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No May Flowers for Investors

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May was the cruelest month for U.S. stock investors.

The major equity indices took it on the chin as inflation and high oil prices, among other factors, weighed heavily on investor sentiment. All style categories posted losses for May, with small-cap growth portfolios doing the worst, shedding 6.2% of their value. Meanwhile, large-cap value suffered the least, down 2.6%. The S&P 500 lost 3.1% (on a price return basis) for the month.

“In May, value-oriented and larger-cap companies had the least declines, while growth style and smaller-cap companies were at the bottom of the rankings, as investors shifted to more stable companies,” said Standard & Poor’s mutual fund strategist Rosanne Pane. “In down months, there is also a focus on value stocks, with expectations that they have less downside risk relative to growth stocks that may be aggressively valued.”

The average equity fund dropped 4.2% in May. “It was pretty much a bad month all around,” said Sam Stovall, Standard & Poor’s chief investment strategist. “Thank goodness there are 12 months in a year, not one.”

Stovall warns that historically, a bloody May can spill over onto the next month, when the “June swoon” can set in. In the 10 worst May market performances since 1945, the S&P 500 declined an average of 1.21% the following June.

Worse, Stovall added, the mid-term election year is historically the weakest of the four-year presidential cycle. The market gain is historically about 25% that of the strongest year in the cycle — the third year. The second and third quarters of Year 2 have fallen an average of 2% and 2.2%, respectively, since 1945, he added. “So far this pattern is playing out,” Stovall said. “It was a positive first quarter, but through May 31, we are down about 2.2% in the second quarter.”

Stovall attributes the May declines less to concerns over interest rates than to an overreaction to the small rise in the Consumer Price Index (the May 11 report was up 0.01% above expectations.) The S&P 500 fell two basis points on May 10 in anticipation of the Federal Reserve’s meeting, making it “a non-event day,” he said. “Investors are like hyperactive fourth-graders playing musical chairs.They’re all trying to outanticipate everybody else.”

The market’s reaction, Stovall thinks, was a bit overdone. “Those who want to play it safe have to remember that the market has rebounded quite substantially in the fourth quarter of the mid-term election year,” he said. Out of all 16 quarters of the presidential cycle, the fourth quarter of Year 2, and the first and second quarters of Year 3, have been the best periods for the S&P 500, on average.

Despite their poor showing in May, small-cap equity funds have excelled on the year-to-date basis. Small-cap value portfolios have risen 7.5%, making it the best performing style category. Large-cap growth funds have done the worst — with a 0.7% loss year-to-date, it is the only sector in negative territory through the first five months of the year.

A bruising May notwithstanding, Standard & Poor’s Global Investment Policy Committee (IPC) continues to expect full-year gains for the S&P 500 — an 11% price rise and a 12% growth in earnings. The committee anticipates that corporate earnings will get a big boost from an expected 20% advance in profits for the S&P 1500 materials sector, a 17% snap-back for consumer discretionary (versus a 1% decline last year), and 16% earnings increases for both the energy and telecom services sectors.

For full-year 2006, the IPC projects operating earnings-per-share gains of 18% for mid-cap issues and 19% for small caps, compared with 12% for the large-cap S&P 500. Moreover, IPC sees the greatest profit increase for large-cap growth stocks, with a projected 26% gain on the year.

Fund Investment Style

May 2006 Average Returns (%)*

Average Return Year-to-Date**

Large-Cap Growth



Large-Cap Value



Large-Cap Blend



Mid-Cap Growth



Mid-Cap Value



Mid-Cap Blend



Small-Cap Growth



Small-Cap Value



Small-Cap Blend



All-Cap Growth



All-Cap Value



Domestic Equity Funds (excluding sector and balanced funds)



S&P 500-Stock Index



Source: Standard & Poor’s. Total returns include reinvested dividends.

*4/28/06-5/31/06. ** Through 5/31/06.