BULLS’ ROUGH RIDE

Stock mutual funds just racked up their biggest quarterly advance in six years.

Now, try finding investors who’ll say they truly enjoyed the ride.

The stock market’s bounce in the three months ended June 30 triggered widespread relief after the fall and winter meltdowns. The average U.S. stock mutual fund rallied 16.8% in the second quarter and was up 7% for the first half, according to Morningstar Inc.

Many foreign stock markets posted much stronger gains, after falling more sharply than U.S. funds in the 2008 dive. The average foreign fund surged 25.2% in the second quarter, helped by a weaker dollar.

Yet the usual sense of optimism that accompanies bull markets has been largely absent.

Technically speaking, at least, a new bull was born March 10. From that 12-year low the Standard & Poor’s 500 index rose a stunning 40% through June 12.

But Jim Stack, editor of the InvesTech Market Analyst newsletter, labels this “the most despised and mistrusted bull market in decades.”

In part, investors’ wariness reflects the incredible pain -- and wrenching volatility -- their portfolios have suffered since the market crash began last September.

The S&P; 500 still is down 44% from its record high in 2007. It would have to climb 78% just to get back to even.

The overriding fear, of course, isn’t about stock prices but about the economy itself, and whether the horrendous recession that began in December 2007 is winding down -- or about to worsen again.

Federal Reserve Chairman Ben S. Bernanke famously referred to the appearance of “green shoots” in the ravaged financial system late last winter, and his optimism set the tone for Wall Street’s improved mood last quarter.

It helped that much of the economic data of the last few months suggested things had stopped getting worse, even if they weren’t getting better.

A popular view on Wall Street is that the stock market’s sharp snap-back this spring reflected a mental “reset” by investors: At their March lows, many stocks appeared to be priced for the end of the world. When it became clearer that Armageddon had been at least postponed -- as investors gave the benefit of the doubt to the unprecedented sums the government was pumping into the financial system and the economy -- share prices had room to move up from their worst levels.

But the question that now dogs the market is whether the U.S. economy, and corporate earnings, are at best facing a long period of dismally slow growth, as American consumers struggle with falling home prices, soaring unemployment and a desperate need to pare their crushing debt loads.

If that’s what’s coming, the second quarter’s double-digit percentage returns on stocks may be the last of that magnitude for a long time.

Ted Kellner, who co-manages the FMI Common Stock and FMI Large-Cap funds in Milwaukee, thinks the economy will bottom sometime in the second half. So far, however, he isn’t hearing much encouragement from the companies in his portfolios, he says.

“Those ‘green shoots’ -- I don’t see them to the extent that people are talking about them,” Kellner said. Many corporate managers still are describing business conditions as “the worst [they’ve] ever seen it,” he said.

Wall Street’s mood has darkened in recent weeks on renewed fears about the economy. The S&P; 500 index is off 4.4% since the third quarter began and down 7.1% from its spring peak reached June 12.

Bruce Berkowitz, co-manager of the $8.6-billion-asset Fairholme Fund in Miami, says he agrees with the widely held view that the U.S. economy faces “a long hangover” ahead.

But he also believes that much of that struggle already is reflected in depressed stock prices, he said.

For a long-term investor, “There are better bargains now than any time in the last 10 years,” Berkowitz said.

That sentiment helped drive the market in the second quarter. Among stock mutual fund categories, the biggest winners in the second quarter generally were those that had been slammed the hardest in the prior six months:

* U.S. small-stock funds trounced their big-stock brethren. The average fund that owns small-capitalization “growth” stocks jumped 21.1% in the quarter compared with a 15.5% gain for the average large-cap growth fund, according to Morningstar.

* Funds focusing on financial-services stocks, including banks, rallied 26.5% in the period -- after plunging 47.3% in the prior 12 months.

* Real estate funds, which typically own real estate investment trust shares, rocketed 30.2% in the three months. But concerns about rising commercial real estate vacancies have swelled in recent weeks. An index of 111 REIT stocks has tumbled 16.3% since reaching a five-month high June 4.

* At the top of the performance list for the quarter were foreign stock funds, led by portfolios that focus on emerging-market issues. The average emerging-market fund surged 35.4% in the period as investors reconsidered the damage done in 2008, when the funds lost 55.1% -- far exceeding the average 35.7% drop for U.S. stock funds.

Weakness in the dollar helped boost the performances of many foreign markets, as stronger foreign currencies translated into more dollars.

The heady rebound in foreign stocks rekindled one of the biggest debates on Wall Street: Is it smarter to bet more heavily on foreign markets for the next few years than the U.S. market, if America’s economic hangover is likely to be worse than what many foreign economies will face?

Borge Endresen, co-manager of the AIM Developing Markets fund in Houston, says he doesn’t buy the theory of “decoupling” -- the idea that foreign economies can thrive even if the U.S. is mired in an extended slump.

Still, Endresen says, “There is no doubt that the fundamentals are much better in emerging markets than at home.” In many of the countries, he notes, “There is no banking crisis,” as in the U.S.

His fund, which has outperformed most of its peers over the last five years and was up 39% in the second quarter, focuses on financially healthy companies that generate strong cash flow, Endresen said. In a difficult economy, balance-sheet strength can be a major competitive advantage, he noted.

The fund’s holdings include Parkson, a leading department store chain in Malaysia; Naspers Ltd., a South African media firm that also has the No. 1 instant-messaging service in China; and Oriflame Cosmetics, an Avon-like Swedish firm that does 90% of its business in emerging markets.

Fairholme Fund’s Berkowitz also is a big fan of companies that generate lots of cash flow. His fund produced a 32.7% gain for his shareholders in the second quarter as holdings including healthcare provider WellPoint Inc. and auto loan firm AmeriCredit Corp. resurged.

Berkowitz favors two industries in particular: healthcare, including such names as WellPoint and Pfizer; and defense, including Boeing and Northrop Grumman.

Both industries, he said, are “essential services to the well-being of our country.” And although that scares off some investors who fear government pressure on the industries to cut costs, Berkowitz’s view is that “people have priced these companies as if the government is going to replace them. But there are no alternatives to them.”

Not surprisingly, Berkowitz and other fund managers say their greatest ally now is time -- if investors will stay put through what could be a rough summer.

The FMI funds’ Kellner says he is confident that holdings such as UPS and Rockwell Automation are great stocks to own if an investor can take a two- to three-year view.

Even in a tough economy, he said, well-managed businesses “will find a way to make money.”

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tom.petruno@latimes.com