BY THE WONDERFUL LOGIC of market contrariness, it figured that 2003 would be stocks’ year.
As 2002 ended, the smart money had given up on the stock market. Sure, the sages acknowledged, there might be occasional rallies. But after the bursting of the Internet bubble, stock returns were going to be subpar for years to come.
The way to play stocks was with two-way strategies that gave you a chance to profit when the market went nowhere or declined, not just when it rose. This meant putting your money in hedge funds or similar vehicles that invest on both the long and the short sides of the market, not those tired old “long-only” mutual funds.
Well, according to U.S. indexes calculated by Van Hedge Fund Advisers, two categories of market-neutral hedge funds posted gains of 5.1 percent and 2.7 percent in the first seven months of 2003. Funds of funds, which combine multiple hedge funds in a single portfolio, were up 6.7 percent.
Over the same stretch, the average equity mutual fund as tracked by Morningstar Inc. gained 15.4 percent. So much for the new sophistication.
This proves nothing, I hasten to say, about the inherent long- term superiority or inferiority of either mutual funds or hedge funds. Seven months is a short time.
Besides, hedge funds come in all shapes and sizes, including some that dwell quite comfortably on the long side of the market. Aggressive-growth hedge funds, Van tells us, gained 16.8 percent from Jan. 1 through July.
What it does demonstrate, for the umpteenth time in modern financial history, is the folly of relying on recent investing results to decide in which asset class or type of investment vehicle to put your money. Everything known and expected is already reflected in market prices. So what happens next is inherently unpredictable.
This pinpoints a problem with research that seeks to determine from past performance how any given asset class behaves. Whenever wise heads concur on some characteristic, the behavior is probably about to change.
Much work has been done over the years, for instance, on how best to diversify a stock portfolio using either bonds or short-term money market securities.
This year neither long-term government bond funds nor short-term money funds have done much to distinguish themselves – from each other or from cash in the mattress. Broad-based bond index funds on average returned less than 1 percent through July. So did the average money-market fund.
One standard way to protect yourself against interest-rate risk is to hold both bond funds, which benefit when rates fall, and money funds, whose yields move up quickly after interest rates rise.
Alas, this isn’t much help when long-term rates climb while short- term rates stay low. As always, the markets found a way to confound us.
What now? To stay true to the contrarian creed, you have to be as suspicious of the new bullishness about stocks as you were when pessimism held sway.
Buying stocks with the Standard & Poor’s 500 Index at 1,000 is a different deal from six months ago, when it was around 800. Not necessarily a bad deal, but a different deal. “Stocks have climbed close to fair value, so our return outlook has come down,” says Ken Gregory in his No-Load Fund Analyst newsletter.
It can’t escape notice that investment advisers’ bullishness is up to 55 percent, and bearishness down to 18 percent, as tracked by the Investors Intelligence service, which calls the readings “worrisome” from a contrarian point of view.
A stampede of new money into stock mutual funds also may cause us a misgiving or two.
Fact is, it remains a distinct possibility that stock returns on a sustained basis will continue to disappoint for some time. If that’s what the market has in store, it would be typical of its nature first to get us thinking otherwise, by convincing us that a new bull run has begun.
Contrary opinion is a game everyone can play. Want to do your bit for higher stock prices? Keep telling yourself how bad things are.
Chet Currier covers the mutual fund markets for Bloomberg News. He can be reached at 212-318-2605.
