Notching another gain
Investors latch on to a summertime rally and then hold on as the stock market sputters in September. Can funds maintain their momentum for the rest of the year?
OK, now what?
After a bullish summertime climb, investors struggled to stay in positive territory as a late-September slump wiped out much of what had looked to be a promising third quarter.
As recently as Sept. 4, mutual-fund tracker Lipper Inc. reported that US equity funds had recorded their seventh straight up week; this on the heels of a great second quarter that had delivered double-digit gains to virtually every fund category charted by the company.
Then nagging doubts about the strength of the economy's rebound, coupled with global currency fluctuations and threatened rises in oil prices, began to set in. By the end of the third quarter, most categories had to contend with only minimal gains.
Still, a win is a win and most stock-fund investors were able to hold on, or even add a bit, to what has been the best market rally since 1999. That has made for a good year so far for people who have not put all their eggs into one basket but have diversified their money among several fund categories.
"A broadly diversified portfolio has had a phenomenal year - up 30 percent," says Paul Merriman, president of Merriman Capital Management in Seattle.
Bond funds didn't perform as well, however, as rising interest rates dimmed the lights for many of them. (See story, page 16.)
In some respects stocks and stock funds were victims of their own success, says Emily Hall of Morningstar, the fund-analysis company based in Chicago. "A lot of stocks have really had strong runs this year and their valuations [prices] have run up."
By the end of the third quarter, some investors were worrying whether those companies could maintain the momentum they had built up earlier in 2003, she adds.
The Dow Jones Industrial Average, a weather vane for the stock market, had risen 7.5 percent between July 1 and Sept 18, its high for the quarter. But it then quickly gave ground to finish on Sept. 30 at just 3.2 percent higher for the quarter.
Among domestic stock funds, the science-and-technology category led the way with a 10.5 percent gain, for a year-to-date rise of 37.4 percent.
"Earnings are definitely up" for companies involved in those fields, says Brian White, manager of the mutual-fund marketing department at Ryan Beck & Co. in Livingston, N.J. Other drivers for that category - and stock funds in general - during the quarter included lower expectations by investors, he says.
Sorting through companies by asset size, small-cap funds once again beat their mid- and large-cap cousins.
"Small-cap is where things have been happening since March," says Thurman Smith, editor of Equity Fund Research, in Boston. Small-capitalization funds invest in small companies (measured by the total market value of their stock). Although they can be more volatile than bigger companies, small caps can do well during times of economic rebound as demand for their goods and services picks up relatively faster than it might at a big company.
Looking abroad during the quarter seemed to be a good bet, especially Asia (see story, page 21). Funds specializing in Japan ran up a scorching 21.2 percent, while funds that concentrate on China virtually matched that with a 21.1 percent run-up.
"The Japanese are recovering after what seems like forever," says Mr. White.
More broadly based global and international fund sectors rose 5.5 percent and 7.1 percent, respectively.
Japan funds could continue to do well as that country's economy perks up, says White.
Ditto for the United States.
A recovering American economy should power corporate earnings upward, White adds. As that happens, he sees better times ahead for sectors such as technology and healthcare.
"I think the pieces of the puzzle are in places for a sustained market [rise]," he predicts.
Like most other investment advisers, White recommends that people allocate their money across several types of investments. That means mixing in domestic with foreign funds, value with growth, and so on.
If there's a weak spot, White thinks it might lie with financial services. Rising interest rates could dampen borrowing, he says. They have already slowed the pace of home-loan refinancing that has kept mortgage companies working overtime for the past year.
Looking forward, Mr. Smith continues to praise small-cap funds and downplay large-cap ones.
"Technically, it looks OK for everyone other than large cap," he explains. But "it's going to be a long time before people put serious money in large cap."
Mr. Merriman agrees: "Most people are way overweighted in large-cap growth funds, even though they're the least productive" among fund sectors, he says.
Speculative investors who have chased science and technology so far this year may keep throwing money that direction, especially if they buy into the notion that new ideas in those sectors can mean new profits. But these companies and funds rise and fall faster than the market in general.
Like White of Ryan Beck & Co., Smith advises using asset allocation when it comes to finding suitable investments.
"Play carefully," he cautions.