Still a bit skittish of the bull market

Investors are pleased that the third-quarter Dow has recovered from its July slump. What lies ahead?

By Martin Skala | Correspondent of The Christian Science Monitor

from the October 10, 2007 edition

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Many mutual fund investors will breathe a sigh of relief when they open their third-quarter statements in coming weeks.

Unless their fund holdings were heavily laced with small-company or financial stocks, this summer's stock market gyrations didn't make much of a dent in their net worth. Although Wall Street gave investors a wild ride, the upshot might have been a lot worse if the Federal Reserve hadn't sprung into action with aggressive rate cuts.

By lowering the discount rate twice and slashing the federal funds rate by half a percentage point on Sept. 18, the central bank sent the credit-easing message that investors were craving after the stock market's late-July nosedive. The Fed pumped liquidity into stressed credit markets, calming Wall Street's fears that a protracted housing slump would trigger a recession.

Besides bolstering lenders and mortgage-backed security holders, the Fed's moves also reassured investors that monetary policy had clearly reversed course and would probably ease further.

For the quarter, the average US diversified equity fund returned a mere 0.9 percent, according to fund tracker Lipper Inc. Most overseas markets provided heftier gains, aided by a weakening US dollar. International multi-cap core funds, the most widely held type of foreign equity fund, rose 3.1 percent. Emerging-market funds, which focus on regions such as Latin America and Southeast Asia, scored double-digit gains.

Wall Street's midsummer swoon, followed by a torrid September rally, didn't affect all stock groups equally. Although banks and mortgage-related stocks suffered from the credit crunch, large-cap stocks in such sectors as basic materials, healthcare, and information technology generally held up well. Most growth funds beat their S&P 500 index benchmark by steering clear of financial-service companies and firms dependent on discretionary consumer spending. Large-cap growth funds benefited from owning a variety of globally diversified companies, especially in the thriving capital goods and basic materials sectors. Value funds, on the other hand, were hobbled by their broader exposure to financial stocks.

Following the technology bust of 2000, growth-oriented investment strategies took a back seat to value strategies. The latter favored smaller, cyclical companies as well as financial stocks, whose profits rose rapidly while US economic growth was brisk. That's now changing as America's economy hits a rough patch and corporate earnings growth falters.Heightened aversion to risk is common in the late stages of the business cycle, analysts say. That's why many investors are gravitating toward large companies with more stable income streams rather than speculative stocks promising fat capital gains. "Large-cap growth issues are assuming a leadership role again after a lengthy dry spell," says Harry Clark, president of Clark Capital Management, a Philadelphia-based invest­ment adviser. "Our technical models point to multinational companies that sport steady growth, pay above-average dividends, and have solid cash flows as future standouts."

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