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Stock Funds Go Global, Then Local as U.S. Stock Market Rises

Richard Satran

Americans began the year by sending their investments on a global tour. But vacation time is over, and that's probably a good thing. The bigger promise for now is in the outlook for funds back home, analysts say.

In hindsight, that deluge of cash pouring into international equity funds was not the start of something new but the end of last year's big move. The $30 billion that landed in global investments was probably just an old pattern playing out: Fund flows follow performance. International funds had a solid 2012, as the iShares Core MSCI Total International Stock ETF, made up entirely of non-U.S. global stocks, made nearly all of its 17 percent gain for last year in the second half, while its U.S. counterpart, iShares Core S&P 500 ETF slowed to 5 percent and made no gain in the final quarter.

The bigger trend--a shift toward equity and away from bonds--will likely continue, fund analysts say. Investors put $60 billion into equity funds in January, the most in seven years. After five years of putting most of their fund dollars into income funds, the shift away from fixed income is a smart move, advisers say, since bonds could be hit with big losses when interest rates inevitably rise after a half-decade of Fed easing.

"The macro outlook is improving and the U.S. didn't go over the cliff," says Alexander Young, global equity strategist for S&P Capital IQ. With the economy improving, it's equities, not bonds, that will perform best. And "U.S. equity is looking pretty good compared to the others," he says.

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Equity fund flows edged higher last year, but most of that gain went into bond-like investments in equity dividend funds, says Tom Roseen, head of research for Lipper.

"It is positive that we are seeing more diversifying in equity funds beyond income, and that other areas are coming up," says Roseen. "People are turning attention more to large cap, growth, and value--it's become a bit more of a dichotomy."

U.S. News Best Funds top two picks in large growth are LKCM Equity Portfolio, which is up 15.92 percent in the past year, and Touchstone Sands Capital Institutional Growth Fund.

Slowdown in international. After that initial burst at the start of the year, "the flow into international funds has definitely tapered off in February," Roseen says. And global strategists say that putting more into international now would be hard to justify given the relative strength in the U.S. economy.

"As a diversifier, international [equity allocation] makes sense, but beyond that, it's not so obvious why this would be the time to get into international," says Jonathan Lewis, chief investment officer of Samson Capital Advisors. But in the long term, the dollar's decline is likely to reassert itself, and when it does, those international funds could gain value. "Long-term, it is hard to make a fundamental case on the strength of the dollar."

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S&P's Young says immediate events may have overtaken Europe, but its stocks remain "fairly valued." If the dollar resumes its decline, those reasonably priced euro equity funds could become more attractive, so there is no big reason for investors to dump all of the international stocks they bought last month. U.S. News Best Funds top pick for global equity is the Artisan Global Value Fund, with a one-year gain of 21.78 percent. USAA World Growth Fund up 23.58 percent.

To be sure, Europe's simmering financial crisis slammed Wall Street this week and sent stocks to the biggest one-day loss of 1.6 percent for the Dow industrials since November, when election uncertainty still hovered over the U.S. market. Now it's Europe's turn.

"The split outcome of the Italian election raises new questions about the long-term fate of the euro and the health of the eurozone economy," says Fred H. Dickson, CMT senior vice president, chief investment strategist of Davidson Companies.

[Read: Emerging Markets That Could Pop in 2013.]

Wall Street rebounded this week when reports of strong housing markets eased concerns over that critical sector in the recovering U.S. economy. Federal Reserve Chairman Ben Bernanke's pledge of more stimulus policy to keep the economy on track gave further confidence for Wall Street's recovery.

But investors should probably think twice about chasing after housing stocks after a solid year of recovery. The iShares Dow Jones US Home Construction Index Fund is up more than 80 percent in a year and might not have much further to go.

Investors were looking more widely for gains in areas that could benefit from a housing recovery and a strengthening overall economy. Materials, consumer discretionary, and energy led in the rally, Dickson notes. Two broad-based funds in the space from U.S. News Best Funds are the top-ranked Vanguard Consumer Staples Index Fund and the iShares Dow Jones US Consumer Goods Sector Index Fund, both of which have risen close to 10 percent in the past year.

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