NEW YORK (Money Magazine) - "The dog is in the house," Peter Lynch's assistant announces. My first reaction is that this must be some sort of internal code at Fidelity Investments for the Big White-Haired One himself.
Nope. She means a real dog -- Lynch's dog, Aggie, a bright-eyed little sausage that trots into our room a moment before the master enters. Amazing how much he looks like Peter Fonda in an Andy Warhol wig (Lynch, that is; not the dog).
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"She's a King Charles spaniel," Lynch says. "The breed was a favorite of Charles I, the last English king to be beheaded by his subjects."
Ah, an Irishman who appreciates history's twists. And that's why I'm here in Fidelity's Boston offices on a gray December afternoon: to talk investing history -- notably the 1990s bull run and the 2000s bear maul -- with the man whose stock-picking brilliance turned Fidelity Magellan into the largest mutual fund of his time.
Lynch, 59, hasn't run a fund since 1990, when he retired from Magellan's helm after a 13-year spell that produced market-stomping 29.2 percent annualized returns. Yet he remains one of the most revered names in the fund world, serving as a vice chairman and spokesmodel for the company. He also invests tens of millions of dollars for his family and his charitable foundation.
This is where Lynch tosses me -- and you -- a gold nugget: "I have increased dramatically all year long the percentage of my Fidelity holdings that are in stocks in general and growth stocks in particular."
He's even bought Internet stocks in the past year.
Not something you'd normally tell the world during a horrendous bear market. "This has not been a good year so far," Lynch concedes. But time should be on his side soon enough.
"I've found that when the market's going down and you buy funds wisely, at some point in the future you will be happy. You won't get there by reading 'Now is the time to buy.' These things never go off that way. But this is the third straight year of market declines, and we haven't had many periods like that. I'm not a timer, but I thought I should increase my percentage in stocks. I've bought more as the year's gone on, moving cash from my money-market funds and increasing my equity bet by about a third."
But what if it's still too early for a rebound? With threats of war and recession all around us, what if stocks decline for a fourth year -- or longer? Don't the risks of being wrong outweigh the potential rewards of being right?
Lynch has one word for you: history.
We've been through this before
Look back to 1990, just before the bull really started snorting in 1991. War with Iraq loomed, recession raged, investors yanked money from stock funds. State and local governments faced huge deficits. Big banks reported frightening loan losses. Junk bonds were a mess.
By the fall of 1990, the U.S. stock market had tumbled nearly 20 percent. "A pretty ugly combination," Lynch recalls. "Much uglier than the 1987 crash. Much uglier than the 1973 and 1974 bear market. Much uglier than the 1981 and 1982 recession. America was considered washed-up in 1990 -- remember how we couldn't compete with the Japanese? -- and we were a hopeless country in a lot of people's eyes. It was a very similar environment in many ways to what we've had in the past year. All the pessimism about the future turned out to be misguided."
Lynch had left Magellan a few months earlier and was managing his personal portfolios at the time. "In the summer of 1990, I was buying stocks and I was probably three or four months early there. But we had a great rally in 1991. Some people had said, 'I want to get out of the market,' and they missed it, OK? But the people who stayed are congratulating themselves even today, saying, 'It's hard to stay in there, but I get rewarded by staying.' So I certainly look upon this latest correction as an opportunity to make some money."
Opportunities are everywhere
One surprising opportunity, apparently, was those Internet stocks. This time last year, Lynch's screens showed some 600 technology companies with stock market capitalizations that were smaller than the total cash recorded on their books.
See Money's 10 Best Funds
|Fund ||Ticker ||3-year return ||Expense ratio |
|Fidelity Dividend Growth ||FDGFX ||-3.9% ||0.95% |
|Growth Fund of America ||AGTHX ||-9.4 ||0.75 |
|Thompson Plumb Growth ||THPGX ||6.6 ||1.2 |
|American Century Equity Income ||TWEAX ||9.1 ||1.25 |
|Calamos Growth ||CVGRX ||-1.5 ||1.5 |
|FPA Perennial ||FPPFX ||6.9 ||1.24 |
|Royce Total Return ||RYTRX ||10.8 ||1.24 |
|Van Kampen Equity & Income ||ACEIX ||2.5 ||0.82 |
|Dodge & Cox Income ||DODIX ||10.8 ||0.45 |
|Fidelity Spartan Investment Grade Bond ||FSIBX ||9.9 ||0.5 |
"After these stocks went from $100 to $4, I looked at the balance sheets and said, 'My God, there's a lot of cash at some of these companies.' I won't name them. I did buy some," he says. "I'm still an investor, you know? Some of them were selling for less than their cash -- basic Graham and Dodd!"
Lynch won't offer many details, but Securities and Exchange Commission filings show that he owns more than 5 percent of Varsity Group, an online retailer that distributes textbooks to schools. The stock went for 25 cents-to-35 cents a share late in 2001 (down from a $30 peak), with $1 a share in cash on its books. A year later, the stock was going for $1.45 a share.
Less successful has been Lynch's 10 percent stake in WorldQuest Networks, a money-losing operation that sells long-distance phone calls (mostly to India) over the Net. The stock once went for $39; recently selling for $1.88 and reporting around $3 a share in cash, it was down 32 percent for 2002.
"These are long shots -- I'm not recommending them," Lynch notes. "My point here is: How many times in your life are you going to see 600 companies like that? The goal after that is to find, from that 600, the 50 or the 100 that have a real business and aren't just drunken sailors burning through all that cash. And then you get that business for a negative number."
I could almost swear Lynch was licking his chops when he said this, but alas, there's no such sound on my tape recording of our conversation. What I can hear is the tinka-tinka-tinka of Aggie's dangling dog tag as she darts back into the office from her walk outside.
Lynch scoops her up and rolls her in his lap -- she's all of 11 pounds -- and begins rubbing her belly. "I mean, just because people are redeeming and selling, you can't be clear that that's the bottom, you know? Some people wait until they see a bottom and then they buy. But my system for over 30 years has been this: When stocks are attractive, you buy them. Sure, they can go lower. I've bought stocks at $12 that went to $2, but then they later went to $30. You just don't know when you can find the bottom."
Don't wait for hindsight
It's hard to see trends as they take shape. It's easy -- maybe too easy -- to see things the morning after. The 1990s boom was no exception.
"All this pessimism in 1990 turned out to be wrong," Lynch says. "Then it became clear that the U.S. was an incredibly strong economy. And then we went from running a federal budget deficit to running a major surplus. That's a pretty good deal. And you had Japan going the other direction, losing their way. So, you know, we started to look pretty good. The American psyche went from negative to positive. In retrospect I didn't know it was going to happen. But looking back on it now, you can just see that picture so clearly. People went from saying 'We're hopeless' to 'We're invincible. We may never have another recession again.'"
The exuberance (let's be honest with ourselves) was whipped to the frothiest heights. "Like Las Vegas," Lynch snorts, adding that a relative of famed Fidelity manager Joel Tillinghast pulled out of Fidelity Low-Priced Stock in early 2000, figuring he could pick better stocks on his own. "People would have 10 aggressive growth funds," Lynch recalls, "and they thought they were diversified."
Today, of course, millions of scorched investors appear to be overly pessimistic. Vanguard 500 Index surpassed Magellan as the world's largest mutual fund in 2000. This past fall, the title of biggest was snatched away by a bond fund, Pimco Total Return.
Lynch, for one, has his worries about this turn of events: "There are people now buying bond funds who don't know that if interest rates go up, those bonds are going to go down. I hope they know that. I don't think they do. They're going to lose money if rates go up."
But many of us feel we were sold a bill of goods in the past five years, hustled by analysts, banks, CEOs and others who basically cashed out while we bought in. I ask Lynch if he can possibly understand that frustration -- if the master himself had ever found that he was stuck with (sorry, Aggie) a dog of an investment.
"I had a New York Stock Exchange company just this past year that literally went to zero and was delisted. It had no debt, a very good balance sheet, a 20-year record. Everything looked fine -- it had $100 million in cash on its books -- then, all of a sudden, bam!" (Only one company fits that profile: Belgium-based ACLN Limited, a shipper and seller of used cars from Europe to Africa whose stock climbed as high as $50 in 2001, then collapsed after that $100 million in cash could not be found, ACLN's chairman disappeared and the SEC filed fraud charges against the company and top executives.)
"Despite my due diligence, I don't think I learned much from that experience," Lynch says. "I mean, you just have to say to yourself that maybe once in a long while you're going to have these things where in the end the company lied. I think in my lifetime of analyzing two or three companies a day for 30 years, sometimes more, I've been seriously lied to maybe 10 times."
Further talk of corporate greed and Wall Street corruption doesn't seem to interest him much. Gotta think big picture, people.
"Obviously, you have these glorious examples after the fact, like WorldCom overstating revenue and understating costs. Tyco? Maybe it was overpriced and they had a little spending issue with the CEO. I'm not getting into that," Lynch says. "What I'm saying is if you add up WorldCom and Enron and maybe Tyco, those three companies together were at most maybe 5 percent of the S&P 500. So 95 percent of the S&P didn't go bankrupt or have these allegations of fraud.
"I'm not going to say quality of earnings are better or worse than when I was running Magellan. I'm just saying that I think what people are forgetting is that we've had a major recession. That's why earnings are a problem," he says.
Recessions are scary things, and the obvious worries about jobs and bonuses and bills and bankruptcies -- "the background noise that keeps you awake at night," Lynch calls it -- often mute an important fact: The U.S. economy has seen 10 recessions since 1945, and it has emerged from nine of them stronger than before. Of course, it's not a fact yet that we'll pull ourselves from No. 10 in better shape. But are you willing to bet against that record by staying out of the American stock market?
"You get recessions, you have stock market declines," Lynch says, shrugging. "If you don't understand that's going to happen, then you're not ready -- you won't do well in the markets. If you go to Minnesota in January, you should know that it's gonna be cold. You don't panic when the thermometer falls below zero."
Lessons from the master
Wait a second, I'm thinking. I've heard this before. Lynch has said something like this in almost every interview I've read.
"People spend more time and effort to buy the right refrigerator than they do to buy the right funds," Lynch says. "You should know what kinds of funds you own; you should know them so well you're able to tell your grandchildren what kinds of funds you own in two minutes or less ..."
The man cannot be stopped.
"So I think: great company, great stock...."
Lynch isn't making eye contact anymore, but Aggie sure is. Big wet brown ones, looking straight at me. Has she heard this before too?
If the words are familiar, it's because the lesson of the 1990s is, in fact, the lesson of the 1980s, the 1970s, and decades before.
"People who have made money in the stock market usually bought companies that have done well over time," Lynch asserts. "So Kmart went bankrupt. Guess what? Wal-Mart did very well. If you had put $10,000 into Kmart 20 years ago and $10,000 into Wal-Mart, you would have basically lost the 10 grand on Kmart but you would've made $790,000 on Wal-Mart. So if the companies that make up the S&P do well in the next 10 or 20 years, you will make money. If you think those companies will be making less money in 10 years, then the stock market is not the place to be.
"I think you have to learn that there's a company behind every stock -- and that there's only one real reason why stocks go up: Companies go from doing poorly to doing well or small companies grow to large companies. And that's what you ought to be looking for," he says.
"That's what the 1990s teach us: If the companies do well, the stocks do well. For every company that does badly, like a Kmart or a Xerox, there are companies that do very well, like a General Electric or a Procter & Gamble or a Johnson & Johnson. You have to say to yourself: The reason I'm putting any of my money into mutual funds is because I think over a period of time companies like Coca-Cola and Pepsi will be making more money in the future and new companies are going to come along, like Amgen or Staples or Microsoft, and they're going to be making more money. That's been the history of America through 100 years, particularly in the past 50 years. That's the lesson," Lynch says.
"If all people learn from this boom and bust is that we had this amazingly overpriced market in March of 2000, well, that's not much of a lesson, is it? Go back to the 1880s, the 1920s. You have these periods of craziness. Should the lesson be you should never own stocks?" he asks.
Of course not. And we know all this. But you know what? We have to hear it again and again because we're irrational creatures too easily swayed by greed and gloom, too likely to forget what's lasting and true just when we need that wisdom the most. What makes us think we're any wiser than ol' Aggie over there? After all, she's the one sitting in a rich man's lap.
"People can easily point to Enron and the other 10 examples of companies that just pushed the envelope too far," Lynch says. "But there are 9,000 public companies out there."
Nine thousand companies. Lynch says it like the possibilities are endless.