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June 29, 2003, 4:33 p.m. EDT

Fund Managers Have Trouble Embracing Stocks or Bonds

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By Ian McDonald

CHICAGO -- Whether they buy stocks or bonds for a living, mutual-fund managers don't seem to care much for either these days.

On Thursday stock- and bond-fund managers alike traded grim predictions for the bond market, but most couldn't muster much enthusiasm for equities either at the 2003 Morningstar Investment Conference in Chicago. Bond worries have bubbled for several months, but not this strongly.

"A bubble in Treasurys is no longer a question for debate," said Paul McCulley managing director at PIMCO and a colleague of Bill Gross, the fund world's most prominent fixed-income manager. "Bill and I have been agnostic about it. But I think you can't be agnostic anymore."

More on Funds Mea Culpa: After investors suffered wrenching losses during the bear market, it seems many mutual-fund shops are looking at how they research companies. But most won't admit it. Seven Questions: Fund manager Paul Wick is wary of steep valuations in the tech sector and hunts for health-care stocks.

Fixed-income funds have been in vogue with the Lehman Brothers Aggregate Bond Index averaging a 7.1% annual gain over the past five years, compared to a 1.4% annual loss for the Standard & Poor's 500-stock index. But after 13 interest-rate cuts by the Federal Reserve in more than two years, rates are the lowest they've been in more than four decades. Bond prices and interest rates move in opposite directions, so an interest rate increase would hack away at the value of bond funds that have come to play a large role in many investors' portfolios.

Believing that economy and inflation are set to rise, managers in Chicago said higher rates were on the way.

"When I look at bonds, I don't like the outlook," said Dan Fuss, manager of the $1.9 billion Loomis Sayles Bond Fund /zigman2/quotes/201878769/realtime LSBRX +0.43% . "The economy has strengthened and inflation will rise."

Equity investors chimed in too.

"I'll give you one word," said Bill Miller, manager of the $6.9 billion Legg Mason Value Trust Fund /zigman2/quotes/203623666/realtime LMVTX +0.99% , in summing a presentation. "Well, it's not one word. But I'll say this: Stocks and not bonds." Mr. Miller went so far as to liken the gush of money into bonds to the tech-stock boom at its peak. He wasn't the only one to do so, either.

"Rates will go up," said Byron Wien, senior investment strategist at Morgan Stanley, in a separate panel. "My belief is that the bond market today is where the Nasdaq was at 5000."

Mr. McCulley and other pros advised investors and financial advisers in attendance to focus on shorter-duration bonds to minimize their interest-rate risks.

Of course, the pros weren't gushing over equities either.

"The 15% [annualized] returns on stocks since 1981 are over," said Mr. Wien, who is known for often being bearish on stocks. "I'd expect 10% returns or less. That will still make equities very attractive relative to bonds."

Loomis Sayles' Mr. Fuss predicted a broad trading range for stocks with the top of that range being a few hundred points higher for the Dow Jones Industrial Average from its current position. The Dow closed at 9079.04 on Thursday.

That said, Mr. Miller did say stock valuations were relatively attractive. He also noted that stretches where stocks trailed bonds for five consecutive years often have presaged solid gains for equities historically.

Today's chatter underscored investors' current conundrum in building an asset allocation. After this year's rally stocks don't look cheap. The stocks in the S&P 500 trade at nearly twice their historical average valuation.

At the same time, the 10-year Treasury note is yielding only about 3.5% and money market yields at 0.6% on average according to money fund tracker iMoneynet.com . In slashing interest rates to boost a post-bubble economy, some believe Federal Reserve Chairman Alan Greenspan has merely started other bubbles.

"Greenspan has created a mini-bubble in residential housing," said Jean-Marie Eveillard, manager of the $1.6 billion First Eagle Overseas Fund /zigman2/quotes/209014684/realtime SGOVX +0.35% . "He has also created a not-so-mini bubble in Treasury securities and might have started a new bubble in stocks."

Legg Mason's Mr. Miller said he was focusing on companies like Eastman Kodak, with dividend yields north of the economy's gross domestic product growth. He left investors with an alternative that triggered gasps and giggles from his audience.

"I'll also leave you with one country," he said. "Japan."

Write to Ian McDonald at ian.mcdonald@wsj.com

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