Market takes investors on a wild ride
Jitters in Shanghai jangled markets worldwide last month – a wake-up call for investors to keep a closer eye on the downside.
Mutual fund investors may be excused if their knees are knocking a bit.Skip to next paragraph
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While the year didn't begin with high hopes on Wall Street, the first quarter's roller-coaster markets gave investors a jolt. After a smooth ride for nearly two months, a dramatic plunge in the inflated Shanghai stock market sent shivers through world equity markets, pulling down riskier assets leveraged with debt. In the United States, the sell-off was amplified by investor fears that the troubles in the subprime residential mortgage market would aggravate a home-building slump that appears far from over.
Financial stocks were hit especially hard, reflecting concern that rising mortgage delinquencies and deterioration in credit quality might spread to other types of lending. While stocks partially recovered in March, the major market indexes struggled to stay in positive territory.
The increased market volatility is "a wake-up call for investors who had become notably complacent about investment risks," says James Stack, editor of Investech Research, an investment advisory service. A five-year bull market that hasn't had so much as a 10 percent setback should furrow brows among prudent investors, he says.
With an economic slowdown looming, oil prices rising, and a Federal Reserve that has not softened its anti-inflationary stance, investors should focus more on preserving capital than reaching for short-term gains, Mr. Stack says.
Despite wide day-to-day price swings, all major fund categories scored modest gains for the quarter (see PDF or Flash chart). US diversified stock funds rose an average of 2.1 percent, according to fund-tracker Lipper. While value and growth styles ran neck and neck in the first quarter, mid-cap funds – which hold mostly companies with market capitalizations in the $3 billion to $15 billion range – were the cream of the crop. Mid-cap value funds rose 4.4 percent, while small-cap value counterparts rose 2.6 percent. Large-cap growth funds, market laggards since the Internet bubble burst seven years ago, eked out a 1 percent rise, slightly better than large-cap value funds.
Continuing strength in overseas markets gave the popular world equity funds category a 3.3 percent boost.
Among sector funds, utility funds led the pack, rising 7.7 percent.
Ron Sorenson, chief investment officer of W.H. Reaves & Co., credits the utilities sector's strong performance over the past three years to investors' quest for higher-yielding stocks. Though dividend yields are now below 3.5 percent for most gas and electric utilities, these asset-intensive companies have steadily upped their payouts and are expanding their power and transmission infrastructure under supportive regulatory oversight. Financial-services funds, hit by the fallout from real estate woes, were the only sector to finish the quarter in the red.
Investor awareness of elevated risk is reflected in the way money has flown into mutual funds, says Lipper senior analyst Jeff Tjornehoj. Money has been pouring into high-grade bond funds lately as well as into the more conservative equity income and asset allocation funds. Enthusiasm for world equity funds remains higher than that for their domestic counterparts, he notes, but the once torrid pace of flows into emerging markets has ebbed considerably.
Among pure stock funds, multi-caps have been "king of inflows" says Mr. Tjornehoj. People prefer the "go anywhere" nature of multi-caps, he says.
The five-year-long performance disparity between large- and small-cap stocks has many analysts scratching their heads. Large-cap stocks typically outdo small-cap stocks in the later stages of a cyclical bull market, but large-cap stocks have yet to strut their stuff. During the quarter, large-cap core funds rose 0.5 percent, trailing small-cap core funds' 2.8 percent rise. "It's still a tug of war between the large and small caps," says S&P analyst Massimo Santicchia. With good credit conditions, hedge funds with an appetite for risk, and brisk merger activity, many small company stocks can prosper, he says.