With Main Street on Sidelines,
The Stock-Market Rally Stalls
Spooked by Scandal, Losses,
Individuals Now Play It Safe
By E.S. BROWNING and IANTHE JEANNE DUGAN
Staff Reporters of THE WALL STREET JOURNAL
David Thomas MacMillan had had enough.
So first thing last week, the 66-year-old retired Boeing marketing executive fired up the laptop computer in the bedroom of his Seattle home and started attacking his stock portfolio. Owens Corning shares were the first to go. Then, a real-estate-investment trust, then Capital One Financial, a credit-card issuer.
By the end of the week, Mr. MacMillan had sold more than $30,000 of stock and was considering more cuts before the end of the year.
For the onetime true believer, whose nest egg over the years has been 90% dependent on stocks, the change of heart has been building over months, and finally crystallized two weeks ago, when the stock market once again began to sink. "I'm gun-shy," he says. "It's hard to know what to trust right now. Everything's been lousy."
After fueling the mania when stocks were hot in the 1990s, individual investors such as Mr. MacMillan are having the opposite effect now that stocks are struggling. Burned by a collapse of the tech stocks they once adored and dispirited by the accounting and Wall Street scandals that followed, individual investors have turned into the stock market's ball and chain, holding it back, even as the pros talk about a rebound.
Rob McIntosh, a family-practice dentist in the farming community of North Jackson, Ohio, says that a 40% drop in his retirement account prompted him to stop buying new stocks entirely in recent months. "I think I'm like a lot of investors. I am just holding cash right now," says the 47-year-old, who once hoped to retire on his profits by the time he was 60. "I just don't have any confidence right now. I don't have the heart for it."
The reluctance of individual investors to buy into the market recovery comes from earlier rallies that faded, and from a general sense that efforts to clean up the system aren't really changing things much. Many professional investors have returned to the fray -- especially big hedge funds, which are private investment partnerships that tend to make risky short-term bets. But Main Street has stayed home, starving the market of momentum. That helps explain why the stock runup that ran from early October through late November, in which the benchmark Dow Jones Industrial Average rose almost 23%, couldn't be sustained. Indeed, stocks last week fell for a second consecutive week, leaving the Dow down 5.6% since it peaked the day before Thanksgiving.
Skeptics such as Mr. MacMillan and Dr. McIntosh are having a powerful impact: So far this year, U.S. stock mutual funds have received only $7 billion in net new money, down from $59 billion at this point last year and $180 billion at this point in 2000, according to figures compiled by investment strategist Thomas McManus of Banc of America Securities. That's the lowest level of new money moving into stock funds in more than a decade. Investors in September and October took more money out of stock funds than they put in, according to the Investment Company Institute, a mutual-fund trade group.
Individuals are putting more money not only into bonds but also into simple cash accounts, despite the paltry interest payments those accounts pay. Bond funds have pulled in $126 billion so far this year, the highest level of bond-fund investment in more than a decade. And according to a study by New York brokerage firm Miller Tabak & Co., individual investors have more money in cash than usual. They have about 12% of their combined holdings of cash, money funds and stocks in either cash or money funds. That is the highest cash level in a decade, and more than twice the level at the height of the bull market in March 2000, when investors were heavily invested in stocks.
'Just a Casino'
The exodus of Main Street money has many pros nervous about when -- and to what extent -- they will return. "I worry about bringing the individual investor back," says David Briggs, head of stock trading at Pittsburgh mutual-fund group Federated Investors. "The more we jerk people around, the more you hear comments like, 'This is just a casino, it is rigged against us, I don't want to own stocks.' "
That leaves mostly professional money managers in the market, especially hedge funds and other speculators who move rapidly in and out of investments they think will perform the best over short periods. "About the only thing that is driving it in my opinion is aggressive professionals like hedge funds," says Phil Roth, chief technical analyst at Miller Tabak. "Those guys have no staying power. They will run for the hills as soon as they see a sign of weakness."
Hedge funds this year have come to represent a growing share of stock-market volume. As a rough estimate, Mr. Roth points to program trading -- computer-driven trading that typically involves a large group of stocks being traded at the same time. Hedge funds are heavy users of program trading, and program trading has accounted for more and more of total volume, Mr. Roth says. Based on figures from the New York Stock exchange, program trading now accounts for about one-third of all trades, Mr. Roth notes, up sharply from 23% last year.
Analysts say they also can see hedge funds' fingerprints on the kinds of stocks that are gaining the most. Many are faded stars such as Nortel Networks, Corning and Lucent Technologies, which many money managers fear have little immediate prospect for a business recovery and are going up mainly because bottom-fishing hedge funds are betting on a short-term pop. That could make it hard for the current rally to continue.
"It took the public years of witnessing a bull market to get excited about stocks and it will take that again now," Mr. Roth says. "We will have to see months of a bull market before the public decides to move money back to stocks."
Many analysts date the disaffection with stocks to the corporate scandals that intensified last summer, when investors watched televised images of government agents leading corporate chiefs away in handcuffs. It was all too much for Ted Gorman, the owner of a Winterset, Iowa, newspaper. He blew a gasket this summer over the corporate corruption -- and also over the declines in some of his utility stocks, which he had considered safe. Mr. Gorman owned stock in American Electric Power Co., a utility that seemed solid until Enron Corp. melted down and a series of power-trading scandals slashed stock values.
"It was like AT&T or GM, a safe stock," he says. But from mid-April through mid-October, that safe stock dropped 60%. "It was like watching your house burn down," he says.
Now, after 20 years of investing, he has pulled out.
"I am on the sidelines," says Mr. Gorman, 48. He sold most of his stocks and mutual funds, as well as stocks and funds owned by his aging mother -- a portfolio that he figures was valued at around $400,000 in all.
He says that even the bump in stocks since October hasn't restored his confidence in a market he now considers dishonest. "People are falling for the hype, the salesmanship," Mr. Gorman says. "I am a hard-core Republican. But I am pretty disappointed in Wall Street, their ethics, their conduct, their living high on the hog."
There's a danger that if investors wait too long to get back into stocks, they will miss out on the opportunity to buy shares on the cheap -- a mirror image of what happened during the boom, when many investors delayed getting into the market until its peak.
Some longtime money managers look back nervously to the 1970s, when a stock bubble followed by a series of failed rallies disillusioned many ordinary people, who gave up on stocks for at least a generation.
"It is going to take time -- a period of months -- to get the public to do any buying," says Alfred Kugel, senior investment strategist at Chicago investment-management firm Stein Roe Investment Counsel, who has been in the business since 1953. In the late 1970s, double-digit interest rates made bank deposits a real alternative to stocks. Today, interest rates are below 2% and some money funds are losing money, when fees and taxes are taken into account. Although some people are switching to real estate, Mr. Kugel thinks disillusioned investors will find few alternatives and gradually will begin returning to stocks, making this decade different than the 1970s.
"I think it will be easier to tempt them back in," he says.
A number of stock analysts, including Mr. Kugel and Mr. McManus of Banc of America Securities, think the recent rally can continue into the new year despite the tepid Main Street response, as long as the economic recovery holds up.
Tiptoeing Back
And some individual investors are tip-toeing back. But it tends to be in halting steps, at best. Many investors are simply frozen -- not doing much more selling, but not buying any new stocks either. "I know so many people whose portfolios were wiped out and couldn't get back into the market if they wanted to," says Kevin Sullivan, a 45-year-old computer-software writer in West Newbury, Mass.
Mr. Sullivan is among the investors hanging on -- though just barely. After selling tens of thousands of dollars in tech stocks, Mr. Sullivan has kept a few blue chips, such as Johnson & Johnson and General Electric. But he says he plans to buy no more.
"I'm going to lay low for a while," he says. "Even though the market seems like it's doing better, I don't trust it. It seems like every day there's a new major corporation that has some type of accounting irregularity. It makes me feel uncomfortable."
Mr. Sullivan was doing so well in the stock market for a while that he thought he would retire by age 50. He didn't use a broker; he could pick a stock and it would go up. He even made some money on initial public offerings, such as Linux and Red Hat.
"Now, I'm looking at retiring at age 70 or 75," he says.
What most unsettles professional analysts is that Mr. Sullivan and many others like him say it will take a long time for their wounds to heal. Some people who began investing during the boom say it's since become clear that they are cogs in a much bigger machine, and one that doesn't always reflect their interest.
For that to change, individual investors say they'll need to see a more sustained recovery in solid, blue-chip stocks, not just a short-term rally led by volatile tech shares.
Dr. McIntosh, the Ohio dentist, says he and his wife might be willing to venture gradually into stocks again someday, but "I probably would not do anything in the tech market at all right now."
As recently as last year he was still hopeful of recovering his losses, but no longer. "I really tried to feel, 'Hey, wait a second, these are really great companies. They should recover,' " he says. "But none of them survived. All of them took the same beating one by one."
Write to E.S. Browning at
jim.browning@wsj.com and Ianthe Jeanne Dugan at
ianthe.dugan@wsj.com
Updated December 16, 2002
