Look who's moving the market

After enjoying more than a year of stellar returns, investors in US stock markets seemed to spend most of the first quarter of 2004 waiting. Waiting for an improvement in the jobs outlook. Waiting for decent earnings reports from some of the major bellwether companies. And most important, waiting to see who is most likely to win the White House.

Stocks tend to do well in presidential election years. And if history is any guide, the market should perform better in the second half of the year. But analysts warn against making big changes in your portfolio based on guesses of who will win. Politics, it turns out, is even more unpredictable than markets, they say.

For their part, the major stock market indexes struggled to reach positive territory during the past three months. Both the Standard & Poor's 500 and the Nasdaq Composite indexes moved up a little, down a little, then back up before ending the quarter virtually flat.

Investors, it seems, were stuck in waiting mode - a continuation of the cautious investment pattern in the fourth quarter of 2003.

Over the past three months, investors shied away from the more aggressive mutual funds in favor of value funds that look for undervalued stocks, balanced funds that combine stocks and bonds, or equity-income funds that invest in dividend-paying companies.

"We're seeing money flows into value rather than growth," says Donald Cassidy, senior research analyst at Lipper Inc. "We're still seeing flows into cautious kinds of funds like balanced, real estate, income, equity-income, convertibles. We're not seeing a lot of money flowing into sector funds, which tend to be fairly aggressive choices."

While there was some increased interest in technology funds in the fourth quarter, "that's kind of stopped now," Mr. Cassidy says.

At the same time, Cassidy notes, some people showed a somewhat contradictory streak by investing overseas, where risks would seem to be higher.

"There's an awful lot of money flowing to world equity funds," he says. "People are taking advantage of the lower dollar and the prospects that the dollar might go somewhat lower. But they're also chasing performance."

For example, funds that invest in Japan, the overall Pacific/Asian region, and emerging markets continued the strong performance they showed over the last year (see story).

Domestically, more money may have gone into more conservative options, but the best returns were found elsewhere. Funds that invest in small value companies managed average returns over 6 percent. Three categories of sector funds - telecommunications, natural resources, and financial services - all gained more than 5 percent. But real estate funds turned in the highest returns for the quarter. In fact, they have returned nearly 12 percent since the beginning of the year and more than 51 percent over the past 12 months, according to Lipper.

These gains were fueled in part by increased demand from investors who see real estate as a useful hedge against volatility in the broad stock market.

In the fixed-income universe, the low interest-rate environment continued to help long-term bond funds. These funds will be more volatile when interest rates rise but, these days, their yields are still better than short-term bond funds. According to Morningstar, long-term government bond funds returned approximately 4.7 percent during the quarter, while short-term corporate and short-term government funds each returned about 1.2 percent. When interest rates do rise, however, prices of longer-term bond funds could fall dramatically, Morningstar warns.

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