Star Fund Sectors Still Shining
Among stock mutual funds, the rich keep getting richer. And that’s the quandary for many investors: Do they buy the fund categories that have led the way for the last three years -- mainly foreign and “hard asset” funds like natural resources -- or stay away, betting that the glory days for those sectors are ending?
Nearly every stock fund category gained ground in the third quarter ended Sept. 30, in the face of surging energy prices and rising interest rates. Investors were in a mood to keep betting on global economic growth, despite the challenges.
The average stock fund invested in U.S. shares rose 4.7% in the three months, lifting the year-to-date return to 4.4%, according to fund tracker Morningstar Inc. in Chicago.
But the stars were the same fund categories that have shined brightly since 2002. The average natural-resources fund, for example, jumped 21.9% in the quarter as oil and natural gas prices rocketed and lifted most energy companies’ shares.
Over the last three years natural-resources funds have risen an average of 37.8% a year, compared with an 18.2% average annual return for general U.S. stock funds.
Funds that own stocks of emerging-market nations such as Brazil, South Korea and Poland also posted huge gains in the quarter -- 17.3%, on average -- and have risen 36.8% a year over the last three.
Even in bull markets that get out of control, as the technology stock mania did in the late 1990s, there always are fundamental positives underpinning such moves. It’s just a question of when the stock price gains far outrun those fundamentals.
In the case of natural resources, fans of energy companies and producers of other commodities believe these industries are in a long-term uptrend after nearly 20 years of decline that ended in the early part of this decade.
Because commodity prices mostly fell in the 1980s and 1990s, “there has been a massive amount of deferred development in the business,” said Frank Holmes, chief investment officer of San Antonio-based U.S. Global Investors, which is best known for its natural-resources mutual funds.
That lack of development has led to limited commodity supplies, while demand has boomed as China, India and other up-and-coming economies industrialize. The natural result has been higher prices.
The bullish case for natural resources stocks is that the supply/demand imbalance won’t be solved anytime soon.
In the oil market, for example, even if U.S. demand went flat, China and India make up a substantial amount of the annual growth in demand worldwide, said John Segner, manager of the AIM Energy fund in Houston, which jumped 55.2% in the first nine months.
But recent days have demonstrated how quickly hot stock sectors can turn cold. As crude oil prices have fallen for six straight sessions, to $61.36 a barrel as of Thursday, an index of 13 major oil and natural gas stocks has tumbled 11.5% from its record high reached Sept. 29.
Financial advisors say the plunge is a good reminder that investments in narrow market sectors should be relatively small pieces of a diversified portfolio, not large chunks.
Holmes, however, notes that any long-term bull market is sure to have sharp pullbacks along the way -- as the 1982-2000 bull market in U.S. blue-chip stocks did in 1987, 1990, 1994 and 1998. Those are the buying opportunities, he said.
Segner says his long-term optimism about energy companies is rooted in the belief that most companies are taking a conservative approach toward the business and the outlook for oil and natural gas prices.
Many companies “are optimistic about the future, but they run their businesses like they have $25-a-barrel crude” instead of $60-plus oil, he said.
As oil and gas exploration ramps up in the search for more supply, Segner also favors oil field services companies such as Schlumberger and Nabors Industries.
At the Excelsior Energy and Natural Resources fund in New York, manager Michael Hoover has the bulk of the portfolio in energy shares, but also owns producers of other commodities -- such as Aracruz Cellulose, a Brazilian forest-products company, and Peabody Energy Corp., a major U.S. coal miner.
Assuming the world economy continues to grow, “My view is, buy the low-cost producers [of commodities] around the globe,” Hoover said.
The long-term growth story also appeals to fans of emerging-market economies and stocks.
Although those markets are notoriously volatile -- indeed, they have dived in recent days as stocks in general have slumped -- most of the countries aren’t facing the economic risks they did in the 1980s and 1990s, according to investment firm Bridgewater Associates.
“Previous emerging market booms have followed a similar path, ultimately ending in over-consumption financed by foreign capital, [then] capital retrenchment and a sharp recession,” Bridgewater said. This time, “emerging markets are accumulating wealth, exporting capital and are not exposed to a sudden pullback of foreign money.”
The simplified view is that countries such as China, India, Brazil, South Korea, Poland and others are early in their economic growth phases, compared with the mature or maturing economies of the United States, Europe and Japan.
Although emerging-market stocks have soared in recent years, and aren’t as cheap as they used to be, “the growth stories are still there,” said Brett Gallagher, equities strategist at Bank Julius Baer in New York.
Owning foreign stocks also means owning foreign currencies, which offer U.S. investors diversification in case the dollar continues the sinking trend that began in 2002, experts note.
A weak dollar can provide a bonus for U.S. investors in foreign shares: As foreign currencies appreciate against the buck, foreign stocks are worth more when translated into dollars.
This year, the Brazilian market is up 12% in local-currency terms, but is up 29% in dollars because Brazil’s currency has strengthened.
But as emerging markets soar, some veteran foreign-stock managers are shying away.
David Herro, who manages the Oakmark International fund in Chicago, says he has become much less interested in emerging markets. His fund has about 7% of its assets in those markets now, he said. By contrast, 68% of the fund’s assets are in European stocks and 13.5% are in Japan. Herro owns names such as Nestle and Honda Motor Co.
Big, blue-chip companies in Europe and Japan offer much more compelling long-term value now than many emerging-market issues, Herro said. “We’re value investors, and that’s where we’re finding value now,” he said.
Similarly, many money managers say the best values in the U.S. market are the classic blue-chip growth stocks -- including some tech issues -- that led the market in the 1990s but have largely been out of favor since.
There were more signs in the third quarter that those growth names are attracting more attention: The average U.S. large-capitalization growth stock fund rose 4.8% in the quarter, outpacing the 3.6% gain for the average large-cap value fund.
Growth stocks are shares of companies whose earnings are expected to grow at a faster-than-average rate. Value issues are those that appear underpriced, compared with earnings or other measures, relative to the average stock.
The value sector, and small-company stocks, have ruled for the last five years, but many money pros contend that big-name growth stocks are the true value play today, and are better long-term bargains than many of the smaller stocks that have continued to outshine them.
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Buy the leaders -- or sell?
The stock mutual fund categories that gained the most in the third quarter were mostly the same ones that have led for the last three years -- raising questions about whether they’re peaking.
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Stock fund category: Three-year return (annualized, through Sept.)
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Latin America: +56.5%
Natural resources: +37.8
Emerging markets: +36.8
Foreign small/mid-cap growth: +32.0
Foreign small/mid-cap value: +29.4
Europe: +26.9
Real estate: +25.9
Utilities: +25.8
Average U.S. fund: +18.2
Source: Morningstar
