Stock fund investors took modest losses in October as the market sat in a wait-and-see mode ahead of the presidential elections while facing a historic hurricane, disappointing third-quarter reports, ongoing eurozone debt troubles and slower growth in China.
Investors who bet on China and real estate won out, thanks to economic stimulus programs on both sides of the Pacific.
The average U.S. mutual fund lost 1.6% in October, paring year-to-date gains to 11%, according to Lipper Inc. Midcap value funds outperformed all-size-and-style funds by losing the least, 0.09%, in October, bringing their year-to-date gain to 12.76%. Large-cap growth funds, down 3.35%, lost the most. Small-cap growth fell 3.02%.
"A 10% to 15% correction could be possible in the near term," said Dave Carlsen, who manages Buffalo Discovery in Mission, Kan. "But once the macro-event risk passes, investors will then be able to focus again on companies with growing fundamentals and good old-fashioned stock picking."
He's focused on consumer discretionary, industrials and technology companies that are innovative, expanding globally and serving the growing, urbanizing middle class in emerging markets. He's avoiding defensive dividend payers, which he believes are overvalued, given their slower growth rates.
"Our base case is that government stimulus efforts around the globe will successfully reflate asset prices and rekindle demand and confidence levels," said Carlsen, who manages $962 million between Buffalo Discovery and another fund.
Buffalo Discovery returned 13.92% year to date vs. 12.25% for its benchmark MSCI World Index.
SPDR S&P 500 ETF ( SPY ) shed 1.82%, closing the month at 141.35, down 4% from a four-year high. It remains ahead 14.29% year to date.SPDR Dow Jones Industrial Average ( DIA ) fell 2.44% in October, while gaining 9.33% year to date. The tech-heavyPowerShares QQQ ( QQQ ), tracking the 100-largest nonfinancial companies on the Nasdaq, lost 5.28% and surged 17.13% over the same periods.
Brian Frank, president of Frank Capital Partners in New York with $25 million in assets under management, perpetually prepares himself for a 20% or more market sell-off and sees such events as buying opportunities.
"We are seeing a momentum- and headlines-driven market," said Frank, who manages Frank Value . "This is great for fundamental investors like us because the more valuations are ignored, the more bargains we can purchase."
Both companies are undervalued relative to their competitors and the market while showing higher return on capital and margins, Frank said. Frank Value has returned 6.44% year to date, underperforming the S&P 500 by 7.86 percentage points. But it's beaten the S&P by 1.11% annually on average the past five years.
Foreign Markets Mixed
China region funds surpassed all global markets, returning 2.90% in October and 9.82% year to date, according to Lipper. Emerging market funds shed 0.20%, while climbing 11.35% year to date.
"In early 2012, globalization and the emerging-markets-growth theme waned cyclically, but we think investors will quickly return to this favorable long-term story," said Carlsen of Buffalo. "Emerging markets are increasingly open to global trade and will continue to benefit from urbanization, industrialization, job creation and higher consumer wealth levels."
The People's Bank of China decreased reserve requirements to increase the money supply. It cut the key interest rate twice this year to stimulate the economy and encourage investment. Although the world's second-largest economy grew 7.4% in the third quarter -- the slowest rate since early 2009, it's projected to expand at a faster rate, 8%, in 2013.
European funds added 1.67% in October and a respectable 15.47% year to date, despite negative economic reports. By contrast, the average world equity fund ticked up 0.28% in October and 11.71% this year. Unemployment in the 17-country eurozone hit a record high of 11.6% in September, or 18.5 million people, putting the region in danger of another quarter of economic contraction as the debt crisis enters its fourth year with no solution in sight.
Gerry Mihalick, a portfolio manager at Berkshire Asset Management with $700 million under management in Wilkes Barre, Pa., believes both emerging and foreign developed markets will lag the U.S.
"Until the world economy shows a more sustainable growth trend, investors will probably gravitate to the relative safety and quality of U.S. equity markets," Mihalick said. "If investors can buy stocks around 13 times earnings, and things get even modestly better, they are likely to be rewarded handsomely from these levels."
Sector Fund Performance
International real estate funds led all sectors in October with a 2.47% gain and an eye-popping year-to-date surge of 31.48%. Data overwhelmingly show the U.S. housing market is recovering as the Federal Reserve engaged in more quantitative easing by buying $40 billion a month in mortgage backed securities.
Technology fared the worst among sector funds, losing 5.76% in October. Tech companies' reported and estimated earnings in Q3 rose just 1.3% year over year. Third-quarter profit for basic materials producers fell 26% year over year -- the most among all S&P sectors. Energy profit fell nearly 18%. The biggest earnings growth came from consumer discretionary up 7% and financials up 6.4%.
Mihalick of Berkshire is bearish on commodities producers, especially oil firms, on expectations that crude prices will drop heavily from low demand and excess U.S. output and capacity.
"Investors trying to hedge against all the money printing going on should look to instruments that can provide a growing stream of cash and haven't run up in price like dividend-growth stocks or even real estate," Mihalick said.