Mutual Subtraction

America’s torrid love affair with mutual funds, which was sparked by the fantastic returns of Peter Lynch at Fidelity’s Magellan Fund, then stoked with the great returns by S&P 500 index funds, and finally went red-hot with the massive performance by the Janus family, has, almost overnight, turned into a vicious lovers’ quarrel. The next few weeks will determine whether this spat winds up in a nasty divorce. In many ways, the relationship holds the key to whether this crippled market can stage any sort of Santa Claus rally.

The nineties belonged to the mutual funds, particularly those that embraced technology. And even when tech lagged, either because of a slowdown, like the ones in 1990 and 1994, or a collapse in demand, like the one that followed the 1997 Asia crisis, these funds still got lucky. Either the Fed cut rates dramatically, or a new innovation – massive networking of personal computers, the Internet – swamped the negatives and brought ever-higher earnings growth.

In the past two years, the tech funds’ performance has been so extraordinary that they drew money from bonds, from index funds, and from managers who embraced value strategies. These funds became asset-gathering juggernauts. They knew no boundaries, because tech stocks were all chronically undervalued. Every dollar that came in over the transom got put to work, regardless of how the stocks were doing, because we all knew that tech grew to the sky. Were there levels at which the money shouldn’t be put to work, because stocks, at times, got too crazed? Never.

Anyway, people don’t send these managers money with the idea that caution will be exercised; they wanted the pedal to the metal. In fact, for those of us laboring at hedge funds, where we bet against many of the overvalued stocks these mutual funds were propelling still higher, we began to despise them for their hubris, their inability to see that you can’t just walk up any old stock to where you want it to go. This is, of course, exactly what some of these funds were doing: using incoming new dollars to prop up prices of the old stocks you already own. The SEC recently opened an investigation into this practice of portfolio pumping, but we don’t know which funds they are going to pursue.

The mutual funds have driven me so crazy with these kinds of machinations that I even developed two fictional characters in my daily columns, Buzz Gould and Batch Hammer, who are forever marking up their stocks or creating performance to make up for their own stock-picking shortcomings. They can’t accept the market’s verdict and, through sheer power of mar-keting, take their new dollars and push them into a handful of stocks to keep them higher than they would normally be.

There are more than 120 major funds that are down more than 40 percent this year, a staggering number.

That game worked for so long because the fundamentals, the economic background for technology, were nothing short of fantastic. This year, however, everything came unglued.

First, insiders who saw their stocks thrust to ridiculous heights this spring began to sell their shares with reckless fervor. Who can blame them? Stocks had been taken to levels that were just plain absurd.

Second, the Fed took rates up six times in just a few months, in part to slow down the borrowing by individuals who were buying stocks on margin in order to take advantage of the endless bull.

Third, the personal-computer market, which had been fired up by the demand to get on the Web, cooled as the Web became less new and fascinating.

Fourth, cell phones, which seemed to have endless growth, sputtered for the first time since they became popular. We still don’t know why that happened, but it sure came at a terrible time for the semiconductor industry, which had ridden cell-phone demand to monster heights.

And finally, the last major driver of technology, the telephone companies, ran out of money for all of that fancy equipment that had to be bought for the vast array of networking and fiberoptic companies to beat the estimates they set at the beginning of the year.

This crushing com-bination snuck up on these managers almost overnight. They were so busy walking their stocks up that they finally got caught buying at the top. Now their performances have been crushed and their year’s been obliterated. There are more than 120 major funds that are down more than 40 percent this year, a staggering number. But that only tells a portion of the story. Much of the money came into these funds during the first few months of the year, when the averages were much, much higher. Losses of 50 to 60 percent are now commonplace.

People in these big-cap tech funds are bleeding from their eyeballs and seem to be in no mood to give more money to these managers. Which is why these next few weeks hold the key. If these funds can somehow generate some performance, either because the Federal Reserve surprises the market with a decline in rates or the selling in tech somehow abates, they might be able to narrow the losses. Last week, the Fed gave them some reason to hope that an easing in rates might actually save those that are down less than 20 percent.

But if that turns out to be too little, too late, the gloom will be carried into the first quarter, as individuals continue to flock to the only asset that seems to be working right now, cash.

Fortunately, these funds have also raised a lot of cash in order to handle year-end redemptions. And if those redemptions don’t materialize in a couple weeks, the funds can take that sidelined cash and put it back to work, hopefully driving their stocks back up. Still, they have a problem they have never faced before: There is not much to buy. Tech companies’ fundamentals continue to deteriorate. The possibility of putting money to work in a stock that might “blow up” on an earnings disappointment has never been greater. Which is why, in the end, I believe there will be more pain before there’s a second honeymoon.
Check out’s “10 Questions” this week. John Calamos, manager of the Calamos Growth Fund, is in the hot seat. Available free at

James J. Cramer is manager of a hedge fund and co-founder of At the time of publication, his fund has a long position in His fund often buys and sells securities that are the subject of his columns, both before and after the columns are published, and the positions that his fund takes may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer’s writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites comments at

Mutual Subtraction