Quarterly mutual funds report

Fed's signals disconcerting

July 09, 2006|By LAURA SMITHERMAN | LAURA SMITHERMAN,SUN REPORTER

For years Wall Street had hoped for clearer signals from the Federal Reserve on the future of the nation's monetary policy.

They got their wish with the retirement of longtime Chairman Alan Greenspan, who was known for what could be called the financial equivalent of speaking in tongues. February marked the ascendancy of plain-spoken Ben S. Bernanke as the new chief.

But mutual fund investors might be pining for the old days and just assume Bernanke had kept his mouth shut.

After a volatile springtime on the market, when Bernanke's rhetoric on inflation sparked both a huge sell-off and a smaller rally, stock funds ended the second quarter down 2.7 percent and bond funds finished relatively even at plus 0.2 percent, according to mutual-fund tracking firm Lipper Inc.

Among more than 250 Maryland-based mutual funds, only about two dozen funds that invest in stocks posted positive returns, while most bond funds had lukewarm returns within 1 percentage point of zero, a survey by Bloomberg Funds shows. Stock portfolios concentrated in the energy and utility sectors tended to fare better, while T. Rowe Price's foreign bond fund far outpaced the fixed-income pack with a 3.1 percent return.

"The biggest issue in the second quarter was uncertainty, and I think the market looked to Chairman Bernanke for certainty, and they didn't get it," said Sharon L. Stark, chief fixed-income strategist at Stifel Nicolaus & Co. in Baltimore.

"This was a case of be careful what you wish for," Stark said.

A look at the S&P 500 stock index from April through June shows peaks and valleys that correspond to every move Bernanke made during that time - on the job and out on the town.

In April, investors cheered, and the index bobbed upward, when minutes of a Fed meeting indicated that the central bankers believed an end to their two-year credit-tightening cycle might be near. Bernanke confirmed a pause in interest-rate increases might have been in the works when he testified before Congress later that month.

Then trouble started brewing in May. Bernanke reportedly told CNBC anchor Maria Bartiromo that he wasn't necessarily done raising interest rates. The one-on-one chat occurred at the annual black-tie dinner for White House correspondents. Bernanke later acknowledged to Congress that he had made a mistake in chatting up Bartiromo.

When the Fed met and raised interest rates days later as expected, investor hopes were further deflated when the central bank didn't also announce it was done pushing rates higher. Instead the Fed indicated it might, or might not, continue with the increases.

From mid-May to mid-June, the S&P 500 plunged more than 7 percent. After a placid time on the markets last year, when the index of larger companies was up 3 percent, investors were spooked. Charles vK. "Chip" Carlson, who manages the Greenspring Fund in Lutherville, said investors have been nervous because they don't trust Bernanke as they did Greenspan.

"People believed in Greenspan so passionately that they gave him a pass, so to speak, whereas it seems now the jury is still out on Bernanke," Carlson said. "It's like he's driving a car and swings the wheel to miss something in the road and then overcorrects by swerving in the other direction."

By raising rates, the Fed slows the economy by increasing borrowing costs for businesses and consumers to ensure that inflation doesn't become a problem.

Two camps of investors formed in recent months with different takes on the Fed's inflation-fighting abilities, said Kevin A. McCreadie, chief investment officer at Mercantile Bankshares Corp. of Baltimore. There were those who believed that the Fed was going soft on inflation despite signs that it was heating up, and there were those who believed the Fed would clamp down too much and hurt the economy.

Don Cassidy, an analyst at Lipper, said in a research note that the market downturn "took a painful toll on both investors' wealth and their moods." He said mutual funds might suffer as skittish investors moved their money into certificates of deposit and other savings accounts, some of which are paying interest of more than 5 percent.

Investors appear to be pulling away from mutual funds. According to Financial Research Corp., the 25 largest mutual fund companies took in $5.3 billion in May, the latest month for which figures are available, compared with $31 billion in April and $18 billion in May of last year.

But the market started rebounding in June when Bernanke gave another speech, this time in Chicago to a group of economists. He vowed to be vigilant against inflation but differentiated between inflation that is driven by higher energy prices, which are dictated by global demand, and inflation expectations that presumably could be manipulated by the Fed. By the last day of the month, the S&P 500 was up about 3 percent.

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