Ever see a movie, or hear a song, and think to yourself, “I’ve seen or heard this before?”  Well there is a new “movie” coming to Wall Street and I know I have seen it before.  In fact, I saw the movie 50 years ago!  One of the advantages of longevity is that you get to experience many things twice.  This soon-to-be released movie is about a bear market in fixed income ... and what really happens.  The “new” movie will have two surprising plot twists; the length of playing time --- bear markets play out over decades not months --- and its surprising effect on stock portfolio performance --- it’s actually favorable for active managers and will be --- if the past is any guide --- quite negative for index funds. 

The time line involved in this directional change in the fixed income market --- from bull to bear --- is beyond most individual’s life experience or even conception.   Consider first that bear markets in stocks average just nine months.  Even secular stock bear markets such as 1973-1974 or 2008-2009 lasted just two years.  However, secular bear and bull markets in fixed income last for decades! 

I entered the investment business in 1965.  That year would prove to be a top in the market for 17 years.  From 1965 to 1982 the stock market went through five cyclical bear and bull markets and went NOWHERE.  Why?  It was a period of rising interest rates.  Fed funds climbed from 4% to 16%! Today Fed funds are 00.25% … climbing to?  Even just 1% would be a fourfold increase.

In 1965 I was sitting in a conference room at Estabrook & Co.  At a table in the front of the room was Oaks Spalding --- a Boston scion --- expounding on how great an investment Allied Chemical was with its high dividend.   Spalding, like all Boston Brahmins at the time, wanted a return on his money.  It had been that way since the crash of 1929.   Stocks had yielded more than bonds because they were deemed riskier.  I didn’t listen to Spalding because I didn’t have anymoney.  I was looking for a way to make money.  And in the late 1950s there had been a paradigm shift towards what would become known as “growth” stocks.  That was what I wanted to own.  Growth stocks could make you money. 

So much money, in fact, mutual fund growth managers began to become cultural icons.  They were called “gun slingers.”  Books, like “The Go Go years” and “The Money Business” were written extolling their stock market prowess.  Managers such as Roland Grimm, Jerry Tsai, Peter Lynch, Joe Mc Nay, Fred Alger et al. became, essentially, celebrities for beating the S&P 500.  I’ve had lunch with Joe Mc Nay many times when people, whom he did not know, came over just to shake his hand.  These managers also became very, very rich!  Again, it was a period of rising interest rates.

Nomura strategist Joe Mezrich recently examined mutual fund performance data from the University of Chicago.  He discovered mutual fund outperformance from 1962 to 1981 (the top of interest rates).  That’s 20 years.  The industry then underperformed during the past 30 years of falling interest rates.  That goes against all conventional wisdom.  But then consider that phrase.  It’s oxymoronic.

Francis Patrick Boland