April Gains Defy War, Disasters

03  May 2011 - Investor's Business Daily - Trang Ho 

Mutual fund investors enjoyed handsome returns in April as a wave of stellar corporate earnings reports powered the market to new highs despite a torrent of bad news. 

Weighing on the market were war in the Middle East, Japan's nuclear crisis, a free-falling dollar, rising oil prices, the Fed ending its stimulus program and U.S. GDP rising at 1.8% annualized — less than expected.

Bond funds were also broadly higher, helped by stable interest rates, steady if slow U.S. economic improvement and flights to safety in U.S. assets.

Not every May is bad, but any further advance this month would go against the norm. The month marks the beginning of the Dow and S&P 500's historically "worst six months" of the year, according to Yale and Jeffrey Hirsch of the Stock Trader's Almanac.

"The list of potential risks does continue to grow, including high energy prices, changing inflationary expectations and U.S. fiscal problems," Bob Doll, chief equity strategist at BlackRock, wrote in a client note.

"And stocks have come quite far quite fast, suggesting that some sort of near-term consolidation may be coming," he added.

Small caps, which climbed to a record high, helped push the average stock mutual fund up 2.63% in April and 8.94% year to date.

Small-cap growth and midcap growth funds, both rose 3.90%. Large-cap growth funds, +2.82%, climbed to their highest level in nearly three years. But large caps failed to take leadership as many analysts had expected on cheap valuations.

More Room To Roam

Small and midcaps are expected to continue outpacing large caps because of their ability to grow earnings at a faster clip. They also make for appealing takeover targets at a time when corporate America has lots of cash on the balance sheet and with interest rates likely to remain low for the foreseeable future.

"I think we're at the beginning of the largest M&A (merger and acquisition) boom that we've ever seen," said fund manager Harry Rady. Rady Contrarian Long/Short has risen 7% year to date and 5% in the trailing 12 months. Rady Opportunistic Value has climbed 8% and 11.6% in those periods.

U.S. companies have "more than a trillion dollars on their balance sheets and so they have to make acquisitions to justify the multiples they're trading at," he said.

They're also having difficulties growing their sales, and profits will have to resort to growing by buying out smaller companies. More than 10 of his portfolio holdings have been acquired in the past year.

Rady buys companies he believes are potential takeover targets and trading far below their intrinsic value. They include BlackBerry maker Research In Motion (RIMM) and cloud-computing giant F5 Networks (FFIV).

"The small and midcaps seem more stretched in valuations, but they can grow earnings at a faster rate too," said Brian Lazorishak. He co-manages Chase Mid Cap Growth and is a senior quantitative analyst at Chase Investment Counsel, which oversees $1.4 billion in assets. "But at the same time, we can find plenty of stocks that have attractive valuations too."

Lazorishak has overweighted his portfolio in technology stocks, which account for more than 30% of assets, including CommVault Systems (CVLT), Fiserv (FISV), Informatica (INFA), Teradata (TDC), Tibco Software (TIBX) and VeriFone Systems (PAY).

"They're all benefiting from improved technology spending both here and overseas," said Lazorishak. "They continue to have strong earnings momentum and strong earnings growth quarter after quarter."

As a bottom-up stock picker and as a growth-at-a-reasonable-price (GARP) investor, he pays little attention to macro economic trends. He screens for companies that have at least 10% historical earnings growth annualized for five years and then assesses potential earnings and sales growth drivers, risks, valuation and technical trends. His fund has returned 18% year to date and 36% in the trailing year.

Global health care funds outpaced all sector funds, rising 6.79% in April, pushing their year-to-date return to 14.77%. Another defensive sector, consumer goods funds, rose 5.39% for the month and 7.71% so far this year.

"The knee-jerk reaction when the market goes down is people shift funds into those defensive areas," said Lazorishak, referring to the market's brief pullback during the second and third week of April. "Consumer staples have been a laggard, so there's reversion to the mean there."

Real estate funds climbed 5.32% in April and 11.93% year to date. Global real estate tagged along with 5.12% and 7.83%.

Lagging all other sectors last month were natural resources funds, up 0.36% and financial funds, up 0.71%.

Batting For The Cycle

Cyclical sectors with large overseas operations capitalizing on stronger emerging market demand, dollar weakness and high commodity prices are expected to post the best year-over-year gains, says Alec Young, equity strategist at Standard & Poor's.

He recommends that investors overweight energy, industrials, basic materials, while underweighting consumer discretionary and utilities — the sectors dependent on domestic consumption.

With two-thirds of the S&P 500 companies having reported first-quarter results, nearly three in four (72%) have beaten consensus earnings estimates, with 70.9% exceeding top-line forecasts.

International funds eked out a gain despite the lingering economic shock from Japan's earthquake, war in the Middle East and Europe's credit crisis.

The average world stock fund gained 4.79% in April, outpacing U.S. stock funds. Europe was the best of the world regions, rising 7.43%. Pacific ex Japan funds followed with 4.84%. Emerging markets funds climbed 3.42%.

China funds gained 3.24%, while Latin America trailed with 2.01%. It's still the 10-year leader, with an average annual return of 20.06%.

The worst-performing group in April, Japan funds, were still positive with a 1.99% gain.Mutual Funds involve risk including possible loss of principal.  ETFs are subject to investment advisory and other expenses, which will be indirectly paid by the Fund. As a result, the cost of investing in the Fund will be higher than the cost of investing directly in ETFs and may be higher than other mutual funds that invest directly in stocks and bonds.  When the Fund invests in foreign securities through ADRs, the Fund could be subject to greater risks because the Fund's performance may depend on issues other than the performance of a particular company or U.S. market sector.  Stocks of mid-cap companies may be subject to more abrupt or erratic market movements than those of larger, more established companies or the market averages in general.  The Contrarian Value Long Short Fund has the same management practices and is in all material respects identical to the predecessor Limited Partnership and is managed by the same portfolio manager since the predecessor limited partnership's inception on February 2007. The Fund's investment goals, policies, guidelines and restrictions are, in all material respects, equivalent to the predecessor limited partnership. From its inception date, the predecessor limited partnership was not subject to certain investment restrictions, diversification requirements and other restrictions of the 1940 Act of the Code, if they had been applicable, it might have adversely affected its performance. In addition, the predecessor limited partnership was not subject to sales loads that would have adversely affect performance. Performance of the predecessor fund is not an indicator of future results.