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Mutual Funds
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Stars align for big caps, gold in 2004
The weak dollar, low interest rates and upcoming elections will tilt the fund world, with foreign funds and big exporters also sharing in the gains.
By Timothy Middleton
In the magnificent new movie, The Lord of the Rings: The Return of the King, Gollum takes the ring of gold into the molten heart of Mount Doom. Thats fine for him -- that ring was evil incarnate -- but I wont be throwing my gold away anytime soon.
A major rally always has followed a multiyear decline in stock prices, so 2003 was more normal than it appeared at the time. A continuation of that rally into a presidential election year also would be normal. So, for different reasons, would be a continuing rally in the gold market.
And with the Federal Reserve vowing to hold down interest rates, a weak dollar should add fuel to the fire for nearly all investors.
Asians are going to be buying aircraft from Boeing (BA, news, msgs), not Europe. Theyre going to be buying X-ray machines from General Electric (GE, news, msgs), not Philips, says Frank Holmes, chief investment officer of U.S. Global Investors. Coca-Cola (KO, news, msgs), Procter & Gamble (PG, news, msgs) -- their products are off basically 40% from two years ago. Its going to be very good for companies benefiting from a price-competitive dollar.
Barker French, chief investment strategist for Brinker Capital in suburban Philadelphia, notes that unemployment is falling, capacity utilization is increasing, housing starts are strong and consumer confidence is increasing. All the stars are lining up to keep the economic recovery and the market recovery under way, he says.
But 2003s easiest money probably wont pave the path to riches in 2004. This years biggest winners were beaten-down sectors like technology and domestically oriented companies like small caps. Next year should see a rotation into giant exporters, such as Gillette (G, news, msgs), which means large caps are likely to lead.
The rallys not over
The weak dollar also means foreign stocks are likely to beat domestic ones, as they did this year, but only in portfolios that don't hedge currencies. Fortunately for fund investors, most foreign-stock funds don't. Broadly diversified foreign funds also can capture an economic rebound in emerging markets, as well as in Europe and Asia.
Fixed-income investors will have a tougher time, but a less dangerous one than they faced last summer, when long-term interest rates spiked 40%. They have since ebbed and the Fed may not raise short rates (whether at all or very much is the question) before the presidential election.
As for the gold bugs: With the spot price of the metal solidly above $400 for a month now, the rally that began early in 2001 shows no sign of fatigue.
Even though the S&P 500 Index ($INX) has shot up more than 25% this year, many market analysts say stock prices are still attractive.
We thought when this rally started last winter it would move up 50% to 60%, and weve seen nothing to change our opinion, says Craig Callahan, chief investment officer of Icon Funds. Were still 15% below fair value. We see this rally moving toward fair value in those sectors where there is not fair value yet. They include consumer discretionary industries, specialty retailing, homebuilding and autos, he says.
For fund investors, that would translate into opportunities at large-cap growth funds. In 2003, large-cap growth, value and blend funds each advanced on average around 25%, compared with 33% gains at mid-cap funds and 40% at small caps, according to Morningstar.
In 2004, big caps are likely to seize leadership, as industrial giants such as DuPont (DD, news, msgs) and other dogs of the Dow seize market share from competitors weighted down by stronger currencies.
On the flip side, stocks denominated in those stronger currencies, namely foreign ones, should enjoy spillover economic growth from the United States, as well as currency kicks. Broadly diversified funds that dont hedge currency risk, such as William Blair International Growth (WBIGX), could outpace domestic stock funds.
2 ways to gain more income
Bond analysts who foresaw a rise in long-term interest rates to the range of 5% to 6% in 2004 are revising those numbers down or pushing back the date. The 10-year Treasury note is yielding less than 4.2%, down from 4.4% five months ago.
Investors who cant afford to suffer any significant loss of capital are coping by reducing the duration, or interest-rate risk, of their portfolios by substituting five-year bonds for 10-years, and two-years for five-years. In fund terms, that means nothing longer than an intermediate-term fund, hedged with a short fund.
For more income, investors have two choices. One is accepting more risk, possibly buying funds that invest in real estate investment trusts, such as Third Avenue Real Estate Value (TAREX) or Cohen & Steers Special Equity (CSSPX).
The other, advocated by Ric Edelman, chairman of a financial advisory firm in Fairfax, Va., is to take income from equity profits rather than bond yields. You can generate a systematic income stream based not on yield but on total return of the portfolio, he says. You shouldnt refuse to sell assets -- shares -- to generate the cash you need. Living on (interest income) alone is not sufficient, and is not the ideal approach.
More gains for gold
The unlikeliest investment star of 2004 could be gold. The average precious-metals mutual fund rallied more than 60% in 2002 and again in 2003, according to Morningstar. Absent surging inflation, further increases should be much harder to achieve.
But Holmes, whose firms US Global Investors World Precious Metals (UNWPX) is up 80.3% through Dec. 18, says the gold market has more gains in store.
In our investment process we look at cycles, he explains. One is the four-year election cycle; the years before and during a presidential election are usually positive. Another is gold prices, which he says move in six-year cycles. Every 12 years you can get both going in the same direction, he says, and 2004 is such a year.
Because gold is priced in dollars, it's still relatively cheap for Asians and Europeans, he adds. When a weak dollar is added to the mix, I think that next year is going to be very good for gold, he concludes.
In 1993, which was 11 years before 2004, the average gold fund shot up nearly 80%. The prior year -- the 12th -- it was down, for the third year in a row.
Splitting the difference, I plan to hold onto my gold fund until and unless it falls 15% or so below its peak, at which point I would reconsider whether I want to own it.
I only hope that whether and when to take profits are the toughest decisions I face in 2004.
At the time of the publication, Timothy Middleton owned the following securities mentioned in this article: Tocqueville Gold Fund (TGLDX).
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