about the potential for a severe global recession.

“It was about as bad as a worst-case scenario would have envisioned,” said Jeff Cardon, who manages Wasatch Small Cap Growth fund.

And even after the sell-off ends, the economy and the stock market could hover around their lows for months before turning up, many analysts say.

“The stock market has given up big enough chunks over the last three or four weeks that the selling pressure is getting to be exhausted,” said Jeff Tyler, a fund manager at mutual fund group American Century Investments. “That said, there are really not a lot of catalysts out there to suggest a turnaround. While the market might stop going down, it’s not going up any time in the immediate future.”

Investors have responded to the downturn by yanking money from equity funds.

Through Thursday, they had pulled a net $166 billion out of stock funds this year, including $44 billion in September and $48 billion this month, according to TrimTabs Investment Research.

After stuffing $138 billion into international funds last year, they’ve withdrawn $58 billion this year.

Only three of the 40 broad stock categories followed by Morningstar Inc. notched gains in the third quarter -- and the biggest was a 7.9% advance for bear market funds, which rise when everything else is falling.

The two other fund categories with gains were the real estate and financial sectors -- the epicenters of the economic maelstrom. Those sectors plummeted earlier in the year and seemingly didn’t have much left to give up -- at least not until the beginning of the fourth quarter when they plunged with the rest of the market.

Some of the largest third-quarter losses came in areas such as commodities and emerging markets that had been star performers.

Natural resources funds tumbled 32.4%, and precious metals were off 31.8%.

Stocks often rise while a recession is still underway, as the market anticipates a recovery down the line.

Small-cap stocks often have bolted out of the gate on the assumption that smaller companies are more nimble and can quickly seize opportunities as they crop up.

The average small-cap blend fund, focusing on “growth” and “value” small-company stocks, fell only 6% in the third quarter, although the Russell 2,000 small-cap index declined 17%.

But some managers say small caps might not be the best bet this time around.

The credit crunch has weighed heavily on smaller companies, and their ability to grow could be constrained by limited access to credit.

“Bigger, well-capitalized businesses are going to lead this market up,” said Ron Sloan, manager of the AIM Charter fund.

Jim Swanson, chief investment strategist at fund group MFS Investment Management, predicts the bleeding will stop soon.

“You have to say you really think the world’s falling apart to think it’s going down a lot more,” he said.





The credit crisis sent many investors scurrying to buy government securities, pushing yields down. Government funds were the only fixed-income categories to record a positive return in the quarter.

Foreign stocks

As the credit crisis intensified, fears of a global recession grew. International funds posted third-quarter losses ranging from 18.1% for foreign large-cap value funds to 28% for emerging-market funds.

Real estate

Funds that invest in real estate stocks returned 2.4% in the quarter, one of only three equity-fund categories to be in the black. But the sector tanked this month along with the rest of the market.

Corporate bonds

Yields on corporate debt surged as credit markets tightened, slashing the value of the securities. Long-term investment-grade bond fund prices lost 7.2% in the quarter. Junk bond funds slid 8.2%.


Prices of many commodities peaked at record highs in early July before starting a steady descent. Natural-resource funds sank 32.4% in the quarter. Precious-metal funds lost 31.8%.

Bear funds

Bear market funds, which bet that stock prices will fall, led all categories with a 7.9% third-quarter average return. Their performance only improved as shares plunged this month.