Ready for liftoff?

Wow! How else to describe 2003's second quarter for mutual funds. They turned in their best show since late 1999, as the market powered up like a rocket on the possibility that better economic times lie ahead.

Wall Street drew new vigor from the notion that lower, lower, lower interest rates have combined with other positive business themes - such as tax cuts and negligible inflation. Investors snapped up tons of stocks that have wandered aimlessly over the past two or three years. Among 35 types of funds charted by Lipper Inc., only one - specialty diversified equity funds, mainly bear or market-neutral funds - lost value in the quarter that ended June 30.

The other 34 all not only posted gains but did so in double-digit fashion. Telecommunications funds, long in the dumps, leaped 24.2 percent, while another cellar dweller, science and technology, roared back with a 25 percent gain.

Among general equity funds, small-cap growth funds turned in the best performance, up 22.2 percent. In general, however, value funds beat growth funds during the quarter.

"Typically we see that pattern as the economy emerges out of a recession," says Jeff Tjornehoj, a se- curities analyst with Lipper. Stocks that had been beaten down enough to become value investments bounced back sharply enough to outperform growth equities.

The average equity fund gained 17.5 percent for the quarter, the best stretch since a 21.6 percent rise in the fourth quarter of 1999.

Lest you get too excited by this impressive performance, bear in mind that all these recent upward movements have not yet canceled out all the double-digit declines from the past.

Lipper's stats show that over the past two years just six of those 35 investment categories are in plus territory, and that, overall, funds are off about 9 percent for the two-year period.

A lot of those bad numbers would be wiped out by a repeat of the second quarter. But opinion is divided on whether stocks can lash together another such victory so quickly.

Lipper's Mr. Tjornehoj, for one, believes that a back-to-back performance of what we saw in the second quarter just isn't likely.

"There's not a catalyst out there for big growth," he says. It's more likely that stocks - and funds - will tread water during the third quarter.

But Todd Fullam dismisses any notion that the market has come too far, too fast. Investors just realized that the market had bottomed out and decided to free up some of the trillions of dollars that they have collectively squirreled away, says Mr. Fullam, an analyst at the stock brokerage and money-management firm J.B. Hanauer & Co., in Parsippany, N.J.

That trend should continue, he says, though maybe not on as sizzling a track as it was on during the second quarter.

If nothing else, though, the just-ended business period did a good job of building a solid floor for stocks, Fullam says.

"It tells those who have been on the sidelines that 'you'd better get back in the game,' " he adds.

And despite the runup in telecom and biotech funds, Norman Fosback thinks they still have momentum for the third quarter.

Mr. Fosback, publisher of Fosback's Fund Forecaster, says part of that potential lies with the ebb and flow of the markets: Stocks in those sectors got clobbered so badly over the past three years that all their value was beaten from them, he says.

Now the survivors have just about nowhere to go but up.

These can be very risky plays, however, especially in biotech, where the average investor can't keep track of clinical trials or licensing procedures.

And that's why mutual funds are a perfect fit, says Fosback, since a good fund diversifies money across a spectrum of investments.

Just as investors can play value funds off against growth funds, Fosback thinks they would do well focusing on small-cap funds instead of large-caps.

(Capitalization, or "cap," is the value of a company measured by the price of one share of stock multiplied by all its outstanding shares. Ford Motor, with its $20 billion market cap, falls into the large category, while retailer Office Max, with a market cap of under $1 billion, is considered small.)

In the rout of stocks over the past three years, Fosback says large-cap stocks have fallen the least.

"The group that remained most overvalued was blue chips," in the second quarter, says Fosback.

So these giant companies have a potential for underperforming other kinds of stocks, especially if their earnings don't live up to expectations when third-quarter earnings projections start dribbling out in mid-July.

As the general business climate improves, that underperformance could open the door for small-cap stocks that, like biotech, took their lumps over the past few years and left surviving firms doing well, price-wise.

Hanauer & Co.'s Fullam says his predictions are "no knock on growth funds." It's just that in comparison to value funds, he thinks the latter will do better.

Finally, Fullam also likes funds that buy stocks that pay dividends. Those stocks got a boost with the recent federal tax-cut legislation, and reminded investors that there's nothing wrong with a return to fundamentals - and to companies that share their profits with their stakeholders.

"As a corporation, you can manipulate earnings," says Fullam. "One thing you can't manipulate is a cash dividend."

Stocks attract buyers for second consecutive month

The combined assets of the nation's mutual funds increased by $219 billion, or 3.4 percent, to $6.7 trillion in May, according to the Investment Company Institute.

Stock funds, which account for nearly $3 trillion of that total, had an inflow of $12.1 billion in May, compared with $16.1 billion in April (see chart, below).

Bond funds had an inflow of $9 billion. Hybrid (stock-and-bond) funds had an inflow of $3 billion. Money-market funds, hurt by low interest rates, had a May outflow of nearly $18 billion.