stock indexes don't reflect reality fo the market

At dinner the other night the conversation turned to investing.

"I've got to call my broker," a friend said. "The indexes are hitting new highs and I'm not making any money."

Reality strikes again. And my friend wasn't alone.

A whopping 90.16% of all U.S. stock funds not counting those that invest in just one market sector did not perform as well as the Standard & Poor's 500 Index during the first quarter of 1995, according to Lipper Analytical Services Inc. of Summit, N.J.

The average U.S. stock fund had a total return of 7.16%, including reinvested dividends, for the first quarter. But the S&P 500 showed a return of 9.73% more than two percentage points higher.

And the Dow Jones industrial average was close behind the S&P index with a return of 9.20%. Not Everyone Making Money

Just because the "senior indexes" are soaring doesn't mean everyone makes money, said Bill Mahoney, chief investment officer at Reinhart Mahoney Capital Management.

Neither the Dow nor the S&P 500 accurately represents the average investment portfolio, he explained.

A mere 30 companies all of Leg 1 ends here them large make up the venerable Dow index. The index is weighted by price, meaning more expensive stocks have a greater impact on the index than cheaper ones.

"The Dow is simply outdated as a measure of what most investors are realizing," Mahoney said.

The S&P 500 a benchmark that gets more respect from investment professionals is weighted toward big companies with a large market capitalization. The 100 biggest companies in the index make up two-thirds of its value, said Bill Warnke, partner at Merit Investment Group.

"Most portfolio managers are more broadly diversified and not weighted like the S&P," Mahoney said. `Closet Weighters'

Many portfolio managers are "closet weighters," paying close attention to the way the S&P benchmark is designed, Warnke said.

They realize their clients also are paying close attention to how their investments are doing in comparison with the index.

Even so, most portfolio managers' industry weightings weren't in the right places during the first quarter, Warnke said.

Most individual investors who pick their own investments don't weight their portfolios at Leg 2 ends here all, Warnke said they buy stocks without worrying about matching or beating an index.

"They don't say Exxon is a certain percentage of the S&P, so I'll make it that percentage of my portfolio," Warnke said.

First-quarter stock price increases were dominated by large company stocks, Warnke said. He and Mahoney believe that when big company stocks outperform small company stocks in one quarter, many portfolios are bound to come in below the averages.

"When the rally broadens to include a lot more stocks, then the portfolio managers will generally outperform the averages," Mahoney said.

Foreign investors may have been a factor in how well large company stocks performed in the first quarter, Warnke said. Problems in the markets of other nations such as Mexico likely frightened foreign investors.

"If they get worried, foreign investors tend to gravitate toward the U.S. stock market and toward large company stocks," he said.

Index numbers also can be deceiving because they represent a relatively narrow range of stocks, said Marv Swentkofske, president of Summit Investment Management Ltd.

Only 26 of 111 industry groups outperformed the S&P during the first quarter, he said. Leg 3 ends here Those 26 groups fall into five categories: technology, health care, transportation, financial and oil-related.

"If you weren't overweighted in those areas, there would be very little opportunity to outperform the indexes," Swentkofske said.

He believes the indexes reflect a rotating market where price movements have been bouncing from one industry group to another. Of the 26 groups that outperformed the S&P 500 in the first quarter, for example, just nine outperformed the index in the previous quarter.

Technology stocks represent about 11% of the S&P 500, and they were up about 14% in the first quarter.

"If you weren't there, you missed out on a big chunk of the market," Warnke said.

That doesn't mean investors who owned few technology stocks in the first quarter should run out and buy them now.

"The technology group has a great deal more risk than the market," Swentkofske said. "And after a good quarter, the eventual decline will be even greater."

Technology stocks are expensive and their prices tend to drop during the summer, Mahoney said.

"From April to October, it's a little dicey," he said.

Copyright 1995
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