Value stocks out of vogue? Technology and growth funds back in the black? As you scan the first-quarter list of top-performing mutual funds, you may think your eyes are playing tricks. For all the market's fitfulness about war in Iraq and worries that the economy is stalling, aggressive equity mutual funds have fared exceptionally well so far this year. Scores of tech and telecom funds that had vanished from the charts for three years are making a comeback. Amerindo Technology, RS Information Age, and Firsthand Technology Leaders, to name a few, have trounced the slight 2% gain of the Standard & Poor's 500-stock index through Mar. 21, showing gains of 28.97%, 13.51%, and 10.23%, respectively.
Will the trend last? "That's the 10 zillion-dollar question," says Douglas MacKay, portfolio manager for the $250 million Red Oak Technology Select fund, which is up 13% so far this year. He concedes that tech stocks may be getting what could turn out to be a temporary boost only because they're less likely than Old Economy stocks to suffer from any wartime disruption to oil supplies. Added to that, hedge-fund managers and other pros who shorted tech stocks last year are now rushing to buy them back to close out their positions. But MacKay believes something more lasting may be afoot: "People are thinking about how to be positioned post-Iraq," says MacKay, who favors big tech names such as eBay (EBAY), Intel (INTC), and Microsoft (MSFT). "If you believe it's time to play ball, you're lightening up on slow-economy, recession-resistant sectors."
Individual investors are far from convinced that the tech turnaround is real. For one thing, the market has an acute case of the jitters: It snapped back dramatically from its Mar. 11 lows -- with all major indexes up about 10% -- then quickly took a turn for the worse on sobering news from the war's front lines. Investors have been pulling money out of equity funds for most of the year: Outflows averaged $3.3 billion a week through Mar. 19, while inflows averaged just $1.1 billion. "The overall trend of feeble investor demand for equities remains in place," says Brian Belski, strategist for U.S. Bancorp Piper Jaffray. Thomas McManus, a strategist at Banc of America Securities, says that the recent market rally "stoked some investors' greedy instincts," but there's still no sign of a surge in demand for stocks. The recent outflows -- in a quarter that is usually the strongest for new mutual fund investments -- are a reflection of a three-year bear market, 10-year lows in consumer confidence in Corporate America, and murky prospects for economic growth. Meanwhile, business leaders continue to clamp down on capital spending plans until the future is clearer.
These worrying macro trends have made the more circumspect mutual-fund managers wary about how long any tech rally is likely to last. Their concern is that the stocks of leading large-tech names are racing too far ahead of their real prospects. "The market looks like it's anticipating better days," says Dan Cantor, manager of the $1.2 billion Liberty Select Value Fund, down 1%. "But we don't see signs from companies that things are getting better."
Value managers such as Cantor aren't ready to throw in the towel yet. They argue that while growth managers have outperformed them this year, a few months don't necessarily make a trend. The same uptick in growth stocks occurred about a year ago and then petered out. So they believe that favoring inexpensive value stocks and companies with clean balance sheets is still the way to go. Cantor is keying in on mid-caps. They haven't been bashed like riskier small-cap value stocks -- which are the first quarter's worst performers, with a 2.79% loss -- and they're still reasonably valued. And the price-earnings ratio for growth stocks in the S&P Barra MidCap Index is 27, vs. 19 for value stocks. Among Cantor's top picks are Federated Department Stores (FD), Telephone & Data Systems (TDA), and paper company MeadWestvaco (MWV). His biggest bet -- 20% of assets -- continues to be thrifts and small regional banks, such as longtime holding Golden West Financial (GDW).
Of all U.S. diversified funds, those that invest in large-cap growth stocks, up 3.4%, have fared best in 2003. Managers specializing in blue chips say the outperformance is not only driven by the lure of quality in uncertain times but also decent profit reports. "People are gravitating to where the liquidity is," says Charley Winger, manager of AmSouth Capital Growth Fund, a $245 million large-cap fund, up 4% as of March 21. Winger is also bullish on tech and health care. He has put 25.5% of the fund's assets into tech stocks such as Cisco Systems (CSCO), Intel, and Dell Computer (DELL), vs. the 15% tech weighting of the S&P 500. He thinks tech earnings will grow in line with analysts' expectations this year and that capital spending will start rising during the second half. "We're gaining confidence that this recovery is going to remain on track," he says.
Political unrest abroad accounts for the mixed performance of international funds. Some emerging-market funds have leaped into top spots: ING Russia Fund is up 8.8%, and Dreyfus Premier Greater China has gained 9.84%. They have displaced others, such as Matthews Korea, down 13.64%, which had a decent track record before the U.S.'s political confrontation with North Korea began over nuclear weapons. It was up 8% last year and boasts a 13.9% annualized five-year return. Mark Headley, president of Matthews International Capital Management in San Francisco, says he's unfazed by the political tension in Korea, and he continues to favor stocks such as Samsung Electronics and Hite Brewery.
The average foreign fund has trailed its domestic peer by more than 5% so far this year. But managers of European funds, in particular, say the sell-off has been overdone. In fact, the markets -- though extremely skittish as a result of the war -- had begun to turn around: In the seven trading days ended Mar. 21, the Dow Jones Euro Stoxx 50 of blue-chip European companies jumped 21%, a recovery from 27% losses for the 11 preceding weeks, though they lost 4.5% on Mar. 24. With such volatile market swings, says Sarah Ketterer of Causeway Capital Management, the best strategy is to stay fully invested. "We don't dare miss any of this," says Ketterer, who manages $2.3 billion in international equities. Amit Wadhwaney of the $30 million Third Avenue International Value says the wild swings have allowed him to snap up bargains: "In this market, a lot of things can come your way." For instance, he recently invested in Norway's Smedvig, an offshore drilling contractor. Smedvig's stock sells for 65% of its liquidation value and half the price-to-book value of a comparable U.S. stock, such as Houston's Diamond Offshore Drilling.
Of course, the progress of the war is still a wild card. But as long as pessimism and caution linger, investors have a good shot at making some money, says Joseph Zock of Capital Management Associates in New York, which manages $1 billion. "It takes a lot of courage to invest right now," says Zock. "But it's exactly what you should be doing." If he's anywhere near right, investors who are still cashing out of the market will be kicking themselves once the current clouds blow over. By Mara Der Hovanesian