Mutual fund analysts may have set their hopes too high for the first quarter of 2007, as company earnings didn't reach the levels they had hoped, experts said during Lipper's first quarter fund performance review and outlook webcast last week.

Earnings of companies in the Standard & Poor's 500 Index are now expected to grow 5.1% for the quarter, compared to a 9.2% projection when the quarter first started, said Ashwani Kaul, a senior markets analyst with Reuters Estimates. However, once all companies report, the earnings growth rate could reach 7%, Kaul said. By comparison, the first quarter of 2006 had a growth rate of 14.4%.

If earnings do not exceed double digits, it will be the first time in over four years that the S&P 500 companies failed to reach 10%, Kaul noted.

The S&P is comparable to other major global indices this year. Most major markets are expected to post a sharp drop in earnings growth, Kaul noted. On the other hand, emerging markets are expecting high earnings growth, with India and China each projected to deliver 16%.

On a sector basis for the first quarter of 2007, the technology space is expected to show the largest gains over last year, along with non-cyclicals, with gains of 12% and 9% respectively. Although technology gains were downgraded by four percentage points from initially projected numbers, the sector is still favorable and will continue to perform well, especially remembering that it is coming up from a negative value last year, Kaul said. Also, many companies are thinking of upgrading their technology systems, he added.

Revision trends for the quarter are unfavorable across the board. In fact, analysts have downgraded their expectations for all sectors except for one, the non-cyclical consumer goods and services sector, which increased a scant 2%. This is the first quarter in 4-1/2 years that analysts have slashed their expectations so greatly, Kaul said.

The three biggest negative revisions for individual sectors were cyclical consumer goods, energy and technology. The cyclical consumer sector was shifted down by 12 percentage points from -2% to -14%, which could be due to steep declines in auto manufacturing and homebuilding stocks, Kaul said. Energy projections decreased 13 percentage points, from 17% to 4%. Kaul cautioned that energy stocks generally affect the bottom line of the S&P.

Despite the market's overall disappointing returns, equity mutual funds held up fairly well.

"We were excited at the end of the quarter because we were expecting horrible numbers, but we were pleasantly surprised," said Tom Roseen, senior analyst at Lipper of New York.

For the quarter, equity funds gained 2.41%, compared to 6.78% in the first quarter of 2006, said Roseen, adding that over 90% of all equity and mixed equity funds posted positive returns.

In January, equity funds rose 1.88%, due to the price of crude oil declining 6.8% and the Dow Jones Industrial Average and the Nasdaq 100 reaching new highs. And although the Federal Reserve warned that high resource utilization could lead to inflation, there weren't any indications of it during the quarter, he said.

In February, however, funds declined 0.82% due to a weakening global economy, China threatening to decrease liquidity and the troubled subprime mortgage market, Roseen said.

Expecting March numbers not to be stellar due to an increase in crude oil prices, the ongoing sub-prime issue and geopolitical tensions in Iran, equity markets actually rose 1.36%, Roseen commented.

Despite rumors of a turnaround, once again large-cap funds were the stragglers, rising a scant 0.73%, while small-caps posted 2.88%.

Although large-cap stocks benefit from large economies of scale and production, small-cap companies have easier access to money, Roseen said. Also, advanced technology gives smaller companies the capability to produce overseas and adjust inventory on a whim, he said. Since the fourth-quarter of December 2005, mid-cap stocks performed the best, posting returns of 4.38%.

Growth beat value funds by a slight margin, with the average growth fund returning 2.59% and value 2.08%, Roseen said.

Sector equity funds posted 2.74% gains. The highest returns were seen from the utility sector, delivering 7.74%, although down from 10.37% in the first quarter a year ago. Utilities beat real estate funds, which posted 3.5%, possibly due to the turning of the tides and real estate funds having finally run their course, he said.

Natural resources funds rose 6%, the second-best performance of sector funds for the quarter, as greater geopolitical uncertainty drove the price of crude oil up to 11.3% to end the quarter at $65.87 a barrel.

Financial resources funds were down 1.82%, but not necessarily affected by the sub-prime mortgage market problems, which seem to be exaggerated a bit, Roseen said. Obviously it affected smaller banks and mortgage dealings, he said.

Investors are still interested in international stocks, and for good reason, with world equity funds rising 3.27%. All classifications in the group posted positive returns, Roseen said. As seen in the U.S., small- and mid-cap stocks outpaced large-cap stocks internationally as well, he said. Despite the 9% drop in China's market in late February, China region funds posted a 3% return for the quarter. Latin America and European region funds posted 4.6% and 4.2%, respectively.

(c) 2007 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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