Holding Out Hope for the Long Term
Investors Count on Revival

By Nancy Trejos
Washington Post Staff Writer
Sunday, September 14, 2008

Robert Loest recently picked up shares of Bank of New York Mellon for his Integrity Mutual Funds portfolio on the theory that it was sound enough to survive the housing crisis.

"I'm willing to gamble, just a little bit," said Loest, senior portfolio manager for the funds, which are based in North Dakota and have $36 million worth of assets.

Loest and his partners got the shares for $36.44 each just a few weeks ago. On Friday, the stock closed at $39.95. Loest said he's "tickled to death" but terrified because he has no clue what next week will bring given how unpredictable financial stocks have been.

"I'm not feeling confident about anything," he said. "I look at this every day and watch the market go down and wonder, 'Why am I in this business?' "

It's a familiar refrain among investors these days. As the credit crisis slowly and painfully plays itself out, market players are steeling themselves for continued volatility in the short-term. But for the longer term, they are counting on an eventual easing of the crisis and a turnaround in the economy to revive their investments.

Since January, the government has repeatedly stepped in to contain the damage from the subprime mortgage meltdown and subsequent credit crunch. Each effort -- a sharp cut in interest rates, the rescue of Wall Street icon Bear Stearns, the initial promise to prop up Fannie Mae and Freddie Mac and this week's takeover of the mortgage giants -- resuscitated the stock market. Hopes rose that the worst was over. But the rallies were fleeting.

"The actions you see, they feel good, they look good, they sound good," said Morris R. Segall, president of SPG Trend Advisors, an economic research firm in Baltimore. "You get this initial high, a jump in the market, and then reality sets in. There are false hopes. Investors buy in and think, 'this is it,' and then they get disappointed when their expectations aren't met."

The uncertainty has created two types of investors, those who are retreating and those who are buying shares in battered sectors, particularly financials, on the assumption that the cheap stocks will pay off later.

"What we've got in this market is people saying, 'Gee, it really is a bargain. Let's go around and bottom feed,' " said Brett Hammond, chief investment strategist of financial services firm TIAA-CREF. "[There are] other people who say . . . 'The broad equity indices are down 12, 13, 14 percent. I'm giving up and doing more immunization.' "

In the past month, Bernie McGinn, president of McGinn Investment Management in Alexandria, bought shares of Goldman Sachs and increased holdings in Bank of America for his $60 million fund. His fund also owns shares of insurance giant American International Group, whose stock lost 31 percent Friday on concern that it may need a big infusion of capital. McGinn says he is comfortable that Bank of America and Goldman Sachs will survive the credit crisis because they are such institutional giants. AIG he is less pleased with.

"From a longer-term perspective, I think everything is fine," he said. "From a shorter-term perspective, especially AIG, I wish I had waited."

Michael Roden, on the other hand, took money out of the stock market when it became obvious to him earlier this year that the subprime mortgage crisis would not abate anytime soon. "Around January through March, there was a real scare period," he said.

The Leesburg satellite industry consultant moved all $120,000 of his 401(k) retirement account out of an S&P 500 index fund, a foreign stock fund and a bond fund. He put two-thirds into a money-market account and the rest into gold and a foreign currency fund. "I feel good about it because I think the stock market is going to be a lot lower six months to a year from now," he said.

Many investment strategists, however, caution against taking either extreme approach. Instead, they advise holding tight or rebalancing your portfolio if you think you're overly invested in any particular area. "That's a superior approach than always trying to look around to time the market or panic," Hammond said.

Even those investors who parked their money in mutual funds to avoid the hassle of picking specific stocks are feeling the pain. Many mutual funds, mainly financial sector and value funds, had shares of Fannie Mae and Freddie Mac among their portfolios.

The top 10 mutual funds with the biggest combined percentage of their portfolios in Fannie Mae and Freddie Mac are down double-digit percentages year to date, according to a Morningstar analysis. The Fidelity Select Home Finance Fund, for instance, had 17.01 percent of its portfolio in Fannie Mae and Freddie Mac and is down 42.84 percent. With 11.79 percent in the two mortgage companies, the Touchstone Large Cap Value Fund is down 37.02 percent.

"I've been in the business for 20 years," said Ronald J. Rough, director of portfolio management for Financial Services Advisory in Rockville. "I would say it's probably the most challenging environment I've been through . . . There's nothing that looks attractive right now."

Analysts and economists said the stock market would not calm down until home values began rising and unemployment dropped. What's more, the extent of mortgage losses at many of the nation's banks is still unknown.

"The game is more complicated than hide-and-seek. You're dealing with a situation where many of these losses are still unknown," said Christopher Thornberg, a principal at Beacon Economics, which does regional economic forecasting. "It could take a year, 12 months, 15 months to figure out."