Investors can expect mutual funds in 2006, as in 2005, to continue to chug, but not zoom, ahead, according to senior analysts at Lipper of New York.

"Whenever we say, More of the same,' we're a little uncomfortable," said Don Cassidy, a senior research analyst at the Reuters-owned research company. Yet that's what he predicted during a year-end review and 2006 market outlook conference call last week.

"We see the U.S. and world economy growing at a reasonable pace," Cassidy said. Barring an unforeseeable calamity, or runaway inflation, the benchmark Standard & Poor's 500 index should grow between 3% and 9%, he said.

While this all may sound familiar, there will be some new trends with once-hot sectors growing tepid, and large-cap funds overshadowing the once-stellar small-caps, Cassidy and other Lipper researchers said.

This year, like last, will see the world market beat U.S. domestic equities, and emerging markets best them both. In 2005, diversified international funds gained 17.5%, compared to 6.7 % for domestic equity funds, according to the Lipper presentation.

For 2006, Lipper is leaning away from Latin America, which jumped 53.4% in 2005, ending a three-year compounded growth rate of 51% per year. "You look at that and say, Wow! That's great, but how long can it last?'" Cassidy said. Corporate earnings in Latin America cannot keep up with that growth rate, suggesting that the sector may already be overvalued.

The so-called mature markets should have a steady, yet lackluster, year. Increasing interest rates and housing prices are hampering growth in the United Kingdom, Lipper said. Social unrest plagues France. Germany continues to face high unemployment and some social strife, and Italy continues to have high unemployment.

Meanwhile, Eastern and Central Europe, Russia and India, all of which performed well in 2005, will probably not perform as strongly this year, Cassidy said.

In 2006, one likely leader is China, which had shown comparatively modest growth in recent years, and is ready to emerge from its hibernation. Although no one should expect the 30% surges of last year, the Japanese have trillions of yen stashed in savings accounts that could soon be poured into investments.

Large-capitalization and growth funds are two other new market leaders for 2006, ending the long-held dominance of small-capitalization and value funds.

Large-caps began to take the lead from small-caps in the fourth quarter of 2005, for the first time since 2000. Cassidy expects the trend to continue into 2006. "The small-cap leadership phase is over," he said. "It's not going to be a trouncing, not a runaway, but more than a point or two apart."

Biotechnology and healthcare funds will lead growth funds to replace value funds, which are typically weighted in oil and natural resources, Cassidy said. The consistent dividends and tax advantages that have made utilities attractive in the recent climate of flat growth and low interest rates may be offset if interest rates continue their upward creep, Cassidy said.

Interest rates don't pose too serious a threat for 2006, as analysts expect the Federal Reserve Bank to stop ratcheting them up by spring, said Lipper Senior Research Analyst Bill Sickles. And while some see the inverted U.S. Treasury yield curve as the harbinger of recession, Sickles suggested that foreign investors will bail out of domestic bonds, and that the curve will soon flatten.

A flat curve would signal zero inflation, he said, an objective Federal Reserve Chairman Alan Greenspan has clung to since his appointment in 1987. Incoming Chairman Benjamin S. Bernake appears to share Greenspan's zero-inflation philosophy, Sickles said, providing certain stability for the upcoming year.

How overseas markets perform this year will test whether American investors have adopted a new, more global approach to allocation, or whether recent trends simply reflect attempts to chase market spikes. "We will see after the downturn," Cassidy said.

Pension funds, however, will provide stability to emerging markets, as more and more continue to invest overseas. Unlike skittish individuals, who tend to make markets volatile by pulling money out at the first sign of a downturn, institutional investors tend to leave their money in one place for longer periods of time, Sickles said.

Real estate as a sector is cooling, but real estate investment trusts (REITs), still offer value. After a barely believable six consecutive years of swelling housing values, Cassidy expects the market will level off. "We don't think it's time to sell these things [REITs], but we don't think they're going to be big winners," he said.

Investors looking for new investment products will likely be disappointed in 2006, Cassidy said. Existing funds are already trading at a discount, which makes new funds difficult to market. New products likely to debut will probably feature utilities, natural resources, or combinations, such as a mix of utilities and natural resources. "We'll leave that up to the marketing folks," Cassidy said.

(c) 2005 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

Subscribe Now

Access to premium content including in-depth coverage of mutual funds, hedge funds, 401(K)s, 529 plans, and more.

3-Week Free Trial

Insight and analysis into the management, marketing, operations and technology of the asset management industry.