may cringe when they open their July statements, especially if
they were invested in the hardest-hit corners of the global
market: small-caps, utilities and Europe.
High valuations, worries over the Federal Reserve raising
interest rates sooner than expected, Argentina's default and war
throughout the Middle East gave investors reasons as good as any
to book profits after the market hit new highs.
Mutual fund managers
are positioning their portfolios defensively but recommend that
investors buy during the dip, owing to strong earnings and sales
"The plan is to wait for a correction, which may in fact be
happening now," said Phil Orlando, chief equity strategist at
Federated Investors. "The market will do fine into the end of the
year, so we'll look for an opportunity to put more money into
stocks later in the summer, early in the fall."
SPDR S&P 500
) snapped a five-month winning streak, slipping 1.3% in July.
Small-cap growth funds dropped 5.79%, putting their year-to-date
return in the hole by 5.37%, according to Lipper.
Large-cap growth outperformed all size and style categories by
giving back the least, 1.27%. It pared its year-to-date return to
Small-caps likely sold off the most because they were most
overvalued and remain so by some measures.
While SPY trades at 17 times earnings, the
iShares Russell 2000
Index Fund (
), a benchmark for small-cap stocks, trades at nearly 21 times
forward earnings, a level "consistent with sub-par forward
returns," say Credit Suisse analysts Lori Calvasina and Sara
They believe that large-cap outperformance over small caps
will likely persist for the rest of the year because of the Fed's
reducing its economic stimulus, known as quantitative easing, and
the mergers and acquisitions favoring large caps in recent
"Small- and midcaps also lost their leadership vs. large as
Operation Twist and QE2 came to an end," they wrote in a report
released July 31. In Operation Twist, the Fed buys and sells
short-term and long-term bonds. QE2 is the Fed's second round of
quantitative easing. "Flows to small-cap funds have turned
negative in 2014, reversing strong inflows seen in 2013, a strong
underpinning of last year's rally."
Q2 Corporate Results
With three-fourths of S&P 500 companies having reported
second-quarter results, corporate earnings are up an average 7.5%
and sales 4.1%, according to FactSet. Nearly three in four firms
eclipsed Wall Street earnings estimates; nearly seven in 10 beat
"For Q3 2014 and Q4 2014, analysts are predicting earnings
growth rates of 7.8% and 10.2%," FactSet wrote in a report Aug.
1. "For all of 2014, the projected earnings growth rate is 7.8%."
Q3 and Q4 sales are expected to be nearly 4% with full-year
revenue growth forecasts of 3.7%.
The telecom sector, down 0.88% in July, reported the largest
earnings growth of the 10 S&P sectors at nearly 20%.
Financials, down 2.71% in July, was the only sector to see a
year-on-year slide in earnings at 0.1%. It will be the second
quarter in a row of earnings declines.
As July's worst-performing sector, utility funds burned off
5.44%, cutting their year-to-date return to 9.89%. Consumer
spending on utilities fell after the first quarter's spike in
heating demand sparked by exceptionally cold weather across the
U.S., according to IHS.
Natural resource funds lost 5.1% as commodities suffered their
biggest sell-off since May 2012. Unleaded gasoline prices
evaporated 8.1% in July as prices dipped four weeks in a row.
U.S. refineries are producing at their highest rates since 2005,
says the Energy Information Administration. Long-anticipated
buildouts to refinery capacity in the Gulf Coast are also
materializing. What's more, slower-than-expected economic growth
in emerging markets has led to weaker demand than forecast.
Agricultural commodity funds fell 4.66% as ag prices hit their
lowest level since July 2010, according to S&P Dow Jones
Indices. Farmers have ideal weather conditions to thank for their
record yields this summer, says Brian Hicks, a portfolio manager
at U.S. Global Investors in San Antonio, Texas.
Federated's Orlando -- who oversees its Global Allocation
Class A Fund , Managed Risk Class A Fund and Managed Tail Risk
Fund II -- expects a midsummer correction and has positioned his
portfolios defensively. He is heavy on health care, consumer
staples, real estate investment trusts, utilities and telecom,
and light on economically sensitive sectors such as technology,
industrials, financials and consumer discretionary.
He recommends investors have a small allocation to hard assets
such as energy and precious-metals stocks as a hedge against
geopolitical risk in Israel, Iran, Iraq and Syria, "any one of
which could be a tinderbox that results in significant problems,"
Orlando said. "There's no way of knowing that a company or an
industry is going to be able to exist or function based on
something that may happen. But if you've got oil or gold in hand,
those are hard assets against something bad happening in the
Sanctions Hit Europe
European stock funds lagged all global markets in July, losing
4.32% on fears that new economic sanctions against Russia may
ripple through the continent.
"When you are in a fragile recovery at the margin, anything
that hurts your sales when the recovery is very slow is not going
to be insignificant," said Bob Baur, chief global economist at
Principal Global Investors, in Des Moines, Iowa. "Depending on
what some countries import, if those costs rise because of
retaliation, there could be some economic consequences."
The sanctions ban sales of arms, technology and energy-related
equipment, and cut off financing to five major state-owned
Russian banks. Russia's
plunged 11% in July and 16% year to date, according MSCI.
China funds, which were already lagging, bucked the global
sell-off, rallying 4.24% in July, pushing their year-to-date rise
The Hong Kong stock market rallied to multiyear highs as the
government boosted spending on infrastructure, cut some taxes and
reduced bank reserve requirements to spur lending, Peter Kohli,
CEO of 2-year-old DMS Funds with $2 million in assets under
management in Newton, Ma., said in an email.
"These measures have succeeded in helping boost the economy in
the short term. They have also resulted in an increase in
corporate debt," Kohli wrote. "But this is only temporary as the
underlying problems of a soft real estate market and the shadow
banking system have yet to be adequately addressed."
A professor at Peking University says that China could be
overstating its gross domestic product tally by $1 trillion a
year, so China's data don't add up.