What’s Working in the Markets Now

06/09/2009 10:27 am EST

Focus: MARKETS

Janet Brown

Editor, NoLoad Fund*X

Janet Brown, editor of NoLoad Fund*X, says large-cap and value funds ruled the roost in May, while international funds continue to shine.

Stocks continued strong in May, with the broad market Standard & Poor’s 500 up 5.6%, bringing the index into the black for the year. The Dow Jones Industrial Average gained 4.4%, the Nasdaq Composite index 3.3%, and small caps as measured by the Russell 2000 index, 3%.

Markets around the world enjoyed the third consecutive month of gains, their longest winning streak since August 2007, as investors increasingly believe that the worst of the financial crisis may be over and the global recession might be nearing an end.

Since hitting 12-year lows in early March, the DJIA is up 30%, the S&P 500 36% and the Nasdaq 40%. Foreign markets, especially those of developing countries like India and Russia, have rallied more sharply: The MSCI Emerging Markets index is up 57% since March 9th, and the MSCI EAFE index of developed-country stocks is up 42%. Commodity prices, one gauge of economic revival, saw their strongest gains in years, with oil, gold, and natural resource prices surging.

In economic news, consumer confidence jumped as personal income unexpectedly increased. At the same time, personal spending fell by less than consensus estimates and business spending showed signs of rebounding. Separately, construction spending perked up last month, and new data suggested the manufacturing sector was in better shape than expected.

Domestically, large-cap funds outperformed mid- and small-cap in all style categories last month, while value funds were stronger than growth funds [of all sizes]. Among sectors, financials and energy led. Gold and natural resource funds flew last month, surging 30% and 16%, respectively. Health care funds recovered nicely, and technology and telecom funds continue rising up the ranks.

A year ago, internationals were scarce among the top ranks, but their absence proved short-lived. Comparing the long-term history of developed foreign markets to our own, the records are practically identical. European and US markets have both returned about 10% over their entire histories. But these long-term records comprised many periods of over- and underperformance that are easy to identify in hindsight.

Comparing T. Rowe Price International (PRITX), a broadly diversified, large-cap, established market fund with a long history, to Vanguard 500 Index (VFINX), the large-cap US index, we see four major periods within the past 20 years. The average excess return during periods of international strength was over 40%.

In decades past, international funds were regarded as “alternative” investments, and allocations were limited. In recent years, even conventional asset allocators have increased their suggested allocations to foreign funds to somewhere between 20% to 40% of portfolios (with emerging-market funds a small portion of this allocation, ideally done through a broadly diversified fund).

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