Aug. 2, 2004 — As the bull market moves halfway through its second year, investors are becoming cautious, pursuing more established and dependable market segments and gravitating to larger-cap, high-quality value stocks.

The market “is doing what we think it should be in the current economic and earnings cycles,” says Sam Stovall, chief investment strategist for Standard & Poor’s. With earnings decelerating, investors are gravitating to dividend-paying stocks that are trading at reasonable valuations, he noted.

July results for domestic equity funds mirror these market moves, with value offerings holding up better across the market capitalization categories, and larger caps faring better than smaller caps. Large companies tend to outperform in rising rate environments, and their global operations generally benefit from a weak dollar, noted Rosanne Pane, Standard & Poor’s mutual fund strategist.

Traditionally, third quarters also suffer from a few negatives, Stovall said. Unlike the start and the end of the year, when investors add to their 401(k)s and IRAs, and unlike in April, when tax refunds roll in, third quarters don’t have a dependable infusion of cash, he noted. Also, trading volume tends to be lower in the summer, limiting market gains. The adage “Sell in May and walk away” appears to be holding, according to Stovall.

Indeed, bearish tendencies in third quarters also seem to have reinforced pessimism already in the market. The pessimism stems from several unfavorable trends, including terrorism, the war in Iraq, uncertainty about the presidential election, high oil prices, and rising interest rates. Domestic equity fund results show the downsides of such bad news. The average U.S. domestic stock fund lost 1.12% so far this year, including a 4.9% drop in July.

Looking for a Silver Lining

While gloom seems to be taking hold, Stovall thinks the market could brighten in the fourth quarter. “Oil prices, valuations, and time could be a catalyst” for an upturn, Stovall said. Lower oil prices could stimulate the economy, while beaten-down stocks may attract investors. Time is an open question. “If we get through the presidential conventions, the Olympics, and the elections without terrorism, time could be on our side,” Stovall says.

The longer term is also uncertain, Stovall cautions. “It’s possible that the current bull market won’t make to the third year,” he said. The market started to rally in October, 2002. Standard & Poor’s investment policy committee currently predicts the S&P 500 will rise to 1150 by the end of 2004, and to 1220 by the middle of 2005.

Fund Investment Style

Average Returns 2004 Through 7/30/04 (%)

Large-Cap Growth

-3.11%

Large-Cap Value

+0.89%

Large-Cap Blend

-0.91%

Mid-Cap Growth

-2.68%

Mid-Cap Value

+2.61%

Mid-Cap Blend

+0.74%

Small-Cap Growth

-5.10%

Small-Cap Value

+2.41%

Small-Cap Blend

+0.24%

Domestic Equity Funds*

-1.12%

S&P 500-Stock Index

-0.81%

Fund Investment Style

Average Returns July 2004 (%)

Large-Cap Growth

-5.49%

Large-Cap Value

-2.53%

Large-Cap Blend

-3.78%

Mid-Cap Growth

-6.98%

Mid-Cap Value

-3.52%

Mid-Cap Blend

-4.91%

Small-Cap Growth

-8.20%

Small-Cap Value

-4.70%

Small-Cap Blend

-6.05%

Domestic Equity Funds*

-4.90%

S&P 500-Stock Index

-3.43%

Domestic Equity Funds* — 2004 Returns Through 7/30/04

Best Performers

Returns(%)

Worst Performers

Returns(%

Large-Cap Growth MassMutual Instl Aggressive Growth/Y (MAGYX)

+5.8%

Reynolds Fund (REYFX) -23.3%
Large-Cap Value Philadelphia Fund (PHILX)

+7.8%

Integrity Value Fund (IVUAX) -5.3%
Large-Cap Blend Alpine Dynamic Dividend Fund (ADVDX)

+8.3%

Marketocracy Masters (MOFQX)

-12.7%

Mid-Cap Growth Diamond Hill Focus/A (DIAMX)

+7.0%

Grand Prix Fund/A (GPFFX)

-32.1%

Mid-Cap Value Third Avenue Value Fund (TAVFX)

+9.7%

Neuberger Berman Focus/Advisor (NBFAX)

-9.0%

Mid-Cap Blend PIF Partners MdCp VA I/I

+7.9%

Van Wagoner Growth Opportunities Fund (VWGOX)

-17.6%

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

+16.9%

Thurlow Growth Fund (THRGX)

-30.7%

Small-Cap Value Pacific Advisors:Small Cap Fund/A (PASMX)

+11.9%

Corbin Small Cap Value Fund (CORBX)

-19.2%

Small-Cap Blend Strong Small Company Value Fund (SCOVX)

+12.2%

MassMutual Instl Small Company Growth/N (MMCNX)

-14.3%

Domestic Equity Funds* — July 2004 Returns

Best Performers

Returns(%)

Worst Performers

Returns(%

Large-Cap Growth

Analytic Defensive Equity Fund (ANDEX) -1.3% Reynolds Fund (REYFX) -21.8%
Large-Cap Value Amana Mutual Funds Trust Income (AMANX) +0.9% Integrity Value Fund (IVUAX) -6.2%
Large-Cap Blend Oakmark Select Fund/I (OAKLX) -0.1% Legg Mason Growth Tr/P (LMGTX) -12.5%
Mid-Cap Growth Diamond Hill Focus/A (DIAMX) +1.2% Oberweis Funds:Mid-Cap Portfolio (OBMDX) -12.6%
Mid-Cap Value Federated Market Opportunity Fund/A (FMAAX) +1.8% Legg Mason Eq Tr: Special Investment/Prim (LMASX) -9.3%
Mid-Cap Blend ING JPMorgan Md Cp Val Portfolio/Inl (IJMIX) -1.1% Van Wagoner Growth Opportunities Fund (VWGOX) -15.5%
Small-Cap Growth Van Wagoner Post-Venture Fund (VWPVX) -0.4% Apex Mid Cap Growth Fund (BMCGX) -17.9%
Small-Cap Value Homestead Small Company Stock Fund (HSCSX) -1.0% Tocqueville Small Cap Value Fund (TSCVX) -11.1%
Small-Cap Blend WM Small Cap Value/A (WMSAX) -0.8% MassMutual Instl Small Company Growth/N (MMCNX) -13.4%

*Excluding sector and balanced funds.

Source: Standard & Poor’s. Total returns include reinvested dividends. Data as of 7/30/04

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