Wanted: good news to save mutuals' eight-year bull run

News Analysis: Until July, the US funds were attracting $20bn a month

AMERICA'S mutual fund industry, for so long the humming engine of the bull market on Wall Street, is suddenly starting to splutter. Indeed, when all the sums are done, August may show a net outflow of money from the equity funds. That would be first negative month since September 1990, nearly eight years ago.

No wonder managers of the funds, many of whom have never had to deal with a market that is going south, are having kittens. And, for now, there is little they can do except watch and pray that the investors who have kept them flying for so many years ignore the gloom and come back to the party.

"It's hand-holding time right now," one leading manager on Wall Street sighed yesterday. "Our greatest fear is that this goes on long enough that the public will start to go sour on us. Then, who knows what will happen."

How individual investors in America react to the current turmoil is critical to what happens next. No less than 59 per cent of all stocks in the United States is held by households, and much of that investment is directed through the mutual funds. Since 1991, the funds have taken in a flabbergasting $1.1 trillion. Even until July this year, they were attracting $20bn or more in fresh cash every month.

The good news is that so far, there is little evidence of panic. Either because they are not ready to believe that the bull market is really over or because they early on that they were ready to ride out the bad times with the good, large numbers of investors are so far resisting the urge to sell outright.

The evidence that sentiment is worsening, however, is inescapable. With the Dow Jones industrial index down nearly 14 per cent since its 17 July peak, the impulse to get out, by shifting, for example, to fixed-income securities or to money-market funds, can only get stronger. American investors have not witnessed a slide in stock values of this magnitude since the 21 per cent drop suffered during the 1990 Gulf War.

And crucially, while some may for now be holding on to their stocks, few seem moved to see a buying opportunity in the recent slide. Only if investors decide to buy on the dips can there be any realistic chance that the swoon in the Dow will turn out be a correction instead of the start of a real bear market.

With the help of a baseball analogy, Michael Moldar of Salomon Smith Barney commented: "I think the consensus is rolling around that we're in the second inning of a bear market rather than the ninth of inning of a correction".

Some analysts warn there is far worse to come, like Steve Leuthold, a long-time money manager in Minneapolis. He believes that even with the recent slide, US stocks are something like 35 per cent overvalued. "It continues to be one of, if not the most, overvalued equity markets of all time," he suggested, adding that the Dow industrials could fall to 5,000 before the valuations are back in line with earnings. "If we move to net redemptions of mutual funds on a consistent basis, it could happen awfully quickly."

Unless the Dow picks itself up quickly, there is a clear risk that the pace of redemptions will begin to snowball, especially as investors, who have become accustomed to gains of 20 per cent a year, see how far back some of their favourite funds have dropped. As of the end of last week, at least four the largest US fund companies were confirming net withdrawals by investors, including Boston-based Fidelity.

Lipper Analytical, which tracks fund performances, notes that more a third of its fund categories are now off by more than 10 per cent from their highs. That alone, says Michael Lipper, is an indication that "we have elements of a bear market."

Fund managers are attempting to reassure themselves, and their clients, with the mostly good news offered by America's domestic economy. They point out that more than 70 per cent of economic activity in the US derives from households, where, for now at least, the picture remains overwhelmingly positive. Consumer confidence is still high, in spite of the current market crisis. The employment statistics are stellar - just about anyone who wants a job in America has one - and income levels are at historic highs. Nor, with inflation still at bay, is there any obvious pressure on the Federal Reserve to raise interest rates.

Perhaps the most upbeat of voices on Wall Street is that of Abby Cohen, investment strategists for Goldman Sachs. She believes it cannot be long before investors begin to buy up some of the drooping stocks, notably in the financial and technology sectors. "If investors are inclined to raise a little cash, they look to sell the stocks that have gone up a lot," she commented. "But we think that the change in fundamentals has been dramatically overstated".