Good Start; What Next For Stocks?

SO far, 1996 has been another dandy year for equity mutual funds.

Domestic stock funds posted an average 5.6 percent total return, including reinvesting of dividends, for the three months ended March 31.

"The first quarter turned out to be much better than we had anticipated," says Sheldon Jacobs, editor of No-Load Fund Investor, a newsletter.

"It now looks like this year will be also very good, although not as good as last year," he says. In 1995, the average stock fund gained 31 percent. This number lagged slightly behind returns for the Standard & Poor's 500 stock index. The S&P was up about 5.4 percent for the first quarter.

Reasons for this year's gains, Mr. Jacobs says, include relatively low interest rates, continued economic growth in the United States, "a stock market that is not overvalued, and the coming presidential election.

"Election years tend to be favorable years for the stock market," he adds. "Moreover, studies show that good years tend to follow great years, as was the case with 1995."

"This is an excellent economic environment for our fund," says Philip Tasho, manager of Rimco Monument Stock Fund, a growth and income fund that has garnered a five-star rating from Morningstar Inc., in Chicago. Rimco's stock fund rose 5.7 percent in the first quarter.

Mr. Tasho is on the lookout for companies that are creating new products, are gaining market share, or may be planning a successful restructuring process (he cites Sears, for example).

Still, some analysts fret that stocks are overvalued, as measured by the ratios of share price to dividends or company book value.

Stocks Had Good 1st Quarter, But Some Call Market Pricey

"At the least, these two measurements are showing that the market is definitely not undervalued," says James Stack, editor of InvesTech, a market newsletter in Whitefish, Mont. At recent levels, "both measurements are at their highest levels ever, going back to the 1920s. The price-to-dividend ratio on the Standard & Poor's 500, for example, is now around 43. A more normal measurement is around 25. The price-to-book value on the S&P 400, which includes the largest industrial firms in the US, is around 4.1. The historic norm would be around 1.5."

The stock market, indeed, was looking jittery last week, falling sharply on inflation and interest-rate worries. But at press time a full-blown 10-percent correction had not occurred.

"The price-to-earnings ratio [on the S&P 500] is approaching 20, which is not an extreme," Mr. Stack says. "But the P/E ratio is probably the least reliable, as an indicator, of these three main gauges."

"What we've got now is 'mutual-fund mania.' I'm advising my readers that they should be very selective when buying a fund, just as they would be in buying an individual stock," Stack says. He is wary of emerging-market funds, with their foreign investments, given their volatility and close ties to the US stock market. Instead, he prefers more defensive funds, such as the Scudder Growth & Income Fund or gold funds.

To date at least, though, mutual-fund investors certainly seem to like the current market - especially equities. (Bond funds have not scored well, with the average bond fund posting a total return of minus 1.1 percent for the first quarter, according to Lipper Analytical Services in New York.)

Net new-cash inflows into equity funds soared to $29 billion in January, $22 billion in February, and $21 billion in March, according to the Investment Company Institute (ICI), a trade group in Washington. Those numbers far exceed 1995's first-quarter flows.

Almost all areas of equity investing are seeing inflows, according to a spokeswoman for the ICI. Aggressive-growth funds and growth funds saw inflows roughly triple in January compared with January 1995. Precious-metals funds posted a net gain of $278 million in January of this year, compared with an outflow of $288 million the prior January.

Indeed, gold and natural-resources funds were the red-hot funds of the first quarter. Many of the funds, such as Midas, invest in companies that produce or refine raw materials. And despite low inflation, a number of basic commodity prices have shot up sharply this year.

"We've gone from slightly over $20 million in assets in January to over $94 million in early April," says James Turk, strategic adviser to the Midas Fund, a precious-metals/aggressive-growth fund. The relatively small Midas Fund turned in the eighth-best performance among all stock funds during the first quarter, rising 35.76 percent in total return, according to Lipper. For the 12-month period ending March 31, the Midas fund was the No. 1 fund among all stock mutual funds.

HOT sectors the first quarter, besides gold/resources funds, included emerging-market funds (invested in developing-nation and East European stocks), unusual "specialty" funds, small-companies, global funds (invested in US and foreign stocks), and international funds (usually holding foreign stocks alone), with European and Pacific funds leading the way. Utility and technology funds did not fare as well, with technology stocks posting major losses during the quarter (see chart, page B4).

Funds that had a bond component, such as Fidelity's giant Magellan Fund, did not perform as well as straight equity funds; this reflects overall losses in the bond market. Magellan was up a little more than 2 percent, compared with a 25 percent gain for the Fidelity Select American Gold Fund, a front-runner in Boston-based Fidelity's household during the first quarter, Morningstar reports.

For pure equity funds, few sectors are being left out of the upbeat parade. "If the consensus is accurate, and there is moderate economic growth accompanied by a slowing of earnings growth, then that should be good environment for small-cap stocks," says Tim Ebright, co-manager of The Manager's Special Equity Fund, in Norwalk, Conn.

His fund, which invests in small-company stocks, was up 7.08 percent for the first quarter, exceeding a gain of 5.1 percent in the Russell 2000 index, a popular small-company index.

Can equity funds maintain their gains this year? The consensus within the mutual-fund industry is yes. Some analysts worry that the Dow may be slipping into a very narrow trading range, underscored by recent market slips.

But Jacobs puts a positive spin on the market's risks: "Even if there were to be a market correction, that would not be all bad, since it would mean that there would be a good buying opportunity for investors."