Gail MarksJarvis: Investment envelopes likely to arrive filled with red ink

McClatchy-Tribune Information Services

October 5, 2015

Beware of the mail that’s arriving from your 401(k) or other investment accounts.

If you open it, red ink is likely to pour out of the envelope and may soil your view of your financial future.

Almost any mutual fund or exchange-traded fund that contains stocks became a loser in the third quarter of this year. The average fund that invests in the stocks of large U.S. companies lost about 7.5 percent during the last three months, and funds that invest in small company stocks plunged about 11 percent, according to Morningstar.

To add insult to injury, if you believed in the popular themes of the last couple of years, the hurt has probably been worse than it had to be. Your protection from stock market losses during the last three months would have been to own a sizable portion of U.S. Treasury bonds. But the theme of the last few months has been to dump those bond funds because they were expected to become losers.

Many advisers were convinced that the Federal Reserve was about to start raising interest rates in September. And those interest rate increases would have been harsh on Treasury bond funds, turning them into losers. But it didn’t happen. The Federal Reserve instead looked at the dangers building in the global economy and decided the risks could infect the U.S. Already, U.S. company profits are hurting from global pressures and turning stocks of industrial, technology, energy and basic material companies into losers. So the Fed continued to keep interest rates near zero. As a result, U.S. Treasury bonds, and the mutual funds that contain them, ended up climbing in value, not losing.

The average mutual fund that invests in long-term U.S. Treasury bonds climbed about 5.7 percent during the last three months. The funds did exactly what they were intended to do in portfolios — to provide protection for investors during times of worry in the stock market.

And the bond funds that investors added to portfolios when they were worried about rising interest rates turned out to damage, not protect, investors. High-yield bond funds, a popular choice for people weary of low interest rates and worried about the Federal Reserve, got smacked last quarter right along with stocks. High-yield bond funds invest in the bonds sold by struggling U.S. companies. The funds inflicted losses of 4.5 percent because struggling companies are dangerous when the economy is weak. Under such circumstances, struggling companies have trouble selling products and can end up failing to pay bond investors back on their high-yield, or "junk," investments.

The plunge in high-yield bonds could be a rude awakening for investors who thought bonds would protect them from stock market troubles. Typically, high-yield bonds act like stocks — falling in value when worries about the economy build.

Meanwhile, another theme of the last few years injured investors greatly. Emerging markets were believed by many advisers to be the area of the world that would gain considerably as countries like China, Brazil and Russia modernized and grew. But this year, the trend of fast growth went into reverse. China’s economy is growing far less than the last few years, and Brazil and Russia are in recessions.

Consequently, emerging-market mutual funds that invest in developing areas such as Asia and Latin America have turned into a disaster. Emerging markets on average lost 18 percent last quarter and 20 percent during the last year, according to Morningstar. Funds that invest specifically in Latin American countries have been even worse because many countries, like Brazil and Venezuela, depend on selling oil and basic materials to the rest of the world. With the second-largest economy in the world — China — slowing, Latin American companies haven’t been able to sell the quantities of oil and basic materials that they must to Asia. Latin America stocks plunged 23 percent last quarter and 38 percent for the year.

Developed areas of the world, such as Europe and Japan, didn’t encounter nearly the same level of losses. But Europe is down about 10 percent and Japan down about 13 percent.

In the U.S. stock market, the only winning fund type during the last quarter was those that invested in utility stocks. The funds climbed 3 percent, as people chose an industry that’s favored as a defensive play during risky times. Another supposedly defensive choice — health care companies — plunged 11 percent when presidential candidate Hillary Clinton called for drug price regulation.