A Modest Bounceback for Stocks

Stock mutual fund investors have ridden bear markets and bull markets since 2000. This year is turning out to be mostly a bore market.

There were fireworks around the market’s edges in the first half -- big gains in energyfocused stock funds, for example, and another dismal showing by technology funds -- but most fund categories were bunched close to the zero-return mark.

The average U.S. stock fund lost 0.3% in the first half ended June 30, as a 2.3% rebound in the second quarter just recouped most of the first quarter’s 2.6% decline, according to data compiled by Morningstar Inc.

The latest quarter was the fifth in the last six that the net gain or loss on the typical stock fund was in the low single digits.

The funds, which hold $4.4 trillion in investors’ savings, just reflect what has been going on in the market overall, of course. After their sharp rebound in 2003 from the heavy losses of 2000-02, many stocks, and funds, have at best been slowly grinding higher.

That may be more remarkable than it would appear, some analysts contend. Given soaring oil prices, rising short-term interest rates and slowing corporate earnings growth, the equity market could have done a lot worse, particularly over the last year, they say.

The average diversified U.S. stock fund was up about 7% in the 12 months ended June 30. Return figures are based on the net change in price, plus any dividend or interest income.

“Give the market some credit -- there has been some progress, despite the headwinds,” said Don Cassidy, senior research analyst at fund tracker Lipper Inc. in Denver.

On Thursday, Wall Street largely shook off a terrorist attack in London, and major stock indexes made modest gains.

In the second quarter and the first half, the average stock fund again beat the Standard & Poor’s 500, the benchmark U.S. blue-chip index. The S&P; was up 1.4% in the quarter and down 0.8% in the half.

The average fund’s better performance partly reflects investors’ preference for small and mid-size stocks and the mutual funds that own them -- a trend for the last five years.

The S&P; 400 index of mid-size stocks rose 4.3% in the quarter and 3.9% in the half. Last year the index jumped 16.5%; the S&P; 500 rose 10.9%.

Over the last five years, the S&P; 400 rose at an average rate of 8.5% a year -- while the S&P; 500 lost 2.4% a year, on average.

The ongoing poor performance of blue-chip stocks in the first half hurt many of the nation’s largest equity funds. Fidelity Magellan fell 1.2% in the half. Washington Mutual Investors fund, managed by Los Angeles-based American Funds, slipped 0.1% in the period.

But the greater the lead that small and mid-size stocks take over their bigger brethren, the greater some analysts’ concern that the rally in smaller issues is becoming overdone.

The same question is being raised about natural resources funds (which are largely invested in energy stocks), real estate funds and emerging-market funds. All three categories were strong in the first half of this year, adding to their hefty gains of the last three years.

Here’s a look at some of the stock fund trends in the second quarter and first half, and how some fund managers view the prospects for particular sectors:

* Real estate funds topped the second-quarter leaders. The average real estate fund gained 13.1% in the three months, rebounding from a first-quarter decline of 6.6%, according to Morningstar.

The funds, which typically invest in shares of real estate investment trusts, development firms and home builders, have been on a tear for most of the last five years, reflecting the boom in property values worldwide.

The pullback in the first quarter showed that the sector wasn’t immune to profit taking. The second-quarter rebound showed that many investors believe the property bull market isn’t over.

Michael Winer, manager of the Third Avenue Real Estate Value fund in New York, said he didn’t see much appeal in most home builders’ shares at current prices. But he said he still saw value in large landowners such as St. Joe Co. in Florida and Tejon Ranch Co. in California, and commercial developers such as Forest City Enterprises Inc., which operates nationwide.

“They have assets that we believe aren’t reflected on their balance sheets,” said Winer, whose fund rose 9.7% in the first half.

* Natural resources funds led in the first half. Record oil prices helped stoke a 15% gain in the average natural resources fund in the half. But most of that came in the first quarter.

The funds stalled out for much of the second quarter, as oil prices fell in April and May before rebounding in June. The sector gained 2.1% in the quarter.

Utility stock funds, by contrast, continued to roll. They were up 7.3% in the quarter and 10% in the half, on average.

Some big electric utility companies also are involved in the oil and natural gas businesses, so surging energy prices have helped to boost the stocks.

Another appealing aspect of the utility business, according to Lipper’s Cassidy, is the expectation that the industry will continue to consolidate -- which can mean premium prices for shareholders of target companies. The first half saw several large mergers among utility firms.

Some investors, Cassidy said, are happy to earn 3% to 5% in annualized dividend yields on utility stocks, while betting on a bigger payoff down the road from more takeovers in the industry.

* Emerging-markets funds beat the average international fund. Emerging-markets funds, which invest in the developing world, rose 3.9% in the quarter and 5.2% in the half, on average.

International funds, which would typically be heavily invested in stocks of Europe, Japan, Canada and Australia, added 0.4% on average in the quarter and 0.3% in the half. The dollar’s rebound in the first half cut into U.S. investors’ returns on stocks in developed countries. Currency issues were less of a problem for emerging markets.

More important is that economic growth remains brisk in much of the developing world, said Mark Madden, manager of the New York-based Oppenheimer Developing Markets fund, which rose about 8% in the half.

Although emerging-market stocks have been hot for three years, Madden said he believed their bull run was only about half over. His largest single stake is in Indian stocks, he said, because economic liberalization is spurring growth and new business opportunities in that country.

Indian lenders, such as Housing Development Finance Corp. of Bombay, are particularly appealing because Indian consumers increasingly are accruing debt through mortgages and other loans, Madden said. For the banks, “it’s a high-margin business,” he said.

* In the U.S., “growth” funds overtook “value” funds in the quarter. Growth issues are stocks of companies whose earnings are expected to grow faster than those of the average company. Value issues are shares that are considered to be relative bargains compared with earnings or assets.

Value has trounced growth since 2000 as investors have turned more conservative since the technology-stock crash.

But in the second quarter, the average large-capitalization growth stock fund gained 2.6%, topping the average large-cap value fund’s 1.2% advance. Small- and mid-cap growth funds also beat their value peers in the quarter.

And technology funds, the quintessential growth sector, rose 3.3% in the quarter. But in the first half tech funds were down 5.9% on average, and value overall beat growth.

If the second-quarter pop in growth is the start of a sustained comeback, the bore market of 2005 might soon turn into something more exciting.