Five months ago, in May 2002, we began to express
more and more doubts about the prospects for stock funds in each of our subsequent
Newsletters (starting with
Newsletter #63 ). This followed a period of approximately 6 months
during which we were correctly favorable on the stock market's course following last
year's terrorist attacks. (See, for example, our comments in Newsletter 55 on Oct 4, 2001.)
Click here for
more information on how we gradually tried to warn of trouble ahead during the last 5 months.
So, given our increased warnings that stocks were not likely to continue the kind of upward progress we had previously seen any time soon, why then did we suggest in Newsletter 63, and continuing until now, sticking with a 60% allocation to stocks?
There were several reasons:
-Throughout the last few years, there continued to to be categories of stock funds that were doing exceptionally well in spite of the overall bear market. These categories included small cap value and real estate funds in particular, and included other categories of stock funds during the first year or so of the bear market as well. As long as we felt that we could skirt somewhat around the bear market and that there remained "pockets of opportunity", we felt encouraged that a diversified portfolio of stock funds would still do better than the paltry returns available in cash. Bonds, while having previously done well, seemed to offer few prospects for further gains since interest rates were at 40 year lows; once rates reverse, which seemed increasingly likely, bonds will begin to underperform.
-We see ourselves as primarily optimistic long-term investors, looking ahead many years rather than worrying much about short-term results. As such, we would almost never advocate reducing our stock investments precipitously, no matter how low prices went. And, markets often perversely begin to reverse themselves just when large numbers of investors have become so pessimistic that almost no one feels good about their prospects, a condition that seems to exist already.
-Finally, since we have been doing so relatively well against the S&P 500, our overall benchmark, we really have not been all that concerned up to now with the small losses our portfolios were showing. We, like most other long-term investors, have assumed that to achieve a desired long-term result, one must be willing to hold fast in both good and bad markets.
However, since we know that not everybody agrees equally about the wisdom of remaining invested even during a serious bear market, we have decided to make some changes. Our model portfolio allocations should better reflect the kinds of changing, shorter term economic observations that our Newsletter has provided.
Another factor leading to making a change: Up until recently, we felt that in spite of numerous difficulties, the prospects for the economy both domestically and globally were for decent improvement over the next 6 months or so. We can no longer say confidently that we subscribe to this view. There appear to be just too many negatives facing the economy right now: a lethargic job market, relatively low consumer confidence combined with high levels of consumer debt, little improvement in business spending, and now the possibility of war with Iraq that may lead to harsh short-term impacts on both the stock and oil markets.
Naturally, it would be foolhardy to think that our predictions, nor anyone else's, are sure to go in the anticipated direction. But, in light of the fact that we believe our overall observations on the markets and the economy have generally been accurate, we think the time is right to adjust our recommended allocations to more closely reflect what we anticipate over the next six months or year or even more. Therefore, as of Sept. 16, the following is our new suggested allocation for our Model Portfolio. As a long-term investor, following this balanced allocation should help prevent one from further large losses in stocks while providing a good opportunity for gains if stocks rebound.
Class | Previous | New |
|---|---|---|
Stocks | 60% | 50% |
Bonds | 32.5 | 50 |
Cash | 7.5 | 0 |
Our current appraisal of the markets suggests that virtually no category of stock fund shows the kind of technicals that make for a compelling buy. Specifically, not a single category of mainstream fund shows a positive price trend over the last 3 months. On a year-to-date basis, the same is still true, with the exception of REIT (real estate) funds, a category of stock funds we have been recommending since Newsletter #15 (Dec 31, 1999). (Since that date, our recommended REIT fund, Vanguard REIT, has increased in value by 51.7%, or 16.7 annualized!)
On the contrary, some of the best gains during the last several years have generally come in the very types of bond funds we have been recommending. For those who haven't noticed, most categories of high quality bond funds have thoroughly trashed the average stock fund by huge amounts over the last several years, (+20 to +25% per year advantage fairly typical) and even are ahead of stocks cumulatively over the last 5 years!
Although our contrarian bent suggests otherwise, bond funds continue to look attractive. However, that same contrarian perspective still suggests that you focus on some of the overlooked bond categories such as international bonds and inflation protected bonds. US Treasury bond funds may continue to thrive as long as the geopolitical and economic climate looks as uncertain as it currently does. However, less than investment grade corporate bonds (ie high yield bonds) could resume subpar performance if the economy does not show signs of perking up soon.
We have reduced our cash position to zero because we feel that returns in the order of 1% are simply unnecessary so long as you can earn several times that amount in a short-term bond fund such as, for example, the Vanguard Short Term Treasury Fund.
In our next newsletter, we will present our latest choices for the best funds and fund categories and the percentages which we recommend you allocate them within a successful portfolio. Look for it near the beginning of October (or e-mail me to be notified when it is available.) And we will keep you appraised if we feel that even less than a 50% allocation to stocks appears called for.
We have recently partnered with three other websites where we present our opinions on a weekly basis, rather than approximately once a month (but in more depth) on our own funds-newsletter.com site. My articles on these shorter-term oriented sites can usually found by looking under "Mutual Funds":
www.trading-ideas.com (Note: Now defunct)
Tom Madell, PhD