October 6, 2004

Domestic Equity Funds -- Third Quarter 2004 Review

Farewell to the Bulls?

Oct. 1, 2004 -- With the average domestic equity fund up a modest 1.04% this year through the third quarter, including a 2.81% decline in the third quarter, is it time to say good-bye to the bull market?

There is a "possibility" that the market is in the midst of a secular bear market interspersed with short-term, cyclical bull markets, although it is too soon to tell, said Sam Stovall, chief investment strategist at Standard & Poor's.

A cyclical bull market starts with a 20% or more bounce off of a prior bear market's closing low, as Standard & Poor's defines it. A secular bull market sets new record highs. At a 10% compound annual rate, it would take less than two years for the Dow Jones Industrial Average to establish an all-time high, less than four years for the S&P 500-stock index, but more than ten years for the Nasdaq.

Standard & Poor's defines a bear market as a decline of 20% or more from a recent high. The S&P 500 would need to close at 926 before Standard & Poor's investment policy committee tagged the current weakness as entering "bear" territory.

Domestic equity funds' third-quarter 2004 results are in keeping with the latter stages of a bull market, with large-cap value funds holding up better amid general declines of the domestic equity funds style categories. After bidding up smaller, lower quality companies in the early stages of a bull market, investors traditionally turn to larger, more stable, and higher quality companies as growth becomes harder to find.

The current bull market may be short-lived because stocks rose strongly last year, when the S&P 500-stock index surged 28.67%. "Many cyclical stocks reached their price potential early" in the current bull market, said David Scott, senior portfolio manager of Chase Mid Cap Growth/A (CHAMX. Believing that the stocks are in a "long-term bull market," Scott said last year was a cyclical bull market, with some cyclical outperformance carrying over into this year.

Some investors are questioning the health of the current bull market because extended sideways-to-lower trading periods have traditionally followed past secular bull markets as the market digests outsized advances, such as from 1982 to 2000. As a result, Stovall says many investors are wondering if "Dow 10,000 will be a repeat of Dow 1,000," when, after the bull market of 1954 to 1966, when the Dow peaked at 1,000, it didn't "materially" rise above 1,000 until 16 years later in 1982. The Dow, which fell 2.27% this year through the third quarter, closed at 10,080.27 yesterday.

Several factors may be in place for a sideways market. Sizable Federal budget deficits and low personal savings rates are likely to limit inflows into the stock market. Rising interest rates are also likely to slow future stock gains.

The market may also be hurt as U.S. economic growth is limited by higher oil and other commodity prices due to rising demand worldwide, particularly in China. "Oil prices at $50 a barrel, which equate to a consumer tax, won't help the [U.S.] economy," said Jay Kaplan, co-manager of Royce Fund Value/Inv (RYVFX). The second best performing small-cap value so far this year, Royce Value rose 16.3% as of the end of the third quarter.

High valuations combined with slow earnings growth is likely to lessen future market opportunities, said Chuck Bath, manager of Diamond Hill Large Cap/A (DHLAX). Bath said he "wouldn't be surprised" if the market rises by single digits for the next few years. He predicts overall earnings could grow by 5% annually over this time period, which would limit increases in stock multiples. The third best performing large-cap value fund so far this year, Diamond Hill Large Cap Fund rose 10.9% for the period.

Outlook

With "conservative expectations," Standard & Poor's Stovall said a bull market could continue in the near term, but with single-digit gains. The Standard & Poor's investment policy committee projects the S&P 500 will close at 1130 by the end of 2004, and rise to 1190 by the middle of 2005.

If we are in a secular bear market interspersed with short-term cyclical bull markets, Stovall says that in the past, nimble investors have been able to turn volatility into opportunity by gravitating toward economically sensitive sectors, such as consumer discretionary, energy, industrials, and technology during bull phases, and embracing traditional safe havens, such as utilities, health care, and consumer staples, during bear phases.

"Right now," investors may want to focus on larger-cap, higher quality value stocks that pay a dividend, such as selected issues in the health-care, financials, consumer staples, telecom, and utilities sectors, Stovall said. For Standard & Poor's analysis of stocks in those sectors, see Standard & Poor's Stock Reports.

Going forward, active managers will need to move from index weightings, said Diamond Hill's Bath. He is focusing on the energy and basic materials sectors, which are relatively small weightings in the S&P 500.

Fund Investment Style Average Returns 2004 Through 9/30/04 (%)
Large-Cap Growth

-2.20%

Large-Cap Value

+3.08%

Large-Cap Blend

+0.44%

Mid-Cap Growth

-0.38%

Mid-Cap Value

+5.87%

Mid-Cap Blend

+3.38%

Small-Cap Growth

-2.41%

Small-Cap Value

+6.78%

Small-Cap Blend

+4.42%

All-Cap Growth

-0.71%

All-Cap Value

+3.30%

Domestic Equity Fund*

+1.04%

S&P 500-Stock Index

+1.36%

Fund Investment Style Average Returns Third Quarter 2004 (%)
Large-Cap Growth

-4.44%

Large-Cap Value

-0.38%

Large-Cap Blend

-2.18%

Mid-Cap Growth

-4.80%

Mid-Cap Value

-0.72%

Mid-Cap Blend

-2.14%

Small-Cap Growth

-5.88%

Small-Cap Value

-0.91%

Small-Cap Blend

-2.35%

All-Cap Growth

-4.00%

All-Cap Value

-1.12%

Domestic Equity Fund*

-2.81%

S&P 500-Stock Index

-2.01%

Domestic Equity Funds* -- 2004 Returns Through 9/30/04

Best Performers

Returns (%)

Worst Performers

Returns (%)

Large-Cap Growth Janus Twenty Fund (JAVLX)

+9.7%

Reynolds Funds Opportunity Fund (ROPPX)

-18.8%

Large-Cap Value Philadelphia Fund (PHILX)

+13.1%

Matrix Advisors Value Fund (MAVFX)

-6.3%

Large-Cap Blend Goldman Sachs Growth & Income/A (GSGRX)

+8.2%

Prudent Bear Fund/C (PBRCX)

-9.0%

Mid-Cap Growth Chase Mid Cap Growth/A (CHAMX)

+9.7%

Ameritor Investment Fund (AIVTX)

-29.4%

Mid-Cap Value FMI Sasco Contrarian Value Fund (FMIVX)

+14.6%

Meehan Focus (MEFOX)

-2.8%

Mid-Cap Blend AIM Trimark Endeavor Fund/A (ATDAX)

+10.3%

Phoenix-Seneca: Mid Cap EDGE Fund/A (EDGEX)

-6.8%

Small-Cap Growth Credit Suisse Instl Small Cap Growth (WISCX)

+22.0%

Thurlow Growth Fund (THRGX)

-30.5%

Small-Cap Value RS Investment Trust: Partners Fund (RSPFX)

+16.4%

Corbin Small Cap Value Fund (CORBX)

-15.1%

Small-Cap Blend Huntgtn: Situs Small Cap/TR (HSUTX)

+13.2%

State Farm Small Cap Equity Fund/A (SFSAX)

-7.9%

All-Cap Growth Quaker Capital Opportunities Fund/A (QUKTX)

+10.0%

Marketocracy Masters (MOFQX)

-11.4%

All-Cap Value Third Avenue Value Fund (TAVFX)

+12.8%

Neuberger Berman Focus/Advisor (NBFAX)

-8.9%

Domestic Equity Funds* --Third Quarter 2004 Returns

Best Performers

Returns (%)

Worst Performers

Returns (%)

Large-Cap Growth ProFunds: UltraShort OTC/Iv (USPIX)

+12.7%

Reynolds Funds Opportunity Fund (ROPPX)

-16.6%

Large-Cap Value Amana Mutual Funds Trust Income (AMANX)

+6.4%

Matrix Advisors Value Fund (MAVFX)

-7.1%

Large-Cap Blend Rydex Dynamic Inverse Dynamic Dow 30/H (RYCWX)

+5.7%

Legg Mason Growth Trust/P (LMGTX)

-10.0%

Mid-Cap Growth Fountainhead Special Value Fund (KINGX)

+2.4%

Van Wagoner Growth Opportunities Fund (VWGOX)

-16.6%

Mid-Cap Value CGM Capital Development Fund (LOMCX)

+7.3%

ING Mid Cap Value Fund/A (IMVAX)

-10.3%

Mid-Cap Blend ProFunds: Ultra Short Mid Cap/I (UIPIX)

+2.8%

TAMARACK Funds Mid Cap Equity/A (TMCAX)

-8.5%

Small-Cap Growth FBR Small Cap Fund/A (FBRVX)

+2.6%

Reynolds Fund (REYFX)

-22.3%

Small-Cap Value CGM Focus Fund (CGMFX)

+7.2%

ING Small Cap Value/A (IVSAX)

-13.2%

Small-Cap Blend ProFunds: UltraShort SCp/Inv (UCPIX)

+3.6%

Credit Suisse Strategic Small Cap/A (CWSAX)

-8.3%

All-Cap Growth Schwartz Ave Maria Growth Fund (AVEGX)

+2.5%

American Century EmVee/Investor (AEVIX)

-12.3%

All-Cap Value Matthew 25 Fund Inc (MXXVX)

+6.2%

Eastern Point Advisors Twenty/A (ICTWX)

-7.4%

*Excluding sector and balanced funds.

Source: Standard & Poor's. Total returns include reinvested dividends. Data as of 9/30/04.

Contact Bob Keane with questions or comments at: bkeane@investmentadvisor.com.

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