The chaos in the mutual fund industry is very disruptive. Right now, there are massive redemptions across the industry as state pension funds are firing their mutual fund advisors.

The quest by New York Attorney General Eliot Spitzer to expose the mutual fund trading scandals hasn't materially disrupted the flow of funds into the market. It's only hurt the mutual fund companies that are involved in the trading scandals. However, the more Spitzer and the SEC dig, the more they'll find, so the trading scandals will likely last for several more months.

The obsession with mutual fund trading has an interesting origin. Many securities firms have been publishing reports on the "oscillating" nature of the stock market. These reports discuss how the market has been very rotational and favoring specific industries at specific times. For example, consumer stocks did well in the second quarter of 2002, followed by health care in the third quarter, telecom in the fourth, airlines in the first quarter of this year, followed by low-priced stocks in the second quarter.

Although these research reports just reported normal industry
rotation, they helped foster a trading mentality that swept through Wall Street. In fact, in my extensive travels, I can attest to the fact that there's an obsession with trading in Manhattan and even with mutual fund whole-salers who cater to trading. The reason that traders prefer mutual funds is that they can buy and sell funds with virtually no bid/ask spreads.

Many of the fund companies that are being investigated were involved in "parking" timing funds in safer fixed-income mutual funds. This was a way to cater to market timers when they were exiting more volatile mutual funds in the same fund family. The mutual funds that are under the most intense investigation are the international funds. Some market timers would try to buy these funds after hours at yesterday's prices to take advantage of a surging market in Hong Kong or elsewhere. These
international mutual fund timers were essentially practicing
"arbitrage" and trying to profit from price inefficiencies.

Overall, there are essentially three types of mutual fund timers.
First, those investors who switch due to oscillating stock markets
(including some 401 and annuity participants). Second, there are
the professional switchers who "park" their money in an income fund after they exit a stock fund. Finally, there are arbitrage switchers who were taking advantage of price inefficiencies in international markets and buying funds after hours.

All of these switching activities cause trading costs to soar and hurt all mutual fund share-holders. The reason that so many state pension funds have been firing mutual fund companies is that the excess costs were being passed on to the state pension funds. As some fund companies offer to refund shareholders, they're setting themselves up to be fired by major pension funds.

So far, these investigations have not reached the average shareholder who switches within a retirement account or annuity, but the media is looking at excessive turnover to uncover more switchers. If you ever go to a major investment conference, like the Intershow Money Shows, you can often see software exhibits dedicated to market timing and switching. These services are designed to cater to active investors.

I suspect that much of this switching activity will escape the scrutiny of Mr. Spitzer and the SEC. The reason is that most major fund companies will impose restrictions to slow down switching activity and lower trading costs for all shareholders. Ultimately, this will lower
the operating costs of the mutual fund industry and will benefit all mutual fund shareholders.

Personally, I'm thrilled to see Eliot Spitzer trying to clean up the mutual fund industry. As the CIO of a mutual fund company that bears my name, I've always believed that mutual funds must serve the interest of all their shareholders. Many of us in the industry are excited about what's
happening. There's going to be a lot of money flying around from one mutual fund complex to another. I fully expect that in the end, the good guys in the business will prevail. The mutual fund industry will emerge from these investigations with substantial reforms and will be better because of the current investigations by Eliot Spitzer and the SEC.

Despite all the mutual fund trading scandals, new money continues to pour into the stock market. All the mutual fund trading scandals are doing is re-shuffling who gets the money. As the SEC and more mutual fund families discourage trading practices, it will likely help to stabilize the stock market, reduce volatility and boost investor confidence.

For this and several other reasons (more on my 2004 stock market outlook when you accept a risk-free Trial Membership to Blue Chip Growth today), I truly believe we are entering a great era for investors. The strongest economic growth in 20 years has arrived. Record corporate earnings will be announced next year. The market will be surging for at least several months as it follows record corporate profits and reaches new highs. Plus, the Fed will hold rates steady for several months as extra insurance. I expect that the market will remain strong right up to the Presidential election, as the stimulus provided by the Fed and Congress will help the economy grow by at least a 5% annual rate for the foreseeable future.

My top "checkered flag" stocks are up 49.4% so far this year. And my overall A-rated stocks are up 419.5% over the past 5 years. Find out what we're buying now for more stellar profits in 2004.

Louis Navellier selects mid- to large- cap stocks with the best earnings and profit potential for the Blue Chip Growth letter using his proprietary computer model. His Buy List has earned over 31% gains for subscribers since this service began in 1997. With a subscription to Blue Chip Growth, you'll receive monthly 8-page issues, monthly email Buy List updates, weekly hotlines (online and via telephone), access to our client only Web site and online investing tools. Put his success to work for your portfolio today, become a member now, RISK-FREE.

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