First Quarter Was a Pretty Good Year
Elated -- and maybe a little nervous.
That probably describes many stock mutual fund investors after the first-quarter market rally.
Nearly every category of stock fund rose in the quarter ended March 31 amid a global advance in equities. Some funds earned almost as much, or more, in the three-month period as they did in all of last year.
The average domestic stock fund, for example, rose 6.7% in the quarter, matching its total return for 2005, according to Morningstar Inc. in Chicago. The average foreign fund jumped 10.2% in the three months, putting that category on track to beat most of its U.S. rivals for a fifth straight year.
Worldwide, stock investors seemed to ignore rising interest rates and another jump in oil prices, focusing instead on the good news of an expanding global economy.
That may prove more of a challenge in the second quarter. On Friday, renewed rate worries triggered a sharp pullback in U.S. stock prices -- and provided a reminder that the strong gains in many market sectors since 2002 also have raised risk levels.
For some professional financial advisors, a breather in the market might be welcomed. It could ease some of the pressure from clients to shovel more money into the hottest stock sectors.
“Clients are asking for more of the sexy areas,” said Mark Petrie, vice president at Solana Beach, Calif.-based Hokanson Capital Management, which oversees about $250 million in individual stocks and mutual funds.
Petrie’s concern is that what’s sexy now -- including small-company stocks, foreign issues and commodities -- could lead the way down if the market stumbles.
Of course, investors heard many of the same warnings about those sectors throughout 2005. That didn’t stop more money from pouring into mutual funds during the first quarter.
“Success builds on success,” said Jeff Tjornehoj, an analyst at fund research firm Lipper Inc. in Denver.
Among the quarter’s best-performing stock fund categories:
* Precious-metals funds, which typically own shares of gold and silver miners, shot up 20.7% in the three months, as gold and silver reached their highest levels since the early 1980s.
With relatively few ways for small investors to play the continuing bull market in commodities, precious metals funds are a natural place to turn, many analysts say.
* Funds that own Latin American stocks jumped 17.2%, on average, after rocketing 54% in 2005. The Mexican and Brazilian markets hit record highs in the quarter.
Investors continued to be encouraged by growth in those economies and prospects for more. Interest rates fell in Mexico and Brazil in the quarter, even as they rose in the developed world.
* Diversified emerging markets funds were up 12.3%, on average. Latin America had no monopoly on markets setting record highs as the equity-investing bug continued to spread worldwide. Among the quarter’s hottest markets were India, Russia and Morocco.
* Europe-focused stock funds gained 12.9%, as major indexes in markets including Germany, France and Spain hit their highest levels in at least five years. A weaker dollar also boosted European returns for U.S. investors.
* Among U.S. fund categories, real estate-oriented portfolios shot up 13.7% after rising 11.7% in 2005. Real estate funds mostly invest in real estate investment trusts that own commercial properties.
A number of takeover deals involving REITs in the quarter raised the prospect that commercial real estate might be a relative bargain compared with residential real estate.
* U.S. small-company funds once again trounced their big-company rivals, as they have for the last six years. The average fund that owns small-capitalization growth stocks soared 12.7% in the quarter, compared with a 3.6% gain for the average large-capitalization growth fund.
Overall, the first-quarter rally was much broader than the fourth-quarter advance, when the average domestic stock fund rose 2.3% and the average foreign fund, 5%. Fund returns are principal change plus any dividend income.
Individual investors stoked the rally with enthusiastic buying. Stock funds had net cash inflows of $31.6 billion in January and $27.3 billion in February, the latest data available from the Investment Company Institute. That was nearly as much as the funds took in during the second half of last year.
If the market party is getting giddy, at least it has a fundamental underpinning: The global economy has continued to surprise investors with its resilience, which in turn boosts optimism about corporate earnings growth.
In Japan, the deflation that has dogged the economy for the last decade appears to have run its course, as spending by businesses and consumers picks up.
In Germany, a business sentiment index in March reached its highest level in 15 years.
In the U.S., the strong March employment data reported Friday underscored the perception that growth remains healthy, economists say.
And worldwide, China’s boom remains a powerful story that is lifting other economies as well.
But the latest U.S. employment data also reminded investors of the big risk of a global boom: the potential for a dangerous rise in inflation and interest rates.
The yield on the 10-year U.S. Treasury bond jumped Friday to 4.98%, up from 4.90% on Thursday and a four-year high.
Many fear that the Federal Reserve might not be nearly finished raising short-term interest rates, as investors have hoped.
At the same time, the European Central Bank warned on Thursday that it may raise rates again in June. And last month the Bank of Japan gave the first indications that it, too, will tighten credit this year.
Stock investors in the first quarter refused to get agitated about higher interest rates. The question now is whether that sentiment can hold up, analysts say.
Few Wall Street pros believe that higher interest rates will be enough to trigger a global recession soon. But rising rates might be enough to spark a short-term “correction,” or pullback, in equity prices.
“There usually has to be some kind of catalyst to change people’s minds about how much risk they want to take,” Petrie said. Historically, rising interest rates often have played that role.
Some fans of long-suffering U.S. blue-chip stocks say a rate-induced market slide could be just what is needed to spur a new appreciation for those shares, perhaps at the expense -- at least temporarily -- of smaller stocks and emerging market shares.
“If large-cap stocks take the lead, it will probably be because people are scared and want to put money into companies they trust,” Tjornehoj said.
But many Wall Street analysts have been banging the table for U.S. blue chips for much of the last year -- ineffectually so far.
“When the conventional wisdom says it’s time for large caps, it probably means it isn’t,” said Ron Sachs, who manages the $1-billion Janus Orion stock fund in Denver.
Despite the heady gains for many small stocks in this decade, Sachs doesn’t find the sector overvalued relative to its growth prospects.
The Orion fund, which rose 11% in the first quarter, can invest across the market spectrum. That has led Sachs to smaller companies such as online travel service Expedia Inc. as well as large companies such as Swiss drug giant Roche Holding. Sachs says he tries to find stocks that not only have good growth potential but pose limited risk.
Many investment pros say the best advice they can give small investors with their fund portfolios today is to focus on weighing risk versus reward. If markets turn more volatile, for whatever reason, that concept will be relearned in a hurry.
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Hot start
Some stock mutual fund sectors scored first-quarter gains that were near or better than their returns for all of 2005.
Real estate: First-quarter return -- 13.7%, Return for 2005 -- 11.7%
Europe: First-quarter return -- 12.9%, Return for 2005 -- 14.0%
Small-cap growth: First-quarter return -- 12.7%, Return for 2005 -- 5.7%
Communications: First-quarter return -- 10.2%, Return for 2005 -- 7.4%
Technology: First-quarter return -- 7.6%, Return for 2005 -- 5.5%
Mid-cap value: First-quarter return -- 6.7%, Return for 2005 -- 8.4%
Large-cap growth: First-quarter return -- 3.6%, Return for 2005 -- 6.4%
Avg. U.S. fund: First-quarter return -- 6.7%, Return for 2005 -- 6.7%
Avg. foreign fund: First-quarter return -- 10.2%, Return for 2005 -- 17.4%
