Advice for the Second Quarter 2004

Tom Madell, PhD
Publisher, Mutual Fund Research Newsletter
Apr 1, 2004
© 2004 Tom Madell, Ph.D.

Our Advice and Performance Continues to Go Against the Majority

The bond market has continued to fool the majority of fund investors who continually refuse to believe that good returns can be had outside of stock funds. In fact, over the last 5 years, even pre-dating the 3 year bear market (approximately the same 5 years we have been writing these Newsletters and frequently telling of the merits of bond funds), the returns achieved by many bond funds have continued to do better than those for the average stock fund. (The latest 5 yr. average annual return for the Vanguard 500 Index is -1.3% as of 3-31-04; for the Vanguard Total Bond Market Index, it's +6.8%)

Even during the just completed 1st Qtr, a time when our economy is said to be expanding and most investors have been expecting poor bond returns, these funds again outperformed many stock funds. In the tables below, each bond fund that we recommended that beat the Vanguard 500 Index fund for the qtr. is shown in bold type.

Just as any relatively unknown writer such as me will probably confirm, we are used to having our thoughts ignored; perhaps even more so because my advice is oft-times "against the majority". After all, it is common "wisdom" that stocks will always be a better investment than bonds. And aside from a relatively few non-mainstream publications, very few editors/publishers who have come across our articles have had enough confidence in the value of our advice to ever even mention our site to their readers. But since most such business publications only tend to respond to those who aggressively market their columns, something we choose not to do, most investors will continue to see mainly the mainstream advice offered by the typical media articles.

Getting back to bond funds, though, we are beginning to feel that the long bull market for some of these fund categories may be getting quite close to ending for all of the reasons you have already heard about: low current yields, the likelihood of eventual higher interest rates, and a return to more normal levels of inflation.

Does this mean that we think stock funds now represent a clearly better alternative for the overwhelming majority of your investment portfolio? Not necessarily. While we are quite positive about the prospects for 1 or 2 stock fund categories, we think that the very problems stated above for bonds will eventually harm the prospects for stocks as well. But perhaps the biggest problem for many categories of stock funds is that the very same categories that many investors are climbing on board today, or are continuing to hold with increased confidence, have already seen unsustainable gains in the last few years (during which time, incidentally, we were among the few recommending these categories early on.) These categories include small cap, real estate, and perhaps to a lesser extent, Asia minus Japan.

The single category of stock fund we feel has the best potential for the next few years is Japanese stocks, as are included in the Vanguard Pacific fund. However, since we don't think that the majority of people will choose to own such a high risk fund, we continue to recommend foreign funds that have a goodly amount of Japanese stocks included.

Our next most positive category looking forward is Large Cap stocks, especially Large Growth.

Our First Qtr '04 Model Performance

The tables below shows our preferred Model Portfolio (moderate risk) performance during the first Qtr as well as the performance of our secondary portfolios. (Please see our issue from the end of 2003 for our complete 1st qtr. 2004 recommendations.)

The benchmark for comparison of our returns is the Vanguard 500 Index which returned 1.7%.

Our stock funds when weighted as we recommended returned 3.8%, more than double the benchmark.

Our bond funds when weighted as we recommended returned 3.1%, 1.4% above the benchmark.

Our combined stock, bond, and cash portfolio returned 3.4%, exactly double the benchmark.

Our aggressive and conservative stock portfolios did as you might expect: better and worse performance than the moderate risk stock funds, respectively.

Stocks

Bonds

Category	Our Favorite	Return	Allocation
High Yield	Vanguard High Yield	2.0%	30%
International Bond	American Century International Bond	1.4	20
Short Term	PIMCO Total Return Instit.	2.7	10
Inflation Protected	Vanguard Inflation Protected Securities	5.0	20
Long Term Corporate	Vanguard Long Term Corporate	4.9	20

Note: Bond funds outperforming most stock funds for the qtr. shown in bold.

Aggressive portfolio results:

Stocks

Bonds

Category	Our Favorite	Return	Allocation
High Yield	Janus High Yield	1.6%	40%
International Bond	American Century International Bond	1.4	25
Emerging Markets	T Rowe Price Emerging Market Bond	3.6	5
Inflation Protected	Vanguard Inflation Protected Securities	5.0	20
Multisector	Janus Flexible Income	2.7	10

Conservative portfolio results:

Stocks

Bonds

Category	Our Favorite	Return	Allocation
High Yield	Columbia High Yield	2.3%	20%
International Bond	T Rowe Price International Bond	1.4	15
Interm Term	Dodge & Cox Income	1.9	15
Inflation Protected	Vanguard Inflation Protected Securities	5.0	20
Long Term Corporate	Vanguard Long Term Corporate	4.9	30

Our New Recommendations for the 2nd Qtr.

The following are our recommended allocations for most investors, that is, for those following a moderate risk strategy. These allocations are unchanged from the 1st Qtr.

Class	Percent of Portfolio
Stocks	60%
Bonds	35%
Cash	5%

Here are our recommended moderate risk fund category breakdowns for stock and bond funds, reflecting some small changes from the 1st Qtr.:

Stocks

Bonds

Category	Our Favorite	Current Risk Level (In our view)	Allocation
High Yield	Vanguard High Yield	Medium	30%
International Bond	American Century International Bond	High	15
Short Term	PIMCO Total Return Instit.	Low	20
Inflation Protected	Vanguard Inflation Protected Securities	Medium	20
Long Term Corporate	Vanguard Long Term Corporate	Medium	15

Our aggressive and conservative risk portfolios remain the same except for the following;

Replace the Janus Fund with the Vanguard Growth Index; replace the Janus High Yield Fund with the Vanguard High Yield Fund; replace the Vanguard Equity Income Fund with the T. Rowe Price Equity Income Fund; change the conservative portfolio allocations to 50% bonds (from 55%) and the cash allocation to 10% (from 5%).

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