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QUARTERLY REVIEW & OUTLOOK

Equity Funds: Bad to Worse

On average, stock funds fell 17.2% in the quarter and every category lost money. Investors still wonder: Where's the bottom?

October 07, 2002|JOSH FRIEDMAN and TOM PETRUNO | TIMES STAFF WRITERS

Even Wall Street's biggest bulls have a hard time sugar-coating the stock market's performance of the last few months.

Beset by corporate financial scandals, doubts about the economic recovery and fears of a U.S.-Iraq war, share prices have continued to slide, extending the worst bear market in a generation.

How bad was it in the third quarter ended Sept. 30? The average domestic stock mutual fund lost 17.2%, one of the biggest quarterly losses ever, according to fund tracker Morningstar Inc.

At this stage of the downturn that began more than 30 months ago, there is almost no place to hide: Fewer than 1 in 100 stock funds gained ground in the quarter, and every equity fund category lost money, on average--even gold-oriented funds and real estate-related funds, which had been market stars in the first half of the year.

Indeed, investors last quarter began selling stocks that, until then, they had regarded as keepers. That knocked many "value"-oriented mutual funds into the red for the year.

The selling hasn't stopped: On Friday, the Dow Jones industrial average closed at 7,528.40, nearly a five-year low. The technology-dominated Nasdaq composite index ended at a six-year low of 1,139.90.

Perhaps the most comforting fact left for investors who are trying to find a reason to be optimistic is simply that things are already so bad. Isn't this the way it's supposed to feel at the bottom?

The decline in blue-chip stocks, as measured by the Standard & Poor's 500 index, equals the drop of 1973-74 at about 48% from the bull market peak. The '73-74 bear market had been the worst since the Depression years.

Unless the economy is going to reprise the 1930s experience, some Wall Street bulls say, why should share prices lose more than half their value?

The market's bears have an answer: Stock valuations, using such classic measures as price-to-earnings ratios, aren't nearly as cheap as they were at the end of 1974, when many big-name shares were valued at P/Es in single digits.

The S&P 500 now is priced at 15 to 18 times this year's estimated operating earnings, depending on whose earnings estimate is used.

Meanwhile, even though the Nasdaq composite index has plummeted 77% from its March 2000 peak, many technology stocks remain highly valued, even assuming a corporate profit recovery arrives in 2003.

Chip giant Intel Corp., for example, at $13.71 a share Friday, is priced at 18 times analysts' average earnings estimate for 2003, according to Thomson Financial.

Some veteran money managers worry that even if the market is bottoming, the psychology will remain so negative toward stocks that share prices will do little more than move sideways for years.

John Bollinger, head of Bollinger Capital Management in Manhattan Beach, said the 1990s "cult of equities" has soured to the point where many investors may give up on the market entirely, just as they did after the mid-1970s slump.

"I fear we're losing a generation of investors, many of whom may never come back," Bollinger said.

Stock mutual funds have faced net withdrawals since June. Foreigners also have soured on U.S. assets. And U.S. corporate managers have lost their appetite for mergers, diminishing another key source of demand for stocks.

Over the last three years, the return on the average domestic stock fund is a negative 8.5% per year, according to Morningstar. The average fund also is negative for the last five years, with a loss of 2.2% per year.

But the gloomier the discussions get, the greater the likelihood that the bear market is nearing an end, some Wall Street veterans say. At least, that's the way it has generally worked.

Oakmark Funds' Bill Nygren, a well-known value stock manager whom Morningstar last year named its equity fund manager of the year, warns that investors who sell stocks now may be "making the same mistake they made three years ago when they sold value and bought growth"--basing their decision on recent returns rather than a thoughtful long-term asset allocation strategy.

For investors who are still daring to keep track of their stock fund portfolios, the third quarter produced some shifts that may have lasting significance.

Some of the third-quarter highlights:

* Growth beat value. Growth-oriented funds lost less than their value-style counterparts, reversing the recent pattern. Large-cap growth funds, for instance, fell 15.8% on average versus an 18.3% decline for the average large-cap value fund.

The financial sector's woes were especially damaging to value funds, according to fund tracker Lipper Inc., as the bear market and investigations of Wall Street conflicts of interest weighed on major investment banking stocks such as J.P. Morgan Chase & Co. and Citigroup Inc. Those stocks long have been among value fund managers' favorites.

Also, investors rushing to sell stocks and funds in the midsummer meltdown may have been taking profits in the few sectors in which they still had them--mainly value--said Don Cassidy, senior analyst at Lipper.

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