A U-turn for tech
Does a rebound for technology mutual funds signal more profitable times for investors?
The nation is at war, the economy is in the dumps, and corporate scandals just won't go away. Yet the best-performing mutual fund in the first quarter wasn't a "safe haven" treasury bond fund, as one might expect. Rather, it was an old bull-market fave, Amerindo Technology, proving that the equity market, like wars, can be maddeningly unpredictable.
Once synonymous with the Internet boom of the late 1990s, Amerindo Technology soared more than 24 percent in the first three months of this year. The portfolio, which Morningstar analyst Laura Lutton describes as "one of the riskiest funds out there," generated eye-popping numbers by making huge bets on Internet stocks such as eBay, Expedia, Yahoo!, and Overture Services. So far this year, many of those gambles have paid off in winning hands. Still, the fund is down 46 percent a year for the past three years, which says something about the frustrating passive-aggressive nature of this market.
Indeed, the winners in the first quarter have until recently been the big losers of the three-year bear market, with tech funds losing an average of 40 percent annually during the period. The tech-heavy Nasdaq composite index was up ever so slightly in the first quarter, while the S&P 500 and Dow Jones industrial average slumped more than 3 percent. "The market is correcting for three years of pounding tech and buying value," says Russel Kinnel, Morningstar's director of fund analysis. Some money managers, trying to look beyond the current economic uncertainty, are bidding up tech in part because the sector's earnings are expected to rise faster than the market as a whole.
Watching the tide. Among mutual funds, growth-oriented tech portfolios did much better than diversified U.S. stock funds in the first quarter. The average tech fund fell 0.5 percent, versus the 2.8 percent losses suffered by domestic equity portfolios. Funds that invest in large, growth-oriented companies lost about 1.3 percent on average, while those that hold beaten-down blue chips slid more than 5 percent. Still, it will take more than one quarter to determine if the market's tide is really changing.
Besides tech, the only other stock portfolios that thrived in the first quarter were real estate and healthcare funds, both up more than 1 percent on average. After enjoying sizable gains over the past two years, gold funds were hammered in the first quarter, falling more than 12 percent. International equity funds also suffered major losses, despite the weaker dollar. (When the U.S. currency declines, it increases the returns earned by U.S. investors abroad, as they get back more dollars when they eventually sell their euro- or yen-denominated securities.) Funds that invest in European and Pacific Rim companies did particularly poorly, losing more than 7 percent.
Among bond funds, the big surprise was high-yield junk bond funds, soaring more than 5 percent on average, trouncing government and investment-grade corporate bond portfolios, which posted modest gains. Many believe that junk bond funds will continue to deliver solid returns. Unlike in the '90s, when companies went on a buying binge, corporations today are focused on paying down debt. As a result, less new corporate debt is being issued. That means that high-yield bond prices could rise, improving the returns of junk bond funds.
Some would regard the relative outperformance by tech and junk bond funds as an indicator of better times to come. After all, if investors are willing to bet on risky fare during such uncertain times, they may be ready to make even bigger bets after the war is over.
Mixed signals. But Richard Moroney, editor of the Dow Theory Forecasts newsletter, notes that the situation isn't so clear. He points out that the Morgan Stanley Cyclical Index of economically sensitive stocks, including Caterpillar and 3M, was down nearly 9 percent in the first quarter. Meanwhile, funds that invest in other cyclical sectors like financial services and telecommunications stumbled in the quarter, though their returns have picked up significantly over the past month.
Other market watchers view tech's surprising resurgence as one more sign that speculation hasn't been wrung out of this market, a bearish signal. "There is absolutely no fundamental reason why technology should be up there like it is," says David Dreman, manager of the Scudder Dreman High Return fund. "This is a real wishful-thinking rally."
Many mutual fund investors are taking a wait-and-see attitude. They continue to pour money into bonds at the expense of aggressive equity funds. Nearly $28 billion of new money was invested in bond funds in the first two months of the year, while more than $5 billion was yanked out of equity portfolios. This comes on the heels of 2002, when investors pulled more than $27 billion out of stock funds.
This illustrates a fundamental problem that continues to weigh down the broader stock market. "Wall Street is suffering from a buyers' strike," says Jim Stack, editor of the InvesTech Market Analyst newsletter. The question is: Will the strike end once the war is over?
This story appears in the April 21, 2003 print edition of U.S. News & World Report.