Dad's Mutual Fund Digest V2#4(1)
James Bridges
Once again I'm uploading a portion of my Dad's family mutual
fund newsletter. I got it Monday, but I don't think much has
changed since then. By popular demand (one direct request
anyway) I'm breaking things up so it doesn't cost as much to
read. Please remember that Dad is writing to folks with some
knowledge on investing but we're not semi-pro. Also keep in mind
that this is a not-for-profit enterprise, unlike most of the
other "newsletters" being posted. The intent here is to
communicate the collected wisdom of the mutual fund financial
press and to educate the reader through explanation. I hope you
find it worthwhile to read and maybe drop me a line with your
opinion.
Dad's son,
James Bridges
In this installment:
***The quarter in review: surprise! (What do 'they' make of it?)
***Current newsletter advisories (What do 'they' say to do now?)
***The dollar, the fed, and foreign markets
Coming soon:
***Reviews of mutual fund 'families': beyond the ratings game.
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BRIDGES MUTUAL FUND INVESTMENT NEWSLETTER V2,#4(1) April 11, 1995
(Issued sporadically--Look for it when you see it, never before!)
WHAT A QUARTER!
---------------
BullÕs canÕt fly, but they do "climb a wall of worry." In spite
of negative investment advisor sentiment throughout most of the
period, fears of either more Federal Reserve rate increases
and/or recession, and the plummeting dollar, both U.S. stocks
and bonds staged a strong rally the first quarter of l995. The
market sliced through old averages and then demolished their
newly-set marks like a child dissatisfied withy new toys. Blue
chips led the way in something of a "flight to quality" with the
S&P 500 up 9.8% and the DJIA up 9.2% and even the NASDAQ,
sometimes lagging, sometimes leaping, up 8.7% for the period. By
the end of the period certain ominous implications seemed to
lurk, however, and some leading mutual funds lagged the market
considerably, due at least in some cases to a large measure of
caution in the form of cash reserves. A great deal of the
strength near the end of the quarter was attributed to "window
dressing" by money managers wanting to spruce up their quarterly
portfolio holdings with popular stocks and bandwagon boarding by
erstwhile bears finally throwing in the towel in fear of missing
out on the good thing. Mutual fund companies reported increased
inflows of money into domestic stock and bond funds although
that into bond funds increasingly slowed near the end of the
period. Investment advisor sentiment, 60% negative as measured
by ~Investors Intelligence~ in December, is now 62% positive by
IntelligenceÕs newest poll. While the growth in investor
confidence on the surface seems a positive indicator, many savvy
investors regard it as cause for caution. When the vast majority
of advisors turn bullish their followers soon become fully
invested and demand dries up. The bond rally was slowing near
the periodÕs end and the utility index, usually the harbinger of
stock prices in general, had leveled off. Some now argue that
the market has "gotten ahead of itself" and is due another
correction.
Two of the biggest influences behind the drive were falling
long-term interest rates and a growing belief that the Federal
ReserveÕs monetary policy was guiding the economy into a "safe
landing," adequate growth without excessive inflation. Although
it has never achieved such before (its actions usually result in
recession) indications seem to point up an increasingly better
chance the Fed might indeed pull it off this time, and the Open
Market Committee left rates alone at its February meeting. It is
still too early to be sure. The February omission merely follows
the committeeÕs pattern of rate increases every other meeting.
If it continues this pattern it will raise rates at its May
meeting. Some market gurus argue that the FedÕs delay in further
increases will force it to raise rates to heights very hazardous
to the market and even the economy. Good earnings
reports-sometimes better than analysts expected-and improving
fundamentals have provided a firmer foundation for the market
rise. In the last 12 months the stocks making up the S&P 500
index have improved their average Price/earnings ratio from 21
to 16 times trailing earnings, and a 10%-11% anticipated 1995
earnings rise puts them at 14 1/2 times prospective earnings,
nearing a more normal 12%. Unfortunately the price/dividend
ratio remains at an historically dangerous 2.7%, and
participation in the drive has been limited primarily to large
company stocks. The broad market is not participating, a bad
sign.
THE DOLLAR, THE FED, AND FOREIGN MARKETS
----------------------------------------
Some fear that the declining value of the U.S. dollar will
force the Fed to boost rates again soon in defense of the
currency. Some currency market experts assert that a rate
increase is necessary to make investments in the U.S. and,
hence, U.S. currency more desirable. Others argue that such
would not help the dollar, that the problem, basically, is
simply too many dollars and too little demand for them.
So far, the Federal Reserve has shown no disposition to raise
rates in defense of the dollar, and currency traders feel the
U.S. government is not overly concerned. Many American
businesses profit from the falling dollar, and a strong economy
will probably be more important to voters in 1996 than a weak
dollar. If the dollarÕs weakness causes too much inflation,
however, it could lead indirectly to an interest rate increase,
which could be hazardous to investment markets. The declining
dollar has been of some help to U.S. investorsÕ foreign
holdings. Small gains from investments in countries whose
currencies are increasing in value over the dollar translate to
bigger gains when converted to U.S. currency. This has been
almost the only good news in overseas investments so far this
year as most of these markets have come nowhere close to the
gains of our own, and the bulk of whatever gains we have made in
international markets have come from the currency situation.
Investments in countries whose currency is tied to, or declining
against, ours have suffered.
The (mis-)fortunes of foreign markets in 1994 have ended the
boast, "There is always a bull market somewhere." Previously,
overseas markets often served as safe havens from U.S. bear
markets, but as world economies have become more closely linked
so have global markets. Usually markets are driven by their own
national monetary policy, but students of international
investing are now concluding that the global bear market of 1994
was due to the U.S. interest rate increases. They point out that
other nationsÕ central banks in general did not increase rates.
The very sharp declines in foreign securities were precipitated
by rate increases by the U.S Federal Reserve.
WHAT NOW? ADVISORY OPINIONS
---------------------------
Since U.S. Federal Reserve policy is unquestionably the prime
market determinant and may now be a powerful--if not the most
powerful--influence on both domestic and foreign markets, its
actions should be our key to predicting the course of world
markets in general. We must remember, however, that markets
anticipate--rather than wait for--developments. Therefore we
must try to predict what the Fed will do and what the marketsÕ
reaction will be.
Since the market now anticipates a "soft landing," to large
degree such has already been "priced into" the market. Such
achievement, therefore, would not seem to have a great impact.
If the FOMC does not boost rates again in May, it may help the
market, but quite possibly it wonÕt be enough of a surprise by
then, especially if investors believe it will be the last
increase. If the Fed does tighten still further a serious
decline would probably result. The decline would start earlier
but probably be less sharp if investors drop their belief in the
"soft landing" ("tooth fairy"?) theory and commence anticipating
an increase. An unexpected rate boost likely would cause a nasty
correction.
The most likely thing to cause a sharp market rally-perhaps
exceeding that of the last quarter-would be a lowering of Fed
rates. But can this be expected soon when recent reports on
economic growth are mixed at best? Can we possibly get enough
slowdown this year to cause the Fed to increase liquidity enough
to trigger a new bull market? And can we have a new bull market
with no more serious a correction than that of 1994?
Noone can be sure of the answers to these questions, but we
still feel that the scenario set forth by Bill Wood, an
investment manager for PaineWebber, and discussed in the
February issue, is worth serious consideration. Wood, who
believes the FOMC raised rates prematurely in Ô94 for political
reasons, expects the agency commence a loose monetary policy in
time for the election of 1996. Near term he expects a 5%-10%
correction with the market bottoming about July or August with
the Fed then pursuing so obvious a credit loosening monetary
policy as to promote an "explosive" upsurge in stock prices. By
then, he anticipates,inflation will have become so severe that
the Federal Reserve will have to increase rates dramatically,
precipitating a bear market of proportions not seen since the
1970Õs.
Some analysts believe that we are already in the
low-performance phase, that the 1990Õs will be like the 1970Õs
with considerable volatility within a restricted range, when the
market for the entire decade never got above the Dow 1000 mark
before sliding back into new pits of despair, each of which saw
a new exodus of investors, commonly selling at lower prices than
they bought while the "smart money" found more rewarding
investments such as real estate.
Dan Sullivan, editor of ~The Chartist Mutual Fund Timer~
believes that the market of the 1990Õs is already correcting the
overperformance of the 1980Õs. Although "stocks have been in a
bull market" most of the decadeÕs first half, this performance
"does not come close to . . . the standards of the 1980Õs bull
market." During the 80Õs the S&P 500 rose at an annual rate of
17.6%; for the 90Õs so far at only 12.0%, he asserts. "The
tremendous inflow of relatively unsophisticated money into
mutual funds in the last three years" could exit the market in
disappointment, he fears, making market timing essential for the
preservation of capital. For some months now some advisors have
been warning of the dangers in the current "mutual fund mania."
Although Norman G. FosbackÕs ~Mutual Fund Forecaster~ does not
warn of any specific perils its "econometric" models forecast
"total return of -4% and -3% decline in the S&P 500 for the next
one year and five years, respectively." Fosback recommends only
a 40% commitment to equity funds at this time with 60% in money
market funds.
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Copyright Ed Bridges, 1995.
***Coming in Vol. 2 #4(2): Analysis of and experience with some of
the better mutual fund families.
James Bridges (electronic identity: tob...@lerc.nasa.gov)
Working for NYMA Inc. at NASA Lewis Research Center, speaking for
myself.