When war stirs a slumbering market

The onset of battle triggered a small rally at quarter's end. But sustained growth will require a clear outcome. And factors beyond war are at play.

The stock market struggled to wake from its stupor in 2003's first quarter, but ultimately jitters over war and the economy proved too much, and most mutual funds again drifted off into negative territory.

The Dow Jones Industrial Average lost 4.2 percent and the S&P 500 Index gave up 3.6 percent. Fund-watcher firm Lipper Inc. said US diversified-equity funds marched in lock step, shedding 3.3 percent in the period ending March 31. The Nasdaq 100 Index rose slightly.

"It was basically a sideways to slightly down quarter," says Don Cassidy, a senior Lipper analyst.

After three straight years of negative returns on funds, experts and investors alike were rooting for better news. Still, Mr. Cassidy says, there were some signs of encouragement in that funds were not down by much either in the first quarter or the fourth quarter of 2002.

"It was [another] quarter in which people can feel a little better," with negative returns that were only in the single digits, he says. "It was a minus sign, but things didn't collapse."

Most analysts now are closely tuned to war developments, awaiting signs of a final resolution to the conflict to better gauge the market's next move.

In the first quarter there was surely enough bad news to discourage the market. The uncertainty of war - once launched, how would it go? - teamed up with a still-middling economy and budget-deficit worries to present formidable hurdles to corporate America and the companies and people that invest in it.

The result: 38 of 43 types of equity funds charted by Lipper posted negative results.

The worst performance of any sector was turned in by gold funds, which were off about 12 percent for the quarter. Christine Benz, a funds analyst at Morningstar Inc., said that over the past three years precious-metals funds have risen an average of 18.7 percent annually, so a breather in this sector, which often follows political events could be understandable.

Other notable laggards included a number of foreign-sector funds - Europe, Japan, and the like. Telecommunications and financial-services funds also lost more than 5 percent each.

But in the diversified-fund arena, Ms. Benz says she was a bit surprised to see that growth funds didn't fare as badly as did value funds.

"Value funds usually hold [up] well in this environment," where the economy is marking time, she says. Not this time: Large-cap growth funds, for instance, lost 1.1 percent, while their value-oriented counterparts lost 5.1 percent.

The contrast was starker in multi-cap funds, where the growth side lost 0.7 percent even as value funds in that group retreated 4.7 percent.

There's no dark secret behind this departure from the norm, says Cassidy. It just so happened that a number of big growth companies performed well between January and April. They included Johnson & Johnson, Intel, and eBay, which ran up in price 26 percent during the period.

Those companies also are classified as pharmaceutical or tech stocks, and funds in those sectors likewise turned in credible overall performances.

Health and biotech funds actually rose 1.2 percent, says Lipper, while science and technology ceded only 0.3 percent during the quarter.

In fact, Benz says, both those sectors were doing well, and had performed especially smartly during the week of March 17, when the Dow rose 6 percent as the uncertainty of war in Iraq turned to reality.

In our last quarterly report on funds Jan. 13, Bryan Piskorowski, a market commentator with Prudential Securities, said that the market tends to rally when military action commences.

That proved quite true this time, as all major indexes rose strongly during the week of March 17, and pulled stocks and funds along with them.

That week alone pushed several fund sectors into plus territory for the first quarter. But the market subsided after the early days of the war, putting just about every fund category back into negative territory.

Still, that week-long rally provided a glimpse of what could lie ahead in coming months for funds, Benz says. She's not predicting where they or the market itself will be at the end of the second quarter, saying that the war in Iraq spawns too many questions. But tech and biotech funds both did well during the war-week rally, and could once again.

Cassidy agrees, saying that healthcare and biotech are two areas to keep an eye on. He's not sure about technology, saying there still appears to be too much production capacity in that industry.

Utility companies may have put their worst times behind them for now, Cassidy says, as they have laid bare their problems with energy trading and wayward diversification moves.

Still, they may not be a hot prospect going forward. And the energy sector may also cool as he says the war-related threat over higher energy prices may have played itself out.

Cassidy looks for better days ahead, but not overnight.

"I think the economy will crawl back rather than zoom back," he says. He thinks second-quarter mutual-fund performance will be mildly better than that turned in during the first quarter.

That pretty well matches his estimate of how funds were to perform in the just-ended quarter.

To take advantage of whatever positive results may arise during the remainder of 2003, Benz cautions investors to "stick with their plan," whatever it might be, or develop one if it's not already in place.

"Resist the temptation to glom onto those funds that have performed so well" in the past, she says.

Bonds provide a Q1 bright spot

Unlike equity mutual funds, which largely fell into negative territory during the first quarter of 2003, bond funds held their own during the period.

Results ranged from timid - general US Treasury funds watched by Lipper gained just 0.6 percent - to bullish, a 7.98 percent rise for emerging-market debt funds. The latter grouping had actually cooled a bit from its fourth-quarter 2002 return of 13 percent.

While world income funds showed the best performance of all categories during the first period, domestic corporate-bond funds outshone government and fixed-income funds.

Lipper estimated that all of its corporate-debt-fund classifications rose in the first quarter, with much of the interest moving toward higher yielding funds. For instance, high-current-yield funds, better known as junk bonds, rose 5.6 percent.

"People are very nervous about the war and they are reducing their risk by entering into bonds," says Mark Kiesel, a senior portfolio manager at Pimco Funds.

In addition, Mr. Kiesel expects bonds to do well in the months ahead. "Companies are not in a growth mode right now. They are using their cash flows to repair their balance sheets and that's a positive trend [for bond investors]."

Keeping Track: money into equity funds

So far, investors remain stock-shy for 2003

The combined assets of the nation's mutual funds - including stock, bond, hybrid, and money market funds - decreased by $65.8 billion, or 1.0 percent, to $6.3 trillion in February, according to the Investment Company Institute.

Stock funds - the largest subset, with some $2.5 trillion in assets - had an outflow of $11.1 billion in February, compared with $371 million in January. Bond funds had an inflow of $19.6 billion in February, compared with $13 billion in January.

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