After a weak January and mid- dlingFebruary, the stock market hit its stride in March, lifting most mutual fund sectors into positive territory.

Equity mutual funds were up 4.6% overall, and large-cap funds benefited slightly from the rising tide, too, up about 4% for the quarter. Yet the blue chips were not top performers, falling short of the S&P 500's 5.3% return. "Whether investors felt burned or disappointed by the performance of large-caps in 2008, they did not feel that large-caps would provide any leadership in the recovery," says Jeff Tjornehoj, senior research analyst at Lipper. Small-cap funds fared slightly better than large-cap last quarter, up 8%.

BIG WINNERS

The financial services sector was up 11.5%, making it the big winner for the quarter. The category leader for the quarter, the ProFunds Bank Fund, was up an impressive 23%, though Tjornehoj warns that it can be volatile.

Domestic real estate funds were up 9.6% for the quarter and a whopping 105% year-over-year. Typically these funds are used to hedge against rising interest rates, though Tjornehoj doubts interest rate sensitive investors are using real estate as a buffer this year. "Investors think that there is still some life left in U.S. real estate," he says, "and they are trying to find opportunities there."

FALLEN STARS

Last year's stars, international and emerging-market equity funds, lagged in the first quarter this year. Chinese funds dropped -0.21%. Aberdeen China Opportunities was the best-performing China region fund, up just 4%, while the largest emerging-market mutual fund, MSCI Emerging Market, was up only 1%.

Emerging-market bond funds proved themselves with good yields, however, returning 4.6% during the first quarter. The GMO Emerging Country Debt fund led that category, churning out an 8.8% return.

HUNKERING DOWN

Retail investors retreated from the domestic equity market, dumping nearly $100 billion last quarter and buying taxable bond funds instead. "This is huge," says Vince Deluard, global equities strategist for TrimTabs, because net inflows to bond funds for the first quarter equaled what the group normally gets in a year. In fact, several market observers have mentioned the possibility of a bond bubble.

The quarter's modest returns-both in equity and fixed-income funds-put investors' confidence in the recovery in check. "The depths of the downturn are still fresh on investors' minds," says Sonja Morris, editorial director at Morningstar. "It has caused some investors to reassess their capacities for risk."

The PIMCO Total Return fund benefited from many investors' flight to relative safety. It took in $12.3 billion during the first quarter, Morris says. With $219 billion in total assets at press time, it was the world's largest mutual fund. The fixed-income fund was up 2.9% from January to March, and 15.9% year-over-year.

Despite the market's strong first quarter, analysts say the long-term picture warrants caution. The broader markets view unemployment statistics as the true barometer of a sustainable recovery. With that number stuck at 9.7%, the stock market may be getting ahead of itself, Tjornehoj says.

Equities could very well have a sobering second half of 2010, Tjornehoj predicts, and take a haircut of some 10% to 15% on their current valuations.