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October 02, 1994|TOM PETRUNO

Not quite 11 years old, the Wayne Hummer Growth stock mutual fund has never had a losing year. But with three months left to go in 1994, portfolio manager Tom Rowland knows his winning streak is in jeopardy.

The $94-million fund closed the third quarter off about 1% for the third quarter off about 1% for the year to date. Like many U.S. fund managers, Rowland has found it difficult to make much headway for his shareholders in a U.S. stock market beset by rising interest rates, inflation jitters and increasing competition from other types of investments.

Worse for Hummer investors, this is the second consecutive year of disappointing results. Last year, the Chicago-based fund eked out a mere 3.6% rise, barely above the rate of inflation and far below the double-digit returns that fund owners have come to expect since 1982.

Rowland is struggling through a market phase that Wall Street has long been anticipating--and fearing. After the wild bull market of the 1980s, wringing big gains out of U.S. stocks now is a tough order.

What ails the market is not so straightforward as to merely be labeled a bear cycle, experts say. Academics call it something else: "regression to the mean."

Simply put, because investors enjoyed such huge returns on U.S. stocks from 1975-1989, it's logical to assume that a lengthy period of overall weak performance--encompassing both bull and bear markets--may ensue in the '90s.

That would ensure that the average annual return on stocks over, say, the 1970-to-2000 period would be in line with the longer-term mean--which, theoretically, is the best return you can reasonably expect from the market over time.

"Regression to the mean is a statistical inevitability," says Robert Markman, whose Markman Capital in Minneapolis directs $265 million in client assets in funds.

But that doesn't make it easier for investors to swallow. Indeed, the possibility of sub-par returns for an extended period on U.S. stocks--perhaps 5% to 8% annually, compared to 17% a year during the 1980s--poses a monumental challenge for the $2-trillion mutual fund industry, which has attracted an unprecedented number of individual investors since 1990.

Though most fund owners profess to be "long-term" holders, the industry's fear is that investors may not easily tolerate poor returns--let alone the 20% to 50% losses that a traditional, drawn-out bear market could bring.

Equally worrisome is the response of portfolio managers to the forces of regression. As competition to attract and retain dollars grows more intense, many U.S. fund managers are already looking to potentially higher-risk securities to beef up returns and gain an edge over rivals.

While some may succeed, the strategy threatens to place more fund managers--and their shareholders--at greater risk of severe volatility and loss than either party may fully understand.

Stock fund managers "are going to be pushing out the envelope in terms of acceptable behavior," predicts Don Phillips, publisher of fund tracker Morningstar.

It's Real, All Right

To be sure, the contraction of U.S. stock returns so far in the '90s has hardly been disastrous for most funds or their investors, even though the average U.S. general stock fund is down 0.5% year to date.

Still, key market measures show that regression of returns is real:

* An index of 30 major growth stock funds tracked by Lipper Analytical Services has risen 56.7% since Dec. 31, 1989, a period encompassing nearly five years.

If the market holds basically steady for the next three months, the growth fund index's gain for the first half of the '90s will be the smallest for any half-decade period in 30 years, except for the severe bear market period 1970-74.

* Using a broader measure of fund performance--Lipper's general stock fund average--three of the last five calendar years (including 1994, to date) have produced returns below the 10.3% average annualized total return on the blue-chip Standard & Poor's 500-stock index since 1925, as calculated by Ibbotson Associates.

* The total return on the S&P index itself since Dec. 31, 1989, is about 54%, compared to 152% for 1985-89 and 99% for 1980-84 and also for 1975-79.

Although measuring the market over calendar-year periods is naturally arbitrary, it's worth noting that in each of the aforementioned five-year periods (including the latest) the market experienced both bull and bear phases.

Of course, it isn't fair to view stocks' returns in a vacuum. Earning 57% since 1989 has still beaten inflation and bank CDs.

But this year, for the first time since the late 1980s, other investments are providing real competition for stocks. Money market funds, for example, now yield 4.3% on average, and that yield is rising at the fastest pace since 1988. One-year Treasury bills pay 5.9%.

Commodities, including gold, are attracting increasing attention from investors as prices rise with the global economic recovery.

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