U.S. diversified stock funds on average fell 0.37% in December. They fell 3.08% in the fourth quarter following a 0.93% gain in third quarter, according to Lipper Inc. That left them up 6.32% for the year.So it wasn't the best of years, it wasn't the worst of years. The annual gain put them below the long-term average of about 10%.
Stock funds in 2007 were 0.4 percentage point below their 10-year average annual return of 6.72%, but 7.47 points below their five-year average of 13.79% and 3.61 points below their 15-year average of 9.93%.
Growth Lengthens Lead
Growth funds lengthened their lead over value for the year. Managers expect growth to continue outperforming value in the new year.
"Relative to value stocks, the growth environment is trading at historically pretty low valuations," said John Wallace, co-manager of RS MidCap Opportunities (NASDAQ:RSMOX - News).
"So that's encouraging to us looking forward into '08."
Value has trumped growth in all size categories the past 10 and 15 years. After such a long run, they're no longer cheap relative to growth, managers say.
The outlook for the economy also bodes better for growth stocks. "Value stocks were more exposed to the cycles of the economy. So they benefit more when the economy is strong," said Glenn Fogle, co-manager of American Century Heritage (NASDAQ:TWHIX - News) and American Century Vista (NASDAQ:TWCVX - News), which together have more than $6.4 billion in assets. "Conversely, they suffer more when economic growth slows, as it has this year."
One of the main reasons that growth has outperformed for the first time in years is that financials -- the worst hit group in 2007 -- were the largest sector of the value index, says ING Investment Management's Brian Gendreau. As an investment strategist, he helps oversee $12 billion in asset allocation funds.
"Growth stocks tend to do well in the late stages of an expansion, and that's where we think we are," Gendreau added. "When growth is scarce, people are willing to pay a lot for growth, and growth is scarce right now."
Troubles in housing, financial and the credit markets are weakening economic growth, Gendreau says. But things won't be clear until March, when companies roll out fourth-quarter results.
Mid-cap growth funds, up 0.56%, saw the biggest advance in December. Large-cap growth funds were the least hit among size and style funds in fourth quarter. They let up just 0.03% while mid-cap growth fell 1.06%.
Overall, mid-cap growth funds outdid their large and small counterparts by a wide margin in 2007.
"That may be because there are so many very, very large financial stocks (like Citigroup (NYSE:C - News) and Merrill Lynch (NYSE:MER - News)) that had a disproportionate impact on the large-cap indexes," said American Century's Fogle. "And the mid-cap (index) is more diversified."
Meanwhile, about 75% of investment managers says they're bullish on large-cap growth stocks, according to Russell Investments' most recent quarterly survey, which polled almost 300 managers.
And 61% of managers are bullish on foreign developed markets -- the second most popular category. About 60% of managers are bullish on mid-cap growth while only 47% are so on small-cap growth.
Reluctance To Lend
"We're in an extraordinary tight credit environment with the subprime crisis. There's a real extraordinary reluctance to lend. That tends to make financing for smaller and midsize companies that much more problematic," said David Reilly, director of portfolio strategies at Rydex Investments, which has $15.7 billion in assets under management.
"In a risk-adverse environment, you want the liquidity of larger-cap stocks," said Reilly.
He expects the outperformance in large caps to last awhile.
"Small caps outperformed for a good five or six years up until about less than a year ago. If you look at the cycle of capitalizations, these tend to run for multiyear cycles," Reilly said. "So if history gives us any guide, then we're still in the very early stage of the large-cap cycle."
Russell's Investment Manager Outlook found that managers are optimistic about the new year. Seventy-six percent of managers think the market will rise in 2008 while only 15% believe it will decline. In comparison with last year, 86% said the markets would rise and 12% thought it would drop.
"The current market is similar to the market of 1990-92, when we experienced spiking oil prices, a slumping real estate market, a falling fed funds rate, the savings & loan crisis and low consumer confidence," said Neil Hennessy, president and portfolio manager of Hennessy Funds, with more than $2 billion in assets.
During that period, the market returned an average of almost 10% per year -- -0.58% in 1990, 23.93% in 1991, 7.35% in 1992, he notes.
Different Background
The difference is that in the early '90s, inflation was 6.5%; today it's 3.5%. The 30-year bond was yielding 9.5%; today it's yielding 4.8%. The fed funds rate was at 9.75%; today it's at 4.5%.
"With history as our guide, we believe that economic conditions bode very well for 2008," Hennessy said. "And barring an unforeseen catastrophe, there is no reason the Dow won't climb to 15,000 and beyond."
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