July 2, 2002 – With the average U.S. stock fund moving toward its third year of losses, shareholders may be wondering, when will they end?
“Don’t hold your breath,” seems to be the collective opinion of the managers of some of the best-performing funds so far this year. The best these managers offer is sideways movement for 2002, with the possibility of moderate gains a few years down the road.
“Anyone who says the market will recover this year is mistaken,” says Alex Chaloff, senior associate at Wilshire Target Small Company Value (DTSVX). Looking at recent economic trends, such as consumer spending, productivity, and unemployment, Chaloff feels there’s a “real scarcity of promising numbers.” One major problem is “too many investors have been burned by poor earnings,” leading them to take a defensive approach, says Chaloff. His fund rose 6.2% so far this year.
Along with weak earnings, investors will likely face lackluster returns because stock prices haven’t fallen to reasonable levels, according to Don Yacktman, manager of Yacktman Focused Fund (YAFFX). “The market has been overvalued for some time,” Yacktman says, because of the “crazy things” that happened in the 1990s, when tech stocks reached unprecedented levels.
Although he is actively shorting the S&P 500 for Leuthold Grizzly Short Fund (GRZZX), manager Chuck Zender is personally “neutral on the market right now — it’s too close to tell.” The second-best performing small-cap blend fund so far this year, Leuthold Grizzly Short rose 14.7%. Looking at the current environment, Zender feels “it’s probably too late to sell, but too early to buy.” The long-term trend line for the broad market may be favorable, but Zender thinks “it might take a couple more years to correct the excesses of the tech boom.”
Neil Hennessy, manager of Hennessy Cornerstone Growth Fund (HFCGX), agrees with Zender’s view of technology, saying “the tech market is dead and will be dead for some time.” Hurt by deep losses, investors will be “kicking the tires to know what they are buying,” says Hennessy, who feels this will lead more money managers to take a quantitative approach. “The future is with formula-driven investors because it a more verifiable approach,” less subject to emotion, according to Hennessy. His portfolio was the second-best performing small-cap growth fund this year, rising 8.9%.
While this year’s market has been hurt by Middle East turmoil, accounting scandals, and concerns about corporate governance, Rosanne Pane, mutual fund strategist at Standard & Poor’s, sees more to be wrung out of some sectors, especially growth. “It’ll be a long while before we see earnings growth return in the tech and telecom areas,” predicts Pane. She thinks value investments, particularly small-cap value stocks, continue to offer the best prospects because their valuations are much more attractive than the growth segments of the market.
Hennessy agrees. Value stocks look attractive this year “because you’re buying cheap things” based on “pure numbers, such as price-to-sales ratios, notes Hennessy. Blindsided by balance sheet misstatements, Hennessy believes investors are increasingly focusing on “pure numbers.”
In times of uncertainty, value names stand up a little better in the opinion of David Lundgren, manager of Hancock Horizon Value Fund (HHGAX). Value investments are likely to outperform, Lundgren feels, because they tend to pay dividends, which indicate better accounting standards. Growth stocks are also less attractive right now, in Lundgren’s view, because their price declines haven’t been as severe as their earnings losses. Within value, Lundgren favors small-cap stocks, although he cautions that “they’re not as attractive as they were because they’ve had a run-up.”
Small-cap value is likely to outperform because the underlying companies are “old economy companies with product lines that are easier to understand,” says Peter Morris, manager of Homestead Small Company Stock Fund (HSCSX). The fund was the third-best performing small-cap value fund so far this year, advancing 16.7%. Despite their recent gains, Morris feels small companies continue to offer attractive opportunities, because they’re underfollowed by the investment community. “Many of these companies don’t have investment banking relationships, so no one covers them,” Morris said.
Value investments could outperform growth for the next three to four years, because growth stocks won’t generate the high returns many investors expect, thinks Douglas Davenport, manager of Wisdom Fund (WSDVX). Davenport favors value investments because he feels they will be less affected by the accounting scandals hitting the wider market. Over the next five years, Davenport expects the broad market to rise 6% to 9% annually.
So far this year, domestic-equity fund returns are in line with Davenport’s outlook. For the first half of 2002, the S&P 500 is down 13.3%, including a 7.3% drop in June. As a group, domestic equity funds show similar losses, with an average decline of 12.1% for the first six months of 2002, and a 7.3% decline in June.
Within the domestic fund universe, small-cap value funds continue to outperform, as they have for last two years, although the category’s 3.9% loss in June suggests some difficulties. Nevertheless, small-cap value’s June decline was the smallest loss among the nine U.S. stock-fund categories.
Fund Investment StyleMid-Year 2002: Returns (%)
Large-Cap Growth Average-17.83%
Large-Cap Value Average-9.29%
Large-Cap Blend Average-13.57%
Mid-Cap Growth Average-15.03%
Mid-Cap Value Average-3.07%