Markets’ third-quarter rally puts most mutual funds back into positive territory for 2010

Mutual funds are back in the black for 2010

NEW YORK — The third quarter set the markets right again.

Most mutual funds rallied over the past three months, with gains coming across stock industries, national borders and investment types. Funds that focused on everything from corporate bonds to small U.S. stocks to global real estate advanced.

It’s a welcome turnaround after the losses logged by many stock funds during the second quarter. It also means most types of mutual funds now have made money for their investors so far this year.

Credit the power of low expectations. Economists and investors were so worried about a possible bond default by a European nation or a relapse into another recession that they were pleasantly surprised by September’s economic data.

Reports on manufacturing, retail sales and employment all came in better than expected. That led to a relief rally where “investors reasoned that while the recovery remains fairly anemic, a double dip isn’t imminent.” Standard & Poor’s equity strategist Alec Young wrote in a recent report.

Yes, anemic is good enough to foster relief. Not only that, it vaulted U.S. stocks to their best September since 1939.

“Weak recoveries do not necessarily signal weak financial markets,” Barclays Capital head of research Larry Kantor wrote in a recent report. Low interest rates are also helping riskier assets to rise.

Some of the quarter’s biggest gains came from stock funds that focus on companies outside the United States, particularly those invested in Latin America and Europe.

Latin American funds returned 24 percent for the quarter, according to Morningstar data. Those funds, and emerging-market stock funds overall, rose on investors’ hungry for growth.

The U.S. economy likely grew just 2 percent in the third quarter, according to Credit Suisse’s estimates. But China’s economy surged by 9.4 percent, India’s by 8 percent and Latin America’s by 5.6 percent, according to the firm’s forecasts.

Investors are willing to pay for that stronger growth, says David L. Ruff, who helps manage the Forward International Dividend fund. He says Indian stocks have surged so much that they may be starting to look expensive, but he still sees good buys in Thailand, Malaysia and other emerging markets.

Stocks in Latin America also benefited from rising prices for the commodities those countries produce. Gold prices, for example, shot to a new record above $1,300 per ounce during the quarter.

European funds, meanwhile, rose as bottom hunters decided stocks on the continent looked cheap after their tumble during the spring. They returned 18.6 percent for the quarter.

Fears about a European government defaulting on its debt have eased in recent months, encouraging buyers. The European Central Bank also boosted its forecast for 2010 growth in early September after noticing stronger demand for euro-area goods at home and abroad.

Many investors, though, may have missed out on those gains from stock funds. Investors continue to be leery of stock mutual funds, focusing instead on the safer returns of bond funds.

Investors pulled a net $26.98 billion out of stock funds during July and August and plugged a net $60.61 billion into bond funds, according to the most recent data from the Investment Company Institute.

Most bond funds offered more gains in the third quarter, though smaller than stock funds’ in general. Long-term U.S. bond funds, for example, returned 6.3 percent for the quarter. Inflation readings remain low, which preserves the spending power of bond funds’ future fixed-income payments.