Magellan's manager explains fund's slide
IN LESS than a week in October, Peter Lynch had to cut short a vacation with his family in Ireland; watch the Fidelity Magellan Fund he manages lose more than a third of its assets; and explain why Magellan almost always does worse than the averages in a down market. Despite all this, Mr. Lynch remains optimistic about the future of Magellan - partly, of course, because of the way the fund is managed, but also because he thinks the United States economy is fundamentally strong and presents the companies he buys with ample opportunity for growth and profits.
The fact that the market, as measured by the Dow Jones industrial average lost more than 750 points in the four days ended Oct. 19 doesn't change that feeling, he says.
``The stock market ran up from under 800 [on the Dow] in August of 1982 to about 1,700 in September of '86,'' Lynch said in an interview. ``In four years, the market made a fairly good move from under 800 to 1,700, with a minor pause in '84.
``Then we had this incredible move of 1,000 points in 10 or 11 months. Now it gives up most of that thousand and people are really concerned. If it had gone sideways for the last year, everybody would say `Gee, it's had a big move and now it's going sideways and consolidating. That's a terrific sign.' We're almost back to where we were a year ago.''
Still, the size of the stock market's ``break'' - he never uses the word ``crash'' - did surprise him.
``If somebody told me the market would go down 1,000 points, I could see that. But not in six weeks, with over 750 of it in the last four days.''
Does the size of the break mean the US is headed for a recession, then?
``Boy, if I knew that, I wouldn't have to work for a living,'' Lynch says with a laugh. ``I could just be an economist. I really don't know what's going to happen.''
Maybe not, but sitting in his office in one of several buildings Fidelity Investments occupies in Boston's financial district, and sifting through the small yellow slips of paper he uses to keep track of stock prices, Magellan's record, and economic numbers, Lynch does not sound like someone who plans to invest for a recession.
``We've never had a recession in the last century when there was plenty of money around and low interest rates,'' he says. ``Every recession has had an inverted yield curve, where the prime rate is above long-term rates. We have a very standard yield curve now. There's about a 3 percent difference between short rates and 15- to 30-year money.''
``Recessions occur usually because interest rates go up, inflation accelerates, and the Federal Reserve tightens money'' - none of which he sees coming.
Even the federal deficit, which he says is a cause for concern, should be viewed in its proper context. And the fact that the stock market break Oct. 19 at least got the politicians in Washington talking about it was a positive sign.
``I think the fact that both sides of the government [Congress and the White House] think it's important we start reducing the deficit is the key,'' he says. ``Our deficit's not a huge item as a percentage of GNP [gross national product]. If we could get it going down ... if it just went down 10 percent a year for the next five years, ... it's the direction that's important. I would have liked to see them do more, but they're moving the right way.''
Speaking of government deficits, Lynch notes a very important positive sign that he says is often overlooked.
``Our state and local governments that ran up huge deficits eight or nine years ago are now running huge surpluses and reducing taxes. I remember when we were seeing horrible stories in Ohio, Massachusetts, and New York City. I mean, there were massive problems. The state and local governments are very solvent today.'' This solvency is a big help to companies in those areas, where black ink means less chance of a tax increase or may even mean a tax cut.
All of this does not mean Lynch believes the economy can or should continue barreling along in an expansion. He expects a slowdown, at least, and feels that would probably be a good thing.
``History would show that we'll probably have a pause,'' he says. ``Probably the stock market break would have had the greatest impact on business, rather than the consumer. With the level of employment now, the level of wages, and the low level of inflation and interest rates, it would be surprising to have a dramatic drop in consumer spending.''
Even if a ``pause'' does come, Lynch says, business is far better prepared for it now than it was in the recession of 1981-82.
``Companies that could be affected by recession are cutting the heck out of costs, and if the economy slows down next year, it's not like there's a bunch of chemical plants coming on, and a bunch of steel plants, and a bunch of electronic capacity,'' he observes. ``The last recession hit us with all this added capacity, new people entering businesses, companies with a lot of excess people. That was rugged.
``I think American industry is more prepared for a recession now.... That doesn't mean the stocks aren't going to do do poorly for a little while, but the decline should not be as violent.''
``The cost cutting is not just in automobiles and steel, the troubled industries. It's in banking, insurance, in health care, in the utility companies, in retailing, in food companies. It's a phenomenal thing that's going on.''
But cost cutting does not mean no new jobs, he hastens to add.
``In the last 10 years the largest 500 companies have eliminated a million jobs. But we've added 15 to 20 million jobs in this country. And that's without the government doing very much. It's a real powerhouse we've got here.
``Other countries have tended to protect their big companies with barriers. They haven't had a great venture-capital environment, a great environment for small companies. They've had relatively sluggish growth and higher unemployment.''
What about the powerhouse known as the Magellan Fund, an investment vehicle that had a 33.8 percent average annual total return from September 1976 until June 30 of this year, in which an investor could have watched a $10,000 outlay grow to more than $175,000 in that time?
Shortly after Oct. 19, there were several stories about some of the big, well-known mutual funds losing millions of dollars - billions, in Magellan's case - as investors frantically switched out of stock funds and into money market funds, bonds, or out of mutual funds altogether.
Although Magellan had lost more than $4 billion of its $12 billion in assets by the time the dust settled after Oct. 19, almost none of that was because of redemptions, Lynch asserts.
``We lost about a third and the market lost about a third,'' he says. All but about 2 percent of the drop in Magellan's assets, then, was nothing more than the smaller value of the stocks in its portfolio.
``A relatively small amount of money went out of the fund,'' he recalls, with some help from his yellow slips of paper. ``In fact, more money went out on the 16th [a Friday], the day before the break on the 19th, and a small amount went out on the 20th.
``Then we had net sales on the 21st, the 22nd, and big net sales on the 23rd.''
Most of those buyers must be used to the dives Magellan takes when the market goes down, but why can't it at least hold its own and keep what it gained?
Thirty to 40 percent of Magellan's stocks are the big ``blue chip'' companies, Lynch explains. The rest are in secondary stocks. ``That's where the public is, that's where you see the margin calls, people doing tax-loss selling, over-the-counter marketmakers worried about losing their shirts.'' When the market goes down, he says, these stocks often go down faster.
In any case, Lynch is not seeking shelter in cash.
``We've never tried to anticipate declines or anticipate advances. We're fully invested, at the bottom and the top.''