Domestic Equity Funds -- Year-End 2004 Review

The Mice That Roared

Jan. 3, 2005 -- Why give up on a good thing?

That seems to sum up investor sentiment for small-cap funds, as they outperformed for the second year in a row. With small-cap value funds leading in 2004, and small-cap growth funds winning the crown in 2003, many didn't seem to want to make the shift into large-cap stocks, contrary to the advice of many market forecasts.

"Investors are saying, 'I want to stick with those areas that have done well for me,'" says Sam Stovall, chief investment strategist at Standard & Poor's. In favoring small-cap stocks, investors may have been focusing more on valuations, but small-cap stocks still aren't pricey despite their recent run-ups. The price/earnings ratio to projected five-year earnings growth is currently 1.2 for the S&P SmallCap 600, versus 1.4 for the S&P 500-stock index.

As the bull market matures, investors often trade up the market cap spectrum to large-cap companies with more stable earnings and easier access to capital. That pattern didn't materialize in 2004, when the current bull market entered its second year. Small-cap stocks' attractive earnings, as well as low interest rates, apparently helped them stave off the traditional challenges of mature bull markets.

Reassuring Value Plays

However, value funds' outperformance this year follows the script of mature phases of previous bull markets. After sizzling double-digit gains in 2003, when the average domestic equity fund was up 32.9%, such outsized gains apparently became harder to come by in 2004, even though the average U.S. stock fund still rose a healthy 11.9%. Having grabbed the easier gains in 2003, investors apparently sought out more predictable returns in value investments, which tend to have lower volatility than their growth counterparts.

To be sure, after strong capital appreciation in 2003, investors also sought yield in dividend-paying companies, which tend to be value oriented. In 2004, dividend-paying companies in the S&P 500 returned 18.2%, versus a gain of 13.2% for non-dividend paying companies.

While value funds generally led across market cap categories in 2004, growth funds outpaced their value counterparts in the fourth quarter. A single quarter's results may not signal a longer-term trend, but investors were apparently heartened by economic growth, lower oil prices, and Bush's re-election during the quarter, which put an end to any fears over a drawn out battle for the White House.

Could 4Q Be the Tipping Point?

Looking at the trajectory of 2004's returns, investors were prudent to be cautious. At the end of the third quarter this year, domestic equity funds were up a modest 1.04%. At that time, investors faced high oil prices, a close presidential election campaign, and rising interest rates.

Since then, oil prices have come down, the election was decided to Wall Street's satisfaction, and the Federal Reserve stuck with its policy of measured rate hikes.

To be sure, fourth quarter 2004 gains significantly boosted domestic equity funds' returns overall last year. They were up 10.7% in the fourth quarter, and gained 11.9% for the year.

Outlook for 2005: Whither the Punch Bowl?

Despite last year's market-friendly trends, how will domestic equity funds do in 2005? As the market well knows, no party lasts forever.

This year, the current bull market will move into its third year, a period during which the S&P 500 has historically gained about 3%. Standard & Poor's investment policy committee projects single-digit advances for the S&P 500, putting the index at 1300 by year-end 2005, and 1255 by mid-year 2005.

A "good economy" and "valuations that won't be stretched," favor those targets, says Standard & Poor's Stovall.

Fund Investment Style

2004 Average Returns (%)

Large-Cap Growth

+7.58%

Large-Cap Value

+12.49%

Large-Cap Blend

+9.41%

Mid-Cap Growth

+12.79%

Mid-Cap Value

+18.02%

Mid-Cap Blend

+15.09%

Small-Cap Growth

+11.21%

Small-Cap Value

+19.51%

Small-Cap Blend

+18.09%

All-Cap Growth

+10.11%

All-Cap Value

+14.21%

Domestic Equity Funds*

+11.94%

S&P 500-Stock Index

+10.71%

Fund Investment Style

Fourth Quarter 2004 Average Returns (%)

Large-Cap Growth

+9.67%

Large-Cap Value

+9.11%

Large-Cap Blend

+8.91%

Mid-Cap Growth

+12.91%

Mid-Cap Value

+11.62%

Mid-Cap Blend

+10.86%

Small-Cap Growth

+14.01%

Small-Cap Value

+12.26%

Small-Cap Blend

+12.48%

All-Cap Growth

+11.31%

All-Cap Value

+10.69%

Domestic Equity Funds*

+10.72%

S&P 500-Stock Index

+9.06%

Domestic Equity Funds* -- Year-End 2004 Returns

Best Performers Returns (%) Worst Performers Returns (%)
Large-Cap Growth Janus Twenty Fund (JAVLX) +23.9% Rydex Dynamic Funds: Venture 100 Fund/C (RYCDX) -25.2%
Large-Cap Value Vice Fund (VICEX) +24.4% Wade Fund -1.4%
Large-Cap Blend Brandywine Blue Fund (BLUEX) +19.3% Rydex Dynamic Funds: Tempest 500 Fund/C (RYCBX) -20.7%
Mid-Cap Growth Baron Asset Fund (BARAX) +27.1% Ameritor Investment Fund (AIVTX) -35.3%
Mid-Cap Value Delafield Fund (DEFIX) +32.9% Harbor Funds Mid Cap Value Fund/Ret (HRMVX) +6.0%
Mid-Cap Blend ProFunds: UltraMid Cap/Iv (UMPIX) +28.5% Phoenix-Seneca: Mid Cap EDGE Fund/B (EDBEX) +5.8%
Small-Cap Growth FBR Small Cap Fund/A (FBRVX) +30.7% Thurlow Growth Fund (THRGX) -33.6%
Small-Cap Value Pacific Advisors: Small Cap Fund/A (PASMX) +36.6% Corbin Small Cap Value Fund (CORBX) -0.7%
Small-Cap Blend Gartmore Micro Cap Equity/I (GMEIX) +32.1% Potomac Small Cap/Short/Investor (POSSX) -19.5%
All-Cap Growth Hodges Fund (HDPMX) +24.5% Choice Focus Fund (CHFCX) -7.0%
All-Cap Value Third Avenue Value Fund (TAVFX) +26.6% Marketocracy Masters (MOFQX) -4.1%

Domestic Equity Funds* -- Fourth Quarter 2004 Returns

Best Performers Returns (%) Worst Performers Returns (%)
Large-Cap Growth ProFunds:UltraOTC/Iv (UOPIX) +30.0% Rydex Dynamic Funds: Venture 100 Fund/C (RYCDX) -25.1%
Large-Cap Value API TR: Value/C (YCVTX) +20.6% SunAmerica Value/A (SSVAX) -2.0%
Large-Cap Blend Thompson Plumb Select Fund (THPSX) +20.9% Rydex Dynamic Funds: Tempest 500 Fund/C (RYCBX) -16.2%
Mid-Cap Growth Perkins Discovery Fund (PDFDX) +20.5% Ameritor Investment Fund (AIVTX) -8.3%
Mid-Cap Value Delafield Fund (DEFIX) +22.1% Harbor Funds Mid Cap Value Fund/Ret (HRMVX) +1.7%
Mid-Cap Blend ProFunds: UltraMid Cap/Iv (UMPIX) +24.1% ProFunds: Ultra Short Mid Cap/S (UIPSX) -20.7%
Small-Cap Growth Perkins Opportunity Fund (POFDX) +29.6% Thurlow Growth Fund (THRGX) -4.6%
Small-Cap Value ING Small Cap Value/A (IVSAX) +21.2% SEI Instl Mgd Small Cap Value/I -1.9%
Small-Cap Blend ProFunds: UltraSmall Cap/Iv (UAPIX) +28.7% ProFunds: UltraShort Scp/Srv (UCPSX) -23.8%
All-Cap Growth Reynolds Fund (REYFX) +28.2% Janus Asp: Risk Managed Growth/Sv -3.7%
All-Cap Value Legg Mason Inv Tr: Opportunity Tr/Prim (LMOPX) +17.5% GMO Tr US Sector Fund/III (GMUSX) +3.9%

*Excluding sector and balanced funds.

Source: Standard & Poor's. Total returns include reinvested dividends. Preliminary data as of 12/31/04.

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

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