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Funds Post Gains, But Recovery Is Still Far Off

Nearly all categories of mutual funds posted strong performance gains in October, but analysts said the numbers don't necessarily mean that the fund industry will grow significantly before year-end.

Equity funds gained 5.76% in October, according to a report issued last week by New York-based Lipper. Sector equity funds rose nearly 8%. And science and technology funds gained 16.6% after six consecutive months of losses.

Equities rallied in October despite a still-hazy economic outlook for 2003, Lipper's report said. Consumer confidence is at a nine-year low, and the GDP has not grown as quickly as some expected. Still, analysts say that investors were heartened by third-quarter earnings.

"It was a good month for stocks in general," said Bill Harding, an analyst at Chicago fund-tracker Morningstar. "Some of the most beaten-down names that have taken the brunt of the bear market rebounded the most."

In fact, telecommunications funds, which have long suffered during the bear market, posted their best gains on record in October, Lipper said. The funds rocketed to an astounding 20.15% gain after six months of double-digit losses. The gains, Lipper said, were the result of stronger-than-expected earnings announcements from the likes of AT&T Wireless, BellSouth and Nextel.

Harding said that "telecom was one of the first areas into the bear market" and now "some people might think it will be one of the first areas to rebound."

All of this was welcome news to a fund industry that has weathered a relentless, three-year bear market leading up to some of the worst outflows on record. Since its exponential growth throughout the 1980s and 1990s, the fund industry has never suffered such a horrendous market, nor such stagnation.

The rally follows dismal mutual fund asset flows for the month of September. Investors drained $329.2 billion from funds in September, leaving total assets at $6.059 trillion. Stock funds alone suffered declines of nearly 10% in September.

October's flow numbers won't be available until the middle of November, analysts said, so it remains to be seen how fund investors responded to the October rally.

Lipper, meanwhile, predicted that any true recovery will not take shape until at least the first quarter of next year, partly because, although earnings results were promising, they were more the product of cost cutting than growth. And analysts said that the industry shouldn't hold its breath for a rapid change in attitude among investors.

"Investors are not as patient as they were a year ago and more quick to punish," the report said. "If the current rally fizzles out and the markets hit new lows, we will see large outflows from equity funds for the next few months."

Analysts at Lipper cited "sluggish economic growth" as well as dwindling consumer confidence figures and the possibility of a U.S. invasion of Iraq as potential confidence spoilers.

The report also said that controversies among regulators in the wake of accounting scandals on Wall Street continue to undermine investors' confidence. The resignation of Securities and Exchange Commission Chairman Harvey Pitt certainly can't help.

Until those matters are resolved, Lipper analysts said, the outlook will amount to a "tug of war between equity and bond markets as wounded investors seek to minimize additional loses and squeak out some gains."

"The sharp rally, which is typical off the bottom in a major bear market end, is a good thing for investors," said Lipper analyst Don Cassidy. "It sort of takes the mental pressure off, but I don't think it's going to encourage them in the near term to become aggressive equity investors. I think it's going to take time to heal the wounds--and probably a couple of hundred points on the Dow--for them to start believing again."

Russ Kinnel, the director of fund research at Morningstar, said that the markets' downward trend will take months to reverse. "One month alone will not take us back into flows like we saw in 2000 and 1999," he said.

But he said a string of months during which funds post gains will likely attract investors back to equity products. "A few months like this might be enough to stave off some outflows," he said. "It may not be until you see nice, positive 12-month returns in the big sectors and the big funds that you really see strong inflows."