Domestic Equity Funds -- January 2005 Review

Feb. 2, 2005 — The U.S. stock market started 2005 with a whimper, rather than a bang. All domestic equity fund categories declined in January. The average stock portfolio dropped 2.71%, versus a loss of 2.53% for the S&P 500. The tech-heavy NASDAQ tumbled 5.20%.

A number of factors contributed to the weak markets in January. For starters, “investors likely took some profits following the post-election, fourth-quarter rally,” noted Michael Sheldon, chief market strategist and director of equity research at Spencer Clarke LLC. High oil prices, worries surrounding the elections in Iraq, comments by the Federal Reserve that interest rates will rise this year, and concerns over the growing trade and budget deficits, also weighed heavily on investor sentiment, he added.

Although most corporate earnings matched or slightly exceeded analysts’ estimates in the latest quarter, Sheldon noted that investors are worried that earnings growth will decelerate as the economy slows down. In fact, several high-profile companies like eBay (EBAY), Caterpillar (CAT) General Motors (GM), and Citigroup (C), have already issued profit warnings. Operating earnings growth for the S&P 500 is expected to average 9.47% in 2005, less than half of the 23.02% gain recorded last year, according to Howard Silverblatt, equity market analyst at Standard & Poor’s.

The current bull market, now about 26 months old, may be entering its “latter” innings, although “we may now see a rotation from small-cap stocks to large-caps for market leadership,” Sheldon said. Noting that small-caps have significantly outperformed large caps and the broader market over the past five years, he added that “as the economy softens, earnings growth weakens, and the Fed commits to further tightening, large-cap stocks, especially in defensive sectors like utilities, health care and consumer staples, will likely outperform as they have historically in such an environment.” While 2005 is only one month old, money is already moving into these areas, away from small-cap issues and higher-beta cyclicals like technology, he said.

The weak dollar, another dark cloud hanging over investors, may also provide a benefit to large caps, said Matthew Sauer, co-manager of the Oak Value Fund (OAKVX). Many large firms export to foreign nations, while smaller companies restrict their products to local consumers, he noted. Although the dollar has rallied somewhat in the new year, Standard & Poor’s chief economist David Wyss thinks it will be down by the end of the year. “Currencies always tend to move in stair-step fashion, he noted. “They take a step down, then stabilize or even rally a bit before taking the next step.”