Domestic Equity Funds -- Aug. 2002 Review

Sept. 5, 2002 — With the average U.S. stock fund down 20.2% this year through August, but up a modest 0.2% last month, is the market beginning to turn around?

“I think we have bottomed,” says Bob Costomiris, manager of Strong Mid Cap Disciplined Fund (SMCDX). While some market watchers expect the market to retest its recent lows, Costomiris thinks valuations are “reasonable,” based low interest rates and little inflation. Although generally optimistic, Costomiris expects a lot of sideways movement. A mid-cap value offering, Strong Mid Cap Disciplined rose 2% last month.

The market’s recent gains signal that “the worst is behind us,” according to Peter Morris, co-manager of Homestead Small Company Stock Fund (HSCSX). An upturn may be likely, but Morris expects that stock returns will be modest in the near term. Up 4.4%, Homestead was the third-best performing small-cap value fund this year through August.

Don Taylor, manager of Franklin Managed Trust Rising Dividends Fund (FRDPX), is optimistic about equity returns because the corporate scandals, which were limited to “a few bad apples,” are fading. Taylor believes these scandals interrupted a market rebound that was beginning last May. Now that these issues have less influence on stock prices, Taylor predicts that the market will shift toward a cyclical upturn. The second-best-performing mid-cap value fund this year through last month, Franklin Rising Dividends rose 1.5%.

One constant through the market’s recent ups and downs has been stronger results among mid- and small-cap funds. An interesting development is the better relative performance of blend offerings in the smaller-cap space. While investors may still favor smaller-cap stocks because of their more attractive valuations, a shift from pure value plays to a blend of growth and value styles suggests cautious optimism, since growth-oriented investments tend to do better as the economy improves.

Strong’s Costomiris feels it isn’t likely that a stronger economy will favor large-cap companies, so he expects that mid- and small-cap value stocks “should at least hold onto their relative gains of the last couple of years.”

Value stocks will likely outpace growth stocks in the near term because value stocks are still so attractively priced that “there is no reason to go to the roulette table” with growth stocks,” said Neil Hennessy, manager of Hennessy Cornerstone Growth Fund (HFCGX). With growth stocks, Hennessy feels investors are “betting on something that might or might not happen” since the economic outlook is uncertain. A small-cap growth portfolio, Hennessy Cornerstone Growth Fund was up 2.2% this year through August.

Fund Investment Style2002 Returns Through 8-30-02 (%)

Large-Cap Growth Average-24.30

Large-Cap Value Average-16.40

Large-Cap Blend Average-19.94

Mid-Cap Growth Average-23.93

Mid-Cap Value Average-12.29

Mid-Cap Blend Average-18.65

Small-Cap Growth Average-27.49

Small-Cap Value Average-10.23

Small-Cap Blend Average-18.25

Domestic Equity Funds Average*-20.21

S&P 500-19.53

Fund Investment StyleAug. 2002 Returns (%)

Large-Cap Growth Average+0.12

Large-Cap Value Average+0.66

Large-Cap Blend Average+0.45

Mid-Cap Growth Average-0.66

Mid-Cap Value Average+0.72

Mid-Cap Blend Average+3.62

Small-Cap Growth Average-0.32