Mike Lipper’s Monday Morning Musings
Contrarian Stock and Bond Fund Choices
Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –
WHY DON’T WE FEEL BETTER?
During the week the three major stock indices reached peak levels and finished less than 1% from their top closing prices. However, last week’s Dow Jones list of weekly price changes indicated that most prices declined for the first time in my memory, with 68% of the prices falling. During past peak periods stock prices generated enthusiasm, something not prevalent today.
General attitudes toward the market are often better expressed by the performance of selected mutual fund portfolios than the precepts of some publishers. The average performance of the 7,539 mutual funds in the Lipper US Diversified Equity Funds universe reflects real expenses, flows, and cash reserves. Through last Thursday’s close the average year-to-date gain was +23.05%, almost three times the normal +8.36% average annual long-term growth of capital for the past five years.
One would have to believe that we have entered a magical era where past experiences are not relevant for this to continue. Even the most optimistic long-term pundits are not suggesting that future sales, earnings and dividends can command stock prices to rise and produce future gains of 20%. Any significant increase from the low to mid-single digit numbers currently being produced creates an unusual level of price risk.
I am sensing a bifurcation of market prices as popular stock indices benefit from the rising prices of an increasingly smaller number of stocks, with few stocks gaining 20% or more. Many stocks are only generating gains that match their single digit earnings, assuming they are growing at all, despite a remarkably strong economy.
I am concerned that analysts are jumping to favorable conclusions without thinking about how our economic system works. This week a long discussed potential merger between Charles Schwab and TD Ameritrade was announced. Charles Schwab is a holding in our private Financial Services Fund and TD Ameritrade is the second largest discount broker after Schwab.
Pundits calculated what Schwab’s’ earnings would be if the merged companies saved only half of the acquired firm’s expenses (called a “one and done” deal), but it does not take into consideration the competitive and market reaction to a potential deal. Furthermore, you might see lower pricing in the profitable arena of wealth management services, particularly through investment advisors. Lower net fees have contributed to the profit squeeze in the investment business.
WHAT TO DO?
Financial history is replete with tales of supposedly bright people fleeing a falling market and failing to come back in to benefit from a subsequent rising market. To prevent falling into this apparent safety trap, I among others have developed a practice of always keeping some money in so-called risky assets.
There are two primary ways to maintain exposure to a risk portfolio.
- Shed most, if not all, low growth stocks/funds in favor of reserve building. Some with enough market experience can do this well, but not many, as committing cash in a down or even a flat market takes internal fortitude. Cash becomes too comfortable, making it is easy to postpone re-entry while you wait for some event, which may or may not happen.
- A second approach also divides the portfolio into two sub-portfolios. The first sub-portfolio contains securities of extreme faith, or stocks that might crater by 50% or more in reaction to unfavorable news. To make it worthwhile being a long-term holder of such former wonders requires raiding reserves or selling other assets. The second sub-portfolio contains underperforming assets expected to perform better with a change in conditions, which is not unreasonable to believe.
The following is a list of country or regional fund investment categories with average returns below the Lipper US Diversified Equity Funds average, in spite of unfavorable currency comparisons:
China +19.58%
European Region +18.65%
Japan +18.31%
Pacific Region +14.65%
Emerging Markets +13.45%
Latin America +13.25%
For those investing in legacy long-term oriented accounts may wish to consider Frontier Markets +8.63% or India Region +2.27%
WHAT SHOULD CONTRARIANS DO ABOUT BONDS?
If you own individual high-quality bonds with a maturity date that fits a detailed financial plan you are exposed to the risk of market forces. Contrarians are always worried when they see excess flows into any asset. Bonds have become too attractive for many investors, particularly those advised by former brokers, now classified as investment advisors.
I am told that interest rates around the world are at levels last seen 500 years ago. Many bonds and bond funds have risen to levels where they have market price risk at the valuations they are currently selling. The table below shows the average total return for various bond fund categories, year-to-date through last Thursday:
Corporate Bond-BBB +12.53%
Flexible Income +12.22%
Corporate Bond-A +11.13%
High Yield +10.88%
Emerging Market Hard Currency +10.38%
Global High Yield +10.34%
Question: Do you have a contingency plan for a slump?
Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/11/mike-lippers-monday-morning-musings-all.html
https://mikelipper.blogspot.com/2019/11/where-are-we-and-so-weekly-blog-602.html
https://mikelipper.blogspot.com/2019/11/top-down-dictums-measured-digitally-are.html
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A. Michael Lipper, CFA
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