For equity mutual funds, the fiscal third quarter yielded mixed results in terms of performance, but conditions are expected to improve as investors look for a fresh start heading into the new year.
Fund research firm Lipper of New York reported that within the U.S. diversified equity fund category, bear funds "rose to the top" in the third quarter, while equity income funds managed to "eke out" some gains. Growth funds, on the other hand, were "definitely not in favor," with large-cap growth funds down 4.6% for the quarter.
Among individual sectors, technology funds swooned after an auspicious start in the first half of the year, losing nearly 11% in the third quarter. The real story this year, however, has been natural resources funds, which continued their strong run with a 10% bounce in the quarter. Real estate funds also turned in a solid performance, boasting an 8% return for the quarter.
In the world equity category, Latin American funds blew away the competition, gaining more than 15% on the strength of a red-hot Brazilian market. In some funds, Brazil makes up about roughly 50% of assets. Gold funds also turned some heads, boasting a near 15% return, ranking second in its category.
Speaking on a conference call last week, Jeff Tjornehoj, a research analyst at Lipper, provided an investment outlook for the fourth quarter and beyond. Beginning with the economy, Tjornehoj cited several reasons why conditions will continue to improve in the U.S. Housing starts, which have been on a roll since the early 90's, are expected to continue their "steady climb," as concerns over a downturn have abated. "People are feeling confident about the future right now, and it takes a little bit of a leap of faith before you jump into a 30-year mortgage," he said.
The job market is also poised for a "mild upturn," as corporate earnings have been strong, prompting many companies to beef up their hiring efforts. "With the jobs and housing data both looking up, I think the economy is on solid ground," Tjornehoj said. Parenthetically, the unemployment rate currently stands at 5.4%, with the nation adding 96,000 new jobs in September, according to the Labor Department.
With respect to equity markets, history bodes well for a strong fourth quarter, as it has typically been "a period of relative outperformance." Tjornehoj explained that the end of the year is a time when investors forget about the prior three quarters and begin looking toward the new year with renewed optimism, serving as a psychological turning point of sorts. Still, Tjornehoj anticipates a period of increased uncertainty about the markets right around the time of the presidential election. "We could see a downdraft in November around the election, but for the most part, we expect sideways trading," he said.
The technology sector is not headed for a turnaround any time soon, he cautioned, and the Nasdaq will trade sideways-to-down for the remainder of the year. With the volatility index at its lowest point in 10 years, he argues that the Nasdaq can't break the 1,970 barrier.
As for interest rates, he speculated that the Federal Reserve is likely to raise rates in November and possibly again in December. The one wild card lurking in this whole scenario is the continued violence in the Middle East. Without a material change in hostilities in Iraq and its bordering countries, the S&P 500 will not exceed the 1,120-1,140 range, he predicted. Tjornehoj concluded that the fourth quarter will feature a sustained rally in natural resources, continued softness in technology and a tighter margin between growth and value. "The value names are a little overbought right now, and growth is a little oversold," he said
On the fixed-income side, bond funds have performed better than stock funds in the third quarter and year-to-date, with emerging market debt funds leading the pack. Rising oil prices pose the biggest threat to bonds, according to Lipper Senior Analyst Michael Porter. He also said that there is "no compelling reason" for the Fed to lift interest rates in December. He recommended that investors maintain a "defensive strategy." and stick to short duration government bond funds.
Another theme touched on was crude oil prices, which have seen a steady bump since 2000. Andrew Clark, senior research analyst at Lipper, observed that there appears to be a higher floor in place at this point for oil prices somewhere near $38 a barrel, as compared to prior decades where it was about $15 to $20 a barrel.
Historically, there have been a number of periods where prices have stepped up over several years. Clark believes that there is the potential for another step-up, with a final target of $67 a barrel within the next five years. From a trading standpoint, five-year contracts are all trading in excess of $36, $13 higher than a year ago. "We're not just seeing a spike in prices related to temporary phenomena," Clark said. "We're seeing a wholesale movement in prices for what looks to be quite a period of time."
Clark noted that current oil prices might slow the economy but probably not a whole lot. Natural resources funds and gold funds will benefit from these price increases, particularly because the average natural resources fund invests about 50% to 60% of its assets in the oil and gas sector.