Mutual Funds Eke Out Small Gain In February

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Although the stock market rose for a fourth straight month in February, mutual fund investors had to fasten their seat belts as volatility increased in the second half of the month.

The choppiness came amid worries over federal spending cuts -- known as sequestration -- hints of the Federal Reserve curbing bond purchases sooner than expected and Italy's election leading to political instability.

The average U.S. stock mutual fund added 0.89% in February and 6.27% year to date. Foreign funds on average shed 0.65% in February as the dollar rallied 3.5%. They've returned 2.94% year to date. The S&P 500 added 1.10% to 1514.60, about 4% shy of its October 2007 all-time high of 1576. It's ahead 6.86% for the year. The Dow picked up 1.40% and the Nasdaq 0.57% for the month.

March is seasonally bullish for the market and the Federal Reserve has been juicing economic stimulus, or quantitative easing (QE) programs, before corrections get too deep, Jeffrey Hirsch, chief editor of Stock Trader's Almanac and manager of Magnet AE Fund, said in his latest client missive.

Since 1945, years in which both January and February rallied corresponded with outsized gains for the year 92% of the time, Birinyi Associates told clients.

Mutual fund managers say they see the stock market chugging ahead, citing several drivers: the housing recovery's resulting wealth effect, improving employment rates, paltry interest rates weaning investors off bonds, strong fourth-quarter earnings and record cash hoards that companies can use to buy back shares or pay dividends.

In addition, the S&P 500 trades at 14 times forward earnings, a reasonable valuation, while both earnings and dividends are higher than their October 2007 zenith.

"The inverse of this multiple is an earnings yield of 7% compared to the 10-year Treasury yield at 1.9%. This historically wide risk premium indicates the potential reward for holding stocks outweighs the underlying downside risk," Eric Marshall, Dallas-based co-portfolio manager of Hodges Small Cap Fund with $401 million in assets, said in an email.

Bonds pose greater risk because if historically low interest rates start to rise, bond prices will fall and eat away principal.

"(This) could result in a wall of money coming out of bonds and into stocks over the next two to three years," Marshall wrote.

His best investment idea now isBriggs & Stratton ( BGG ), which he believes will indirectly benefit from a multiyear recovery in the housing market. The Wauwatosa, Wis.-based firm produces gas engines for equipment makers, generators, lawn mowers, garden equipment and other machines.

"Trading near $19 a share to reflect a forward (price-to-earnings) ratio of roughly 11.5 times, we believe the stock's multiple is attractive especially since the company appears to be in the very early stages of a new growth cycle," Marshall wrote. "(Briggs) has also completed several restructuring actions that has consolidated manufacturing capacity and lowered overall costs, which should result in higher operating margins over the next couple of years."

The company has little debt, has been buying back shares and has a dividend yield of 2.5%.

Continued improvements in the housing and labor markets and corporate earnings surprises will support stock prices, says Richard Weiss, a portfolio manager at American Century Investments with $16 billion of assets under management in Mountain View, Calif. But the market could sell off, owing to instability in Europe, slower economic growth in China and political conflict in the Middle East, he said. He's overweighted his portfolio in real estate and growth stocks.

Lawrence Creatura, portfolio manager of Federated Clover Small Value with $382 million in assets, is playing the housing recovery by investing in building products makers. His top holdings includeAxiall ( AXLL ), a plastic pipe and moldings maker formerly named Georgia Gulf, andUSG ( USG ), a gypsum wallboard and construction plasters maker. Creatura is also betting on defense and aerospace firms --Lockheed Martin ( LMT ) andRaytheon ( RTN ) -- which he believes sold off to attractive levels on fears of federal spending cuts.

Among sector funds, consumer goods topped the equity leader board, gaining 1.24%. Precious metals equity funds crashed hardest, losing 10.56%.

Gold and silver prices melted 5.1% and 9.53%, respectively, as the greenback rose to its highest level in nine months owing to the eurozone's economic deterioration and Japan's move to devalue its currency to boost inflation.

In recent months, Creatura trimmed holdings in the consumer discretionary sector, mainly luxury goods and apparel retailers. Consumers are spending less on discretionary products owing to the payroll tax cut expiration, higher gas prices and fears of the economy.

"People don't splurge as much when they're bombarded by talking heads on TV talking about fiscal uncertainty," Creatura said.

Russell Croft, manager of $302 million Croft Value Fund , has underweighted his portfolio in consumer discretionary stocks for the same reasons. He favors large-cap, dividend-paying U.S. companies trading at "reasonable valuations," such asJohnson & Johnson (JNJ),Honeywell (HON) andWilliams Cos. (WMB), which yield 2.3% to 3.9%.



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



This article appears in: Investing , Mutual Funds

Referenced Stocks: AXLL , BGG , LMT , RTN , USG

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