How have CREF funds performed recently? Correctn Since Drop Crctn
So far the 4th quarter of 1996 is shaping up as the best in a long time. Since the correction bottom on July 24, we've gotten a year's worth of growth in less than 4 months. It is interesting that the biggest laggard so far this quarter has been the Russell 2000, an index of small capitalization stocks, while the biggest gainer has been the Dow Jones Industrial Average of 30 large capitalization stocks. Normally, as we move toward New Year's we would expect the small cap market sectors to outperform the large cap market sectors. In a market surge such as we've seen this month, we would also expect the CREF Growth Stock to be the market leader. While CREF Growth has certainly been the leader since the correction bottom on July 24, it has been outpaced so far in the 4th quarter by both the Social Choice Account and the Equity Index Account. If this trend continues, it is probably not a good sign. As a caveat, however, we made the same observation last February when it was apparent that the big cap stocks had outperformed the small cap stocks over the previous three months. When big cap stocks have outperformed small cap stocks during the October to February period, this has usually been followed by poor market performance over the following months. To be sure if you had sold CREF Stock at that point in February 1996, and you had been very lucky in your timing, you could have bought it back a few percentage points cheaper five months later. But for the year as a whole, this did not turn out to be a very good predictive tool. Anyway, between now and February, we would like to see CREF Growth outperforming CREF Stock and we would like to see the Russell 2000 outperforming the DJIA. If this fails to happen, it does not necessarily mean that the great bull market is over. But it would certainly be a warning that something unexpected is going on in the stock markets.
On Aug 11, we noted that the market the previous week had experienced a surge of gainers over losers by a margin of 3.5 to 1 on two successive days and that the three months following such surges had produced average gains of 7.9%. We are now approximately three months from that point, and the CREF Stock account at its peak two weeks ago had gained 7.0%, while the S&P 500 had gained 7.3%. What impact will next Tuesday's election have on this minibull move? Frankly we have no idea. The conventional wisdom is that the stock markets have discounted a Clinton victory, and they expect the Republicans to retain control of at least one if not both houses of Congress. Most commentators also seem to expect that the markets would suffer a sell off if the Democrats regained control of Congress. If control over Congress were in doubt following the election (most likely due to some redistricting problems in Texas) and it took a month or more to resolve the issue, it also seems likely that the markets would react negatively. Normally, one would expect a nice rally from before Thanksgiving up to early January. After that, however, (or even before that if the rally fails to materialize), there are many reasons to be cautious. We'll mention some of those in the next commentary.
After running out of steam in late August, the recovery rally resumed last week. All of the CREF accounts except Bond and Global Equity closed the week at alltime highs. Following the pattern that has prevailed most of the year, the leading CREF accounts on the upside have been the Growth and the Equity Index funds. These were also the funds that got hit the worst on the downside during the May-July correction. The bulls appear pretty happy now and have found some new arguments to buttress their case. It appears that the markets general move up significantly during the period from the close political conventions to election day during years when the incumbent party retains the White House. The bulls are also happy that mutual fund inflows have picked up again in the past few weeks, and low inflation news appears to have dampened fears that the Federal Reserve Board will raise interest rates in September. The Bears still worry about the market being overvalued, about the fickleness of mutual fund cash flows, about the possibility of interest rate hikes before long, and about the possibility that foreign central banks will repatriot some of the huge amounts of money that they have deposited in the U.S.. And, of course, we all know that presidential election years are followed by post-presidential election years. The record for market advances isn't nearly as good in the first years of presidential administration as it is in the years when presidents get elected.
It looks as though the snapback rally has run out of steam. The rally peaked in the week ending August 23, and as of this writing on early Tuesday morning (Sept 3), the markets are still headed down. For those hoping for the bull market to continue, it is a bad sign that none of the indexes took out their May 1996 highs. It will be even a worse sign if they drop below their July 1996 lows. The best CREF performers in market drops continue to be the Money Market and TIAA Real Estate funds.
It is useful to compare the performance of CREF funds with other benchmark indices. An especially useful number is the fund's performance from the May 24 peak (on the DJIA) to what so far is the low point (July 24) of the recent correction. If you are worried about a prolonged market slump, this number should give you some idea of the riskiest funds and safe havens (if any). Clearly, the high tech laden OTC Composite and the small stock Russell 2000 were the riskiest places during the market drop, along with the CREF Growth Fund, which declined 10.2%. The most lucrative places were the TIAA Real Estate fund with a 1.5 percent gain while the market dropped and the CREF Money Market Fund which rose 0.9%. On the other hand, if you think that the correction is over and the bull market is about to resume, the right hand column shows shows the best performing funds on market rallies. Honors go to the Growth and Equity Index Funds with snapback returns of 9.2% and 7.6% respectively. Year to date, CREF Growth is the highest performer. It had chalked up a substantial gain before the correction trimmed its performance, but it is still ahead 10.9 percent for the year thru August 19. The funds that may bear the most watching right now are the Bond and Global Equities Fund. After a dismal first half of the year, the Bond Fund has rallied sharply the past few weeks and is now in positive territory for the quarter. If the peak in interest rates has been reached, expect the Bond Fund's rally to continue. Global Equities Fund lagged the other equities funds last year and has been in the middle of the pack of CREF funds so far this year. The dollar has been declining against other currencies over the past month, and if the dollar stays weak, Global Equities should do well. But if the dollar resumes its upward move, that could put pressure on Global Equities. CREF hedges its overseas investments against currency fluctuations. Nevertheless, CREF Global Equities seems to be influenced by the movement in currencies.
In sum, in the current market, CREF Growth has been the best performer when the market rises but the worst performer when the market dips. The Money Market has been the safest place to be, but it will never make you rich. TIAA Real Estate has been the best compromise place to put your money so far this year, having enjoyed better than Money Market performance on the upside and having avoided the downdrafts. However, we don't know enough about its investments or how it prices them to be sure that it is the safe haven that the Money Market Fund is or that TIAA Traditional is. The biggest disappointment in the first half clearly was the Bond Fund, a casualty of rising long term interest rates. Those rates seem to be leveling out at the moment, and if they decline from this point, the Bond Fund should do well. A caveat on the market's current prospects. Equity mutual fund cash inflows have dropped dramatically since the stock markets peaked in May. This is not a good sign.
Commentary from August 11. Where the market goes from here is anybody's guess. 1996 is a presidential election year, and the markets usually do well up to election day. On July 27 we said this: "This tendency could be bolstered by a snapback from the oversold condition of the market due to the recent sell off and the correction since late May. From a technician's viewpoint, the market may have made a double bottom this week. On two occasions, over the past two weeks the S&P 500 dropped to the 615 level intraday and closed about the 625 level. There is a good chance that it will rally from this point." A sharp rally in fact occurred, although it petered out last week. No one can predict whether the rally will continue, but exlosive moves on Thursday and Friday two weeks ago are certainly a good sign. On both of those days advances on the NYSE led declines by better than a 3.5:1 ratio. Back to back days of this magnitude are very rare, occurring only 15 times in the last 34 years. On 13 of those 15 times, the S&P500 was higher three months later. The average gain was 7.9%.
Whether the market repeats this historical pattern, we'll just have to wait and see. Three months takes us up to election day. And for the intermediate term beyond election day, it is hard not to have a little skepticism. Even given the damage done by the current correction, this market is still overextended and overvalued by some important historical meansures. This is one of the longest running bull markets to have occurred without a significant correction. One would normally expect to see a 10% correction in the S&P500 every few years, but this has not happened since 1991, although it came very close in July. At their peaks, the DJIA and S&P 500 sported the lowest dividend yields of the century. The years following presidential elections have sometimes been rough for the stock markets (1981 -.97%; 1977 -11.5; 1973 -17.4; 1969 -11.4). And for some strange reason, years ending in 7 have usually been mediocre (1947 0%; 1957 -14.3; 1977 -11.5; 1987 +2.0). Pessimistic commentators predict that the bull is about to end with a crash. U.S. Government deficits are heavily dependent on the willingness of foreign banks to buy U.S. Treasury debt. At some point foreign banks may liquidate their positions in U. S. Treasuries, and that would drive up interest rates in the U. S. bond markets, say the pessimists. Indeed it was a good employment report on Friday July 5 that raised the specter of inflation and higher interest rates that spooked the market into its big drop that day.
The optimists argue that historic valuation measures are obsolete because major technological and economic changes are going to usher in an era of low inflation, low interest rates, and steady economic growth that will keep the equity markets booming in perpetuity. In addition, the oldest baby boomers have now turned 50, have gotten the message about the need to save for retirement and are dumping money by the billions into their 401(k) and 403(b) retirement accounts. Even if the market gets a correction this year or next, say the optimists, this flood of baby boomer money over the next ten years will assure a lucrative stock market.