Mutual Funds Eke Out Modest Gains In July

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Mutual fund investors earned modest gains in July when the market seesawed higher on economic data and European headlines.

Domestic mutual funds on average ticked up 0.19% in July with a 7.25% year-to-date return, according to Lipper Inc. Large-cap growth funds added 0.53% in July. That lifted year-to-date returns to 10.25%, tops among all cap-size and style funds.

Small-cap growth funds underperformed with a 1.26% loss, paring year-to-date gains to 6.75%.

Benchmark 10-year Treasury yields fell 16 basis points to 1.51% on safe-haven buying and U.S. dollar strength. The average taxable bond fund rose 1.65% in July, bringing the year-to-date gain to 6.14%.

The market needs to see Europe coming up with medium- and long-term solutions to its credit crisis, evidence of the U.S. recovering through more hiring and a meaningful stimulus program in China in order to rev higher, said Ron Sachs, manager of Janus Forty with $3.66 billion in assets.

He believes stock valuations are attractive while investors are focused on macroeconomic head winds -- including the European credit crisis, flagging U.S. recovery and slowing growth in China -- rather than corporate fundamentals.

Product Momentum

As a bottom-up stock picker, Sachs looks for "businesses that have interesting product momentum, globalization opportunities and ability to deliver results despite macro head winds." The fund is concentrated in 36 holdings with large stakes in Apple ( AAPL ),eBay ( EBAY ),Celgene ( CELG ),Limited Brands ( LTD ) andNews Corp ( NWSA ).

Janus Forty returned 17% year to date vs. 11.54% for the S&P 500. But it trails the benchmark longer term, returning an average annual 7.97% the past three years vs. 14.52% for the S&P.

High-quality, dividend-paying U.S. stocks are the only logical place to invest right now because bonds can quickly correct when rock-bottom interest rates rise and foreign markets are too uncertain, said Neil Hennessy, CEO of Hennessy Advisors, which manages nine mutual funds.

He contends stock prices can rise substantially because they're trading at historically low 14.6 price-to-earnings and 7.6 price-to-cash-flow ratios. The S&P 500's 2.2% dividend yield surpasses most government bonds. Corporate profits have eclipsed their 2007 highs, yet the market still trades nearly 14% below its historic high.

What's more, corporate America has hoarded wads of cash, which firms have been using to initiate or raise dividends, buy back stock, invest in internal infrastructure or make acquisitions.

"All five of those are very good for a company and they're very good for the stock market, but not for unemployment," Hennessy said.

His top performer this year, Hennessy Cornerstone Growth with $224 million in assets, leads Morningstar's small-cap blend mutual fund category. It climbed a handsome 21.35% year to date vs. 6.96% for its peers.

The fund screens for firms with at least $175 million in market value, a price-to-sales ratio of 1.5 or less, annual earnings that are higher than the prior year and positive price action in the past three to six months. It buys equal dollar amounts of the top 50 stocks with the highest relative strength over the past 12 months on an undisclosed date and holds them for one year.

Holdings include:Arctic Cat (ACAT), a snowmobile maker;LeapFrog Enterprises (LF), a children's educational entertainment developer; and Cost Plus, a specialty retailer that Bed Bath & Beyond (BBBY) bought out in July. These advanced 98% to 126% year to date.

With second-quarter results from two-thirds of the S&P 500 companies, earnings rose 7% from the year-ago period, according to Thomson Reuters. But the growth rate turns negative if financials, which have easy year-over-year comparisons, are excluded.

Revenue growth has been weak also. About two-thirds of companies surpassed earnings forecasts, but only about one-third beat revenue expectations. About one-fifth of companies missed earnings estimates, while about one in 10 met.

A little over 70% of companies that have made pre-announcements have cut their profit outlooks because of slower Chinese growth, recession in Europe and a strong greenback. About 20% guided higher, according to Thomson Reuters. Third-quarter earnings are expected to decline 1% year over year and then climb nearly 11% in the fourth quarter.

Among sector funds, agricultural commodity funds, up 8.57%, gained the most in July. Corn and soybean prices shot up to new highs as a drought and heat wave across the country destroyed crops.

Alec Young, global equity strategist at S&P Capital IQ, recommends overweighting energy, consumer staples and information technology. Energy trades at low valuations, while lowered earnings forecasts resulting from falling oil prices makes it easy for companies to meet expectations.

Consumer staples benefits from steady, global demand and strong dividend growth. Tech enjoys low valuations and pent up demand.

Young recommends underweighting utilities and basic materials. Utilities are overvalued and have weak earnings growth. Slowing global growth will dampen demand for commodities, limiting valuations for basic materials, he says.

Foreign Funds

The average fund investing in foreign markets ticked up 0.63% while returning 5.07% year to date. European funds performed nearly the same during both periods. Japanese funds, down 2.30%, lost the most in July, leaving them nearly flat for the year. Emerging-market funds added 0.97%, giving them a 5.36% return year to date.

European stocks will continue riding a roller coaster and underperform most other global markets, say Charles Schwab's market analysts.

Debates between European leaders over how to control the continent's credit crisis will result in "continued economic suppression in the eurozone as uncertainty halts investment and spending, and a hobbled banking sector hampers lending," Liz Ann Sonders, chief investment strategist at Charles Schwab, and her colleagues wrote in a client note.

They recommend overweighting U.S. stocks, buying on dips and reducing European exposure.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Mutual Funds
Referenced Symbols: AAPL , CELG , EBAY , LTD , NWSA

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