The future looked so bright in the third quarter.
Oil prices fell as Middle East tensions eased and offshore roughnecks struck one of the largest crude discoveries in the nation's history. The Federal Reserve twice took a pass on raising interest rates that affect mortgage payments and business borrowing.
Investors, however, apparently weren't the Pollyannas and piled into larger, blue-chip stocks considered safer havens that had long been overlooked in favor of fast-growing small-cap stocks. This "flight to quality" not only meant the Dow Jones industrial average, a barometer for big U.S. companies, finally reached a record high last week but that mutual funds heavy in stocks with household names tended to fare well.
Among the best performers were Brown Advisory's Value Equity fund, which gained 7.3 percent, and Mercantile Bankshares Corp.'s Equity Income fund that was up 6.7 percent. In both funds, six of the top 10 holdings are Dow components. International funds also did well, including T. Rowe Price's Emerging Europe & Mediterranean fund that had a 12.9 percent return.
Stock funds erased second-quarter losses with an average 2.7 percent return, while bond funds posted an average 2.5 percent return, their best showing in more than two years, according to Lipper Inc, a mutual fund tracking firm.
Three-fourths of 220 Maryland-based stock funds and all but one of 55 bond funds were in the black for the third quarter, according to a Bloomberg Funds review.
"Investors are looking for larger stocks that have been left behind but also expressing overall skittishness about the market by gravitating toward what they consider safer names," said John P. Hussman, manager of the Hussman Funds in Ellicott City. "It is characteristic of aging bull markets to become more and more selective."
While the Dow scored its new peak a few days after the quarter ended, the broader S&P; 500 stock index and the Nasdaq composite index remain below their 2000 summits, and the Russell 2000 index of smaller companies has slipped from a peak in May.
Several economists are predicting a slowing economy next year, arguing that corporate profits aren't likely to be as robust, especially as companies are under pressure to raise wages that have stagnated. Investors, they say, are seeking companies with more predictable earnings and that have enough cash on hand to pay dividends to shareholders.
"I'm not a huge bear, nor am I a raging bull," said John Linehan, who manages T. Rowe Price's Value fund, which returned 5.4 percent in the quarter and whose largest holdings are Coca-Cola Co. and General Electric Co. "There are too many unknowns out there to really have a significant multiple expansion," he said.
"The unknowns being the structural weight of our deficit, geopolitical events and the question marks around the U.S. economy," Linehan said.
Mutual funds focused on real estate and utilities also had good runs in the third quarter, posting on average 8.4 percent and 6.3 percent returns, respectively, Lipper data show.
Technology funds were up 3.8 percent on average.
Real estate funds are a reflection of the commercial real estate market in office buildings, apartment complexes and shopping malls, which are better able to raise rental rates amid higher inflation. That category of funds is the only one tracked by Lipper to have had seven consecutive years of positive annual performance, as measured through September.
Utilities have been providing greater dividends, while technology companies are expected to benefit from increased corporate spending on upgrading computer systems, Lipper analyst Tom Roseen said. Microsoft Corp., for instance, boosted its dividend and soared during the quarter.
Energy funds were hardest hit during a quarter that saw oil prices spike to a record in mid-July before plunging nearly 20 percent. The oil find in the Gulf of Mexico by Chevron Corp. and two partners was announced in September.
Some oil companies such as blue-chip Exxon Mobil Corp. were still up but, overall, natural resources funds were down 8.4 percent on average.
In a possible sign that investors don't see long-term relief from oil - and gas - prices, the Rydex Transportation fund that holds trucking and airline stocks declined 11.7 percent in the quarter.
Douglas G. Ober, who runs the Petroleum & Resources Corp. closed-end fund of energy and natural resources companies, said that although oil supply concerns were allayed during the quarter, Venezuela and Iran have announced cutbacks in production and Saudi Arabia has "quietly" curbed production. "That should result in prices not dropping much below where they are now," he said.
While Petroleum & Resources was down 3.5 percent, Ober could take heart that his other closed-end fund, Adams Express Co., gained 5.5 percent. It counts stalwarts like Microsoft and insurer American International Group Inc. among its major holdings.
With lower energy prices, the Fed decided to pause its inflation-fighting campaign, and bond markets rejoiced. The ProFunds U.S. Government Plus fund, which uses leverage to inflate returns on the 30-year Treasury, rose 9.7 percent.
As with stocks, though, a piece of the economic puzzle indicated wariness. Namely, the yield curve between two-year and 10-year Treasuries stayed inverted during much of the quarter, which some take as a sign of a slowdown.
The markets may have enjoyed a robust third quarter, known for lackluster returns and slow trading, but November elections could inject more uncertainty, Lipper's Roseen said.