No one could have predicted the tragic events of Sept. 11 and their subsequent severe repercussions on the world economy. However, the tragedies seem not to have completely changed the course of the economic events so much, but rather, to have rapidly accelerated processes already in place.
The U.S., and other major world economies, were already slowing to near recessionary levels, central banks were cutting interest rates, stocks were dropping to levels not seen in several years, and high quality bonds appeared likely on their way to putting in a 2nd straight double digit return year.
In the post-attack aftermath, these trends have become even more marked. A recession in the U.S. and many other countries became all but guaranteed, interest rates dove to levels not seen in nearly 40 years, stocks dropped another jaw-dropping 15% or so, and almost all domestic bonds except junk bonds continued to rise. So had you positioned your portfolio to weather the altered climate that really began a year or more ago, your portfolio losses would have been much less drastic than otherwise.
Before I present what I think are the implications of all this to one's future portfolio choices, I would like to review where this Newsletter stood one year ago and then at the beginning of this year.
As long-time readers may note, we have previously pointed out this has not been an easy year not only for stock investors but for web-based Newsletters such as this one. Because times have been so hard, even fairly accurate advice, such as our Newsletter has provided, has not generated much interest or enthusiasm on the part of even a tiny fraction of the millions upon millions of investors in the U.S. who invest in mutual funds. Therefore, I need to take every opportunity I can to show you that since our advice has been valuable in the past, that this is the primary reason that you should continue to put your trust in what we say in current and future issues. (Unlike many other sources of advice, we firmly believe in publicly disclosing in subsequent articles whether our previous advice turned out to be useful or not.)
On Oct 1, 2000 (Newsletter #33), here's what we said:
"In many of our newsletters throughout this year [2000], we have presented data to support our view of currently following a somewhat more cautious approach than usual. Although the present downturn has taken some time to clearly manifest itself, it is now becoming apparent that people who have maintained a highly aggressive approach to their investing, regardless of what is going on in the economy, are now probably beginning to feel some pain."
"Not only have we been advising overall caution, but we have particularly emphasized placing at least some of your investments, especially newly invested funds, in one or more of the following categories based on our current reading of the data we carefully monitor: small/mid cap funds, real estate funds, value funds, bond funds, foreign funds, and money market funds."
Now let's look at the one year performance of each of these fund categories from that Oct 1, 2000 date of publication to Sept 28, 2001 and contrast that performance to that of the other major fund categories according to morningstar.com:
Note: All fund returns can also be compared to the average return of -26.5% during the above period on domestic stock funds in general.
small/mid cap funds
small-cap blend -10.4%
mid-cap blend -21.0
vs.
large blend -28.5
Clearly, small and mid-cap funds were vastly better performers than the large-cap funds. (Also see the similar but even more stark results for small/mid-cap value funds vs. large value and growth below.)
real estate funds
Real estate funds +6.9%
Note: One of the few positive stock categories during the period.
value funds
small-cap value +4.0%
mid-cap value -0.6
large value -11.2
vs.
small-cap growth -36.2%
mid-cap growth -46.4
large growth -44.8
Note: Aside from the clear outperformance of the value funds as compared to growth and blend funds, small and mid-cap value was clearly better than large cap value. Small-cap growth was also better than large growth.
bond funds
Long Government +12.7%
Short Government +10.2
Long-Term General +10.8
Short-Term General +10.2
Municipal Bond +9.2
foreign funds
International Stock Funds, Average -30.4
Note: This was our one miscall as the domestic funds did approximately 4 percent better.
money market funds
Vanguard Prime Money Market: +5.2
Our recommendations at the beginning of 2001 (Newsletter #39) were quite similar at which time we also recommended value, real estate, Europe, and bond funds, while specifically recommending an avoidance of funds specializing in technology and Japan.
The subsequent performance of technology funds for the first three quarters of 2001 has been -54.6% while for Japan-oriented funds was -28.2. This compares to the average domestic stock fund's performance of -21.7 during the same period.
Normally, we present a review of our past and present model portfolio at the beginning of each calendar quarter. However, due to the Sept. 11 events, we do not feel it appropriate to present data for a period so skewed by completely unpredictable events. We hope to review our model portfolio's performance for you in the near future. Suffice it to say that unless you were completely in bonds, money markets, or perhaps commodities, your stock funds, like ours, undoubtedly shrank considerably during the quarter. (Note: As of today's writing, many stock funds had regained all but a few percent of their pre-Sept 11 value with the exception mainly being the small cap and aggressive growth funds whose losses are a bit greater.)
As stated above, we feel that the attacks accelerated the downward trends already in place. While most people shudder at the thought of being in a recession and the possibility of more stock losses, the bright side (if there is one in the midst of terrorism, death, and stark changes across the globe) is that the processes of change we see ahead will likely induce a recovery more surely than otherwise would have been the case.
With interest rates having dropped precipitously already and the prospects for even more cuts, the economy soon will be stimulated without a doubt. For those who own high quality bonds, the good rates of return should continue for a while longer.
But beyond the rate cuts, our government has suddenly turned on the spending spigot and is likely to throw in some tax breaks as well. This too will stimulate the economy, perhaps even more than will prove wise fiscally, although during times of crisis, individuals, families, organizations, or governments don't always seem to have the choice whether to spend or not.
As a result, and especially since many stock prices are already at reasonable levels (back to what they were 3 or 4 years ago in some cases), we feel that this should indeed prove to be a good time to add to your stock investments carefully.
Does this mean we have definitely reached a bottom? Neither I nor anyone can say for sure, just as no one can expect to time a bottom so that they will know just when to jump back in. Looking for the bottom really really resembles trying to predict the exact day an unemployed person who hasn't started interviewing will start on a new job - it just cant be done. If you invest gradually, say over the next 3 months, you are just as likely to have a low basis as the person who guesses when the bottom is and puts in all their new investments at that one highly subjective time.
The gains we forsee are not to be achieved in months but more likely in years. Thus, if you invest in the months ahead, we can't say for sure you will be well ahead within 6 months or even a year. However, consistent with our long-term strategy, we do feel that you will be able to look back on any such purchases five years from now as having been an awfully smart move.
And what about bonds that so many investors are finally starting to consider for the first time? As we stated above, we feel that bonds will continue to do well in the short-term. However, the very conditions we describe above that will serve to stimulate the economy and lower interest rates even further, will soon catch up with bond returns.
As rates go lower, the dividends spun out by bond funds will drop to considerably low levels reducing one's total return. Then when interest rates do stop falling and even begin to go up, investors will no longer capture the appreciation in prices that they have seen in the last two years. Therefore, we feel that current bond owners should be beginning to lighten up a little on bonds in the coming months in anticipation.
Tom Madell, PhD
