MIDYEAR REVIEW OF INVESTMENTS AND PERSONAL FINANCE : High Tech Powers Stock Funds’ Surge : The 16.7% Gain in the First Half Is the Best Since ’87

Stock mutual funds rode the broad market surge of the past six months to their best first-half gains in eight years.

And while funds that loaded up with red-hot technology stocks ran far ahead of the pack, the wealth generated by the rally was otherwise evenly spread among major U.S. stock fund categories.

Indeed, if your fund’s return was minimal or negative in the first half, your manager was probably investing in still-downbeaten Third World stocks. Either that or the manager was simply a very poor stock picker.

The average general stock fund shot up 8.8% in the second quarter after a 7.2% first-quarter rise, bringing the first-half gain to 16.7%, according to preliminary data from mutual fund tracker Lipper Analytical Services in New York. That was the best since a 21.8% rise in the first half of 1987.

Stock funds’ 1995 performance so far has easily surpassed the 9% average gain of bond funds.

For buy-and-hold investors, the stock market’s largely unexpected rally has been sweet to savor. Many short-term market timers, by contrast, had abandoned stocks late last year as interest rates rocketed. The assumption was that a bona fide bear market would arrive sooner than later and that stocks would be available at substantially lower prices sometime this year.

Yet for all the trauma in the market in 1994, the average general stock fund lost just 1.7% for the year. And instead of sliding in the first quarter of this year, as many Wall Street pros had forecast, the stock market began to advance sharply as the slowing economy pulled bond yields lower.

The result: As the market timers who jettisoned stocks in 1994 have scrambled to get back in this year, they have helped to perpetuate the rally--to the benefit of fund investors who’d stayed put.

Now, with the economy seeming to settle into the hoped-for “soft landing” of moderate growth and stable or lower interest rates, many fund managers say the first half’s stock gains may be impossible to repeat in the second half. But, they add, there’s still no good reason to turn outright bearish.

The key is that corporate earnings are continuing to advance. And based on those earnings, stocks don’t yet appear overpriced to most fund managers.

“We think the equity market is fairly valued, but in a fairly valued market you can still make money,” says Rudolph Carryl, co-manager of the MainStay Total Return fund in New York.

The hunt for superior earnings growth was what dictated the stock winners in the first half--and thus the hottest fund categories:

Technology funds led the Lipper rankings, up 25.8% on average for the half and 17.9% in the second quarter alone. With sales of personal computers and other high-tech equipment zooming worldwide--and with American companies dominant in the business--technology became the one “must own” industry for earnings-hungry fund managers this year.

Although tech issues actually have led the market for the past four years, the buzz about the stocks became deafening this year, in part because they were championed by several high-profile fund managers at Fidelity Investments--including Jeff Vinik, manager of the Magellan Fund, the nation’s largest stock fund.

Magellan’s 40%-plus weighting in tech stocks helped steer the fund to a first-half gain of 26%.

Among general stock fund categories, growth funds performed best in the quarter (up 9.4% on average) and half (up 17.7%) because many of them, like Magellan, sought out tech stocks.

But growth funds still lagged the benchmark stock index, the Standard & Poor’s 500, which rose just over 20% for the half, including dividends.

As with technology, the S&P; stocks’ tremendous gains were a function of investors’ search for steady earnings growth: Many of the multinational companies that dominate the S&P; could boast faster-growing overseas profits at a time when U.S. economic growth was in question.

For that same reason, smaller stocks marched behind their blue-chip brethren in the first half. The average small-company stock fund rose 15.3% for the half, though they began to come on stronger in the second quarter, gaining 9% on average.

Among specialty fund categories other than technology, financial services funds shot up 10.2% for the quarter and 21.4% for the half, benefiting as the steep decline in bond yields boosted shares of banks, brokerages and other interest-rate-sensitive stock groups.

Returns were much less impressive for most other niche fund categories. Utility funds, while helped by lower interest rates, still gained just 11.1% for the half, far less than the average general stock fund.

Likewise, health and biotechnology funds’ average gain of 14.3% lagged general funds, as a decline in the stocks of health maintenance organizations offset a strong rally in drug stocks.

And real estate funds, while recovering from a first-quarter decline that many on Wall Street were at a loss to explain, still could muster only a 5.5% gain in the second quarter.

Perhaps the biggest disappointment was the international fund sector. Foreign stock markets, most of which fell more sharply last year in native currencies than the U.S. market, have failed to rally significantly this year. Even with the benefit of a weak dollar, which automatically boosts American investors’ returns on foreign stocks, the average international fund’s return was a mere 2.2% in the first half.

Japanese funds were the disasters of the quarter and the half, losing 6.8% and 14.8% on average, respectively, as the mighty yen threatened to push the country deeper into recession.

And although some emerging-market stock funds finally began to rebound in the second quarter, they still haven’t recouped the first quarter’s losses, when Mexico’s turmoil bit deeply into those markets. The average emerging-markets fund was off 3.7% for the half.

But with the U.S. market up so spectacularly--and with so much riding on the expectation that the economy will neither boom nor bust--should nervous fund investors begin to look elsewhere, to overseas stocks or perhaps the safe haven of money market funds?

Robert Markman, whose Markman Capital Management in Minneapolis invests client monies in mutual funds, contends there’s no good argument for shifting heavily away from U.S. stock funds now.

“I see this market driven by corporate earnings growth,” he says. Until there’s a reason to believe that the economy, and thus earnings, has peaked, the U.S. stock market has further to run, Markman says. With the Dow industrial index at 4,556.10 as of Friday and the typical blue-chip stock priced at a historically average 15 times this year’s earnings, “we’re going to see 5,000 before we see 4,000 again,” he argues.

But Markman also cautions fund investors to be prepared for rising volatility in the second half of the year. Stocks will be prone to sharp selloffs on the road higher, if only because profit takers will be itching to cash in after the first half’s rally.

His best bet for the next six months? Small-stock funds, which Markman thinks will play catch-up to blue chips. “I think the major story in the second half is going to be small stocks,” he says.

And what about those high-flying tech stocks? Paul Wick, whose Seligman Communications fund was the first half’s second-biggest gainer overall (up 48%) thanks to its tech holdings, has closed the fund to new investors as of Friday. A veteran of tech stock investing, Wick decided the fund was in danger of becoming unwieldy as assets ballooned to $2.4 billion.

A selloff in technology may be overdue, Wick concedes. But if investors are looking for an industry whose long-term growth prospects remain stellar, he challenges them to find something better.

“There’s still a lot more excitement in technology,” he says.