The stock market took mutual fund
on a bumpy ride in the first quarter and more jostling is
expected in the second quarter as the stock market enters its
seasonally weakest six months of the year, between May and
Several mutual fund managers said they welcome the recent
market pullback to work off high valuations in some sectors. But
they expect stocks to press higher, driven by corporate earnings
growth, low interest rates and the Federal Reserve's confidence
in the economy in scaling back stimulus.
The stock market typically loses momentum in April, the last
month of the market's "Best Six Months," according to "The Stock
"In midterm-election years like 2014, there have been more
declines during the (seasonally) 'Worst Months' than there have
been gains and the average Dow Jones Industrial Average loss
expands to 2.5%," Christopher Mistal wrote in "The Stock Trader's
Almanac." He likens investing during the stock market's worst six
months to going on a Gulf Coast or Caribbean vacation during
"Sure, you might find a great bargain and have a great trip,
but it could just as easily turn out to be a real disaster," he
The average U.S. diversified stock mutual fund gained 1.33% in
Q1, while world equity funds added 0.4%, according to Lipper Inc.
The U.S. stock market
, as measured by the S&P 500 index, skidded 4% in January and
rallied back just as quickly in February and March to end the
quarter ahead 1.3% at 1872.34.
Charlie Smith, manager of Fort Pitt Capital Total Return and
founder of Fort Pitt Capital Group with $1.3 billion in assets
under management in Pittsburgh, Pa., has set a price target for
the S&P 500 at 1938, up 3.5% from its Q1 close. That's 17
times projected earnings for 2014 of $114 a share.
The consensus of analysts forecast S&P earnings to grow
about 7%-8% year over year.
"If price-earnings multiples stay the same, we can expect the
S&P 500 to perform in the range of 9%-10% for the year,
including dividends," Shawn Blau, a portfolio manager at Westport
Resources in Westport, Conn., said in an email. "Some positive
factors we see include rising inflows of new investments into
stock mutual funds, gradually improving housing data, steady
declines in unemployment, easing credit conditions in the U.S.,
which tend to precede uptrends in the stock market, and rising
activity in mergers and acquisitions."
Blau favors buying stocks in capital goods, diversified
financials, semiconductors, software, technology, real estate,
and utilities. He dislikes automakers, consumer services,
consumer durables, pharmaceuticals, biotech, health care, retail,
media and telecom.
Large-Cap Growth Trailed
Large-cap growth funds, down 0.02%, lagged all size and style
funds while mid-cap value, up 3.23%, outpaced its peers.
Megacap stocks, valued at $40 billion or more, are trading at
the cheapest valuations compared with small- and midcap stocks,
which implies the market expects significant earnings and
economic growth, says James Abate. He manages Centre American
Select Equity and Centre Multi-Asset Real Return , with combined
assets of $191 million.
"We're at the early/midcycle stage of the business cycle, not
in the fifth year of recovery as we actually are," Abate said in
an email. He believes megacaps will outperform smaller companies
the rest of the year because earnings estimates are too high for
most stocks, and as a result they will fail to meet
"Without a pickup in top-line revenue growth, we may have seen
the peak in profit margins and returns on capital for this
business cycle," Abate wrote. "As a result, 2014-2016 earnings
estimates appear at risk."
Precious metals funds, up 12.21% in Q1, outperformed all
sector equity funds as gold and silver regained their luster.
Gold prices rebounded 6% to $1,284 an ounce in the first quarter
after melting 28% last year. Silver prices lifted 2% to end Q1 at
$19.75 an ounce after 36% slumping last year.
"Geopolitical concerns were the major catalyst for the rise
this year," Tom Cahill, portfolio Strategist at Ventura Wealth
Management in Ewing, N.J., with $200 million in assets under
management, wrote in an email. "Gold is probably fairly valued
around $1,200 an ounce, given the cost of production and the fact
that the Fed is becoming less accommodative."
Precious metals funds remain the most battered sector in the
past year, with a 31% loss. Outperformance in last year's most
beaten-down areas of the market shows investors are rotating into
value plays, while selling out of "frothy parts" such as
biotechnology, social media and Internet stocks, said Russ
Koesterich, chief investment strategist for BlackRock.
Mutual funds investing in real estate, up 9.03%, and
utilities, 7.45%, benefited from interest rates unexpectedly
falling in the first quarter despite the Federal Reserve's move
to scale back its monthly bond purchasing program. The Fed's move
was expected to lift interest rates.
General bond funds on average rose 2.7% in Q1 as the benchmark
10-year Treasury bond yield fell 27 basis points to 2.73% at
quarter's end. Yields and prices move in opposite directions.
As the Federal Reserve reduces stimulus and raises interest
rates as early as 2015 in response to the improving economy, real
estate and utilities will continue to underperform the market as
they did last year, said Jeff Vancavage, co-manager of Eagle
Growth & Income in St. Petersburg, Fla.
His $584 million mutual fund has underweighted real estate
relative to its benchmark and has no exposure to utilities. With
the expectation that U.S. gross domestic product will expand 3%
this year, Vancavage has overweighted his portfolio in
industrials and technology names because they are "more levered
to GDP growth."
Economy In Transition
"We're transitioning from stimulus-driven economy to a
fundamentally driven economy," Vancavage said.
However, rising interest rates would significantly increase
the U.S. government's borrowing costs and increase the budget
deficit. At the same time, monetary stimulus will be necessary
for the foreseeable future to make up for decreased productivity
that coincides with an aging population across the developed
markets, contends Abate of Centre Asset Management. His New
York-based firm has $1 billion in client assets.
"This leaves the Federal Reserve trapped in keeping its
short-term policy rate lower for a longer period, and monetary
policy may contribute to an increase in market volatility, just
when expectations are the exact opposite," Abate wrote.