Upbeat outlook buoys stock funds
Global stock markets mostly refused to give up their sunny view of the world economy in the first quarter, and that was enough to keep stock mutual funds modestly in the black.
Investors also favored the market sectors that have treated them best in recent years, with good results. Funds that own foreign shares did well, as did those that invest in commodity producers -- oil and mining firms, for example.
And once again, funds focused on small and mid-size companies did better than portfolios invested in the biggest blue-chip American firms, such as General Electric Co. and Intel Corp.
For sure, nobody got rich in stock funds in the first three months. The average domestic fund eked out a 2.1% total return, meaning price change plus dividend income, according to Morningstar Inc.
But it might have been a lot worse: Stocks suffered a mid-quarter jolt triggered by a brief plunge in Chinese shares and worries that the U.S. economy might slow more than expected.
As it turned out, the sell-off in late February and early March was almost a blink-and-you-missed-it affair. Many global markets have recouped most or all of their losses. And the sectors considered to be the riskiest -- including smaller stocks and emerging-market issues -- came back the fastest.
“Eventually there will be a reckoning for these risky assets,” said Jeff Tjornehoj, a senior research analyst at fund-tracker Lipper Inc. in Denver. “But it wasn’t in the first quarter, and it might not be this quarter either.”
The continuing strength of foreign stocks and smaller domestic issues, in particular, is putting some investors in a tough position. They may be reluctant to commit new money to market sectors that have been hot for years, for fear of getting in too late -- as many people did with dot-com stocks in 2000, just before those shares crashed.
Yet there’s no way to know when the party will end. As long as investors assume the global economy will continue to expand, they may continue to find more reasons to be in the stock market than to be out of it.
Mark Bickford-Smith, a portfolio manager on T. Rowe Price Associates’ international-investing team in London, said he believed that global markets recovered quickly last quarter because investors were confident that the troubles in the U.S. housing market wouldn’t be severe enough to push the American economy into recession.
If U.S. recession fears deepen, Bickford-Smith said, he would expect a much sharper decline in foreign stock markets, and specifically emerging markets, because American consumer and business spending still are crucial to the global growth outlook.
Even so, he said, “The difference now versus 10 years ago is that the world and emerging markets are not nearly as dependent on the U.S. consumer.”
The consumer sectors of countries such as China, Brazil, South Korea and Russia are much better developed than they were a decade ago, underpinning those economies, Bickford-Smith said. That is making for some interesting new stock opportunities for mutual funds.
Two of the shares that helped the T. Rowe Price Emerging Markets Stock fund recover from the mid-quarter sell-off, and finish with a 1.4% gain in the three months ended March 30, were CTC Media, a Russian TV station operator, and X5 Retail Group, a discount-retailing chain that Bickford-Smith says is the “Wal-Mart of Russia.”
At the Thornburg Core Growth fund in Santa Fe, N.M., the 40-stock portfolio is dominated by U.S. names that most investors would know: Microsoft Corp., for example, and casino giant Las Vegas Sands Corp.
But fund manager Alex Motola also has the flexibility to go overseas, and he does. One of his foreign picks is China Milk Products, a profitable Chinese dairy-farming operation.
China is “massively under-penetrated in terms of milk consumption,” and the government wants to encourage people to drink more of it, Motola said.
His eclectic portfolio gained 4.6% in the first quarter.
The average emerging-markets stock fund rose 2.4% in the period, after a 32.6% surge in 2006, according to Morningstar.
One of the factors helping emerging-market stocks in the quarter was a resurgence in prices of commodities, including oil, copper and soybeans. Many emerging-market economies are big exporters of commodities.
The commodity rally also pushed natural-resources stock mutual funds up 5.9% in the period, on average.
Funds that focus on European stocks rose 4.2% in the quarter. That gain stemmed in part from the euro’s rally to a two-year high against the dollar, which meant that euro-denominated stocks were worth more when translated into dollars.
The weaker dollar should be an advantage for many U.S. blue-chip companies that are exporters. It makes their goods less expensive abroad. Yet funds that focus on big-name U.S. stocks lagged most other fund categories in the first quarter.
Large-capitalization growth funds -- which own shares of blue-chip companies whose earnings growth is expected to rise at an above-average rate over time -- added 1.3% in the period. They have been the market’s underdogs for most of this decade.
U.S. blue chips don’t lack for fans on Wall Street. Indeed, the prevailing view is that the stocks are good values. But shares of many small- and mid-size stocks continue to rise at a faster pace than blue chips.
The average small-capitalization growth stock fund gained 3.1% in the quarter; the average mid-cap growth fund rose 4.1%.
Columbia Acorn fund, one of the biggest mid-cap growth funds ($20 billion in assets), was up 4.5% in the period. Chuck McQuaid, lead manager of the Chicago-based fund, said booming takeover activity was providing an unexpected boost to the portfolio, as companies have been bought out at rich prices.
Last year, 26 of the 400-some stocks in the fund got takeover bids, McQuaid said. Last quarter the pace accelerated: 13 of the fund’s stocks got buyout offers.
“There’s no sign that this takeover binge is going to end,” McQuaid said.
Takeovers also helped lift the utility sector in the quarter. Utility-stock funds rose 7.8%, the biggest gain of any category.
At the other end of the spectrum, funds that own financial-services shares were the worst performers in the three months, falling 1.8% on average. That reflected concerns over rising mortgage delinquencies and the effect on lenders’ earnings.
Some money managers believe the risks to the U.S. economy from the housing slump remain high. What’s more, corporate earnings growth in general is expected to weaken significantly in the first half.
The environment calls for a cautious investment approach, said Ben Kotler, a fund manager on Massachusetts Financial Services’ foreign-stock team in London. Their focus, he said, is on “undervalued quality” -- big-name firms with established franchises, strong finances and consistent growth. Nestle is one such name, Kotler said.
“Markets are increasingly synchronized, and particularly on the downside,” he said. “That leads us to be more attentive than ever to downside risk.”
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Old leaders, leading again
The stock mutual fund sectors that have led in performance over the last three years -- including foreign funds and natural-resources funds -- took charge again in the first quarter. Funds that own large U.S. stocks lagged.
*--* Fund category First quarter total return
Foreign small/mid-cap growth 6.2% Foreign small/mid-cap value 5.9 Natural resources 5.9 Europe 4.2 U.S. mid-cap growth 4.1 U.S. small-cap value 2.5 Average U.S. fund 2.1 U.S. large-cap growth 1.3 U.S. large-cap value 1.1
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Source: Morningstar
