The Rally Has Rewarded Persistence

04/08/2010 2:21 pm EST

Focus: MARKETS

Janet Brown

Editor, NoLoad Fund*X

Janet Brown, editor of NoLoad Fund*X, says many investors are missing out or, worse, actually heading the wrong way in the current market.

One year after the stock market turned around, the rally continues. After a steep February sell-off, the Standard & Poor’s 500 index gained 6.1% in March to end the first quarter up 5.4%.

All indices posted gains in the first quarter with the small-cap Russell 2000 in the lead, up 8.5%. Both the Dow Jones Industrial Average and the S&P 500 hit 18-month highs in the face of widespread skepticism among investors. Many Americans seem uncertain of the stock market’s recovery and [are] gloomy about the economy.

Congratulations to those who have held steady, because most individual retail investors have not been fully participating in the stock market rally. According to Morningstar, investors pulled $3.7 billion out of US stock funds in February, the fifth month of outflows in the last six months. And The Wall Street Journal reports that individual investors continue to pour money into bond funds, “even as the Federal Reserve inches forward with its plans to end its unprecedented easing of credit.”

Wary investors are not a bad sign for stocks, though. Many stock sellers could turn into buyers if the rally continues. The broad market remains 21% below its all-time high in October 2007, and skeptics continue to miss this historic bull run.

A raft of March reports showed a surprisingly strong rate of expansion in manufacturing around the world, providing clear evidence that a global economic recovery is progressing. S&P 500 earnings were up 96% last quarter, more than analysts predicted, according to Bloomberg. Consumer spending rose to near-normal levels, yet persistent long-term unemployment remains a big problem.

Lately we see small-cap US funds rising up the ranks, and domestic leadership has shifted to small and mid-caps over large-cap funds. Most value funds outperformed most growth funds in all size categories last quarter and continue rising up the ranks. Most of the top ranked funds are the same names we have held for months and clearly led in this latest rally.

The dollar continued to revive in the first quarter and translated to lower international fund returns. The Dow Jones World index, excluding US shares, gained 1.4% in dollar terms for the quarter, compared with a 5.8% gain for the Dow Jones US Total Stock Market index.

Foreign developed market funds continue to lag. Turmoil in Europe and large budget deficits hurt the euro region, putting downward pressure on European stock and bond funds. The euro may be stabilizing, so it will be interesting to see if foreign stock funds can play catch-up to their US peers.

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