Investors ‘back to square one’
The storyline for mutual fund performance in the first half of 2006 came down to this: What rose in the first quarter generally slipped in the second quarter.
The domestic stock market rallied in the first three months of the year, with small-company growth funds leading the way. But then the market gave back much of that gain in the past three months after the Federal Reserve raised its target for short-term rates on May 10 and later signaled continuing concern about inflation.
After years of vigorous growth, global stock funds also slipped, falling 1.6 percent in the second quarter — after rising in the first quarter — as investors moved out of risky investments such as volatile emerging-market funds and into more conservative ones, including large-company stock funds and money market funds.
Still, global and U.S. stock funds surged during the last few days of the quarter when the Federal Reserve — with its 17th-consecutive rate increase since 2004 — hinted that it might take a breather from further rate increases aimed at fighting inflation.
The average domestic stock mutual fund ended the quarter with a 3.3 percent loss, while the Standard & Poor’s 500-stock index fund, with dividends reinvested, registered a 1.4 percent fall, according to Lipper Inc.
Overall, “We’re back to square one from the beginning of the year” with domestic stock market performance, says Vivienne Hsu of Charles Schwab Investment Management. “But that’s not very different from our predictions going into 2006.”
Bear-market funds — which profit from market declines by selling borrowed shares in hopes of buying them back at a lower price later — were the top-performing domestic fund category, gaining 5.7 percent in the latest three-month period.
The worst-performing funds last quarter were some of the outsized performers of recent years and of the first quarter: science and technology funds, which plunged 9.6 percent in the second quarter, and emerging-market funds, which slid 5 percent. Despite the end-of-the-quarter rally, some of these riskier, “more opportunistic sectors did not recover as well,” Hsu says.
Value funds outperformed growth funds in the second quarter. And large-company stock funds edged past small-company funds in a long-awaited comeback. Every major category of large-company funds outperformed small-company funds; large-company value funds fell 0.1 percent in the second quarter, compared with a 3.4 percent drop for small-company value funds.
Small-company stocks have edged out large-company stocks for seven consecutive years, from 1999 through 2005, so the weakness of small-company stocks was one of “the most significant” trends in the second quarter, says Norm Fosback, editor of “Fosback’s Fund Forecaster,” a newsletter on fund performance.
“Now we’re at a situation where small-caps are overvalued related to large-caps, and what we’re seeing here in the second quarter is a response to this reversal in relative valuation,” Fosback says.
As investors turned away from risky investments, they poured cash into money market funds, the best of which are earning upward of 5 percent, according to Bankrate.com. So far this year, investors have funneled a net $45.3 billion into money market funds, with most of the money coming in during May and June, according to AMG Data Services.