Special Report on Investments and Personal Finance : Stock Funds Have Best Quarter Since 1992

With three quarters left to go in 1995, many stock mutual fund investors might be happy to close the books on the year effective immediately.

The U.S. stock market recovered with stunning vigor in the first quarter from last year’s slump, as extreme pessimism about interest rates gave way to a sense that economic growth is slowing and that rates had room to drop.

And indeed, as bond yields fell in the quarter, stocks and stock funds responded with hefty rallies:

* The average general U.S. stock fund posted a total return (price appreciation plus dividends earned) of 7.2% in the quarter, according to preliminary data from fund-tracker Lipper Analytical Services. That beat the average bond fund’s return of about 4%.

Stock funds’ rise was the biggest quarterly gain since the fourth quarter of 1992, Lipper said, and followed a full-year 1994 decline of 1.7% for the average fund.

* Blue-chip stocks led the pack, as renewed bullishness coincided with a “flight to quality” among investors worldwide in the wake of slumps in Third World markets.

The Standard & Poor’s index of 500 major U.S. stocks jumped 9% in price for the quarter.

Among mutual fund categories, growth-and-income funds--which tend to own mostly blue-chip stocks--gained 8% in the quarter, on average. Growth stock funds, also usually heavy with blue chips, were up 7.5% on average.

* Small-stock funds fared less well, as some investors remained suspicious of smaller firms’ prospects in an apparently slowing U.S. economy, analysts said. The average small-stock fund rose 5.7%, after a 0.7% loss last year.

* Among specialty funds, technology funds were hot, reflecting investors’ search for companies with high earnings growth prospects in a weaker economy. For the quarter the average tech stock fund was up 6.6%, though the tech rally faded abruptly last week.

Tech stocks’ gains also helped many general stock funds that had loaded up on those issues, including Fidelity Magellan (up 8.4%) and Strong Common Stock (up 7.1%).

Meanwhile, funds that focus on health-care stocks rose 10.2% as many medical-related issues rebounded. And financial-services funds also gained 10.2%, amid a rally in many bank stocks that accompanied declining bond yields.

* The quarter’s laggards among U.S. funds mostly were those that are considered inflation hedges. With Wall Street betting on continued low inflation in a slowing economy, hedges lost their allure.

Gold funds fell 1.8% on average; real estate funds dropped 2.5%.

Also on the down side, foreign stock funds--into which U.S. investors had pumped record amounts of cash in 1993-’94--were generally losers in the quarter. The average international fund fell 1.9% and those focused on emerging-market stocks lost much more.

Latin American funds, for example, plunged 30.9% on average, despite rebounding in the final weeks of the quarter. Mexico’s currency and fiscal crises devastated its stock market and other Latin American markets.

As for last year’s big winners--Japanese stock funds, up 15.4% on average in 1994--the first quarter saw an 8.6% decline.

The troubles in Japanese and other overseas stocks partly reflected an accounting of winners and losers in the dollar’s slide to record lows against other key currencies in the first quarter.

The weak dollar boosts U.S. companies’ competitiveness by lowering prices of U.S. exports abroad. At the same time, countries with stronger currencies stand to be hurt as their exports become more expensive.

But as fund analysts consider where the best investment opportunities lie today, some say that beaten-down foreign markets on balance look more appealing for long-term investors than the U.S. market, which is at record highs.

Battered emerging markets, in particular, attract analyst John Rekenthaler at fund-tracker Morningstar Inc. in Chicago.

At the peak for many Third World stocks 15 months ago, “there was only good news” in those markets, Rekenthaler notes. “Now, everybody’s really concerned about the future of those markets. I think the sellers have been cleared out.”

But other analysts argue that U.S. stocks and stock funds still have more to recommend them than many foreign stocks.

“I truly believe we’re in a strong bull market in U.S. stocks. I think you should stay with what works,” says Robert Markman of Markman Capital Management in Minneapolis. If you believe in the “soft landing” scenario for the economy, he says, then corporate earnings should continue to grow decently this year while interest rates stay level or fall further.

“If we sat down and made a list of the (positives for stocks) in this economic environment, I think we’d be mortgaging the house to invest,” Markman says, only half-joking.

Still, he concedes that U.S. stocks may be overdue for a short-term pullback, given the intensity of the first-quarter rally.

But many pros say the key to the market outlook now is that the pessimism of 1994--as short-term interest rates doubled--has dissipated. Even if rates should bump higher this year, any increase from current levels should be relatively small. And until investors begin to worry about recession, chances of a wholesale flight out of stocks seem remote, Markman and others say.