Value and caution pay richer rewards than do growth and excitement. Market action of the last few years contains some great examples of this lesson.
The bear market began in March 2000 and bottomed in October 2002. The market indexes have had a strong run since the bottom, with the Nasdaq returning over 50% and significantly outperforming other market indexes. Yet, investors in “tortoise” investments are far better off than Nasdaq investors. As of Sept. 30, 2003, the Nasdaq still was 60.85% below its bull market peak. The index still needed a gain of 150% to return to the prior peak, according to the Tweedy, Browne, quarterly report.
Meanwhile, the Dow is much closer to its bull market peak. More importantly, most value stock funds have positive returns for this period. American Century Equity Income (a Core Portfolio holding) was up 59.35% for the period. Longleaf Partners gained 67.15%; Dodge & Cox Stock was up 46.50%; and T. Rowe Price Small Cap Stock (another Core Portfolio holding) was up 14.12%. In the same period that bull market superstar Janus Olympus was down 62.50%.
You can see why so many investors fail to achieve their goals. They chase the headlines, buying whatever fund is doing best for the most recent reporting period. Then, they ride that fund down from its peak. You are much better off buying a steady performer whose manager pays attention to the valuation cycle for individual stocks or the market as a whole.
If your goal is to earn steady, solid returns your money is best invested with well-schooled value managers than with an index fund or a top bull market performer.
I can report similar results for one of the public pension funds of which I am a trustee.
During the bull market the fund earned attractive double-digit returns. Because the stock holdings favored value stocks and the portfolio had a diversified, conservative asset allocation, it trailed most public funds. Often the fund’s returns ranked in about the 80th percentile compared with other public pension funds. The posture paid off in the bear market. It consistently ranked in the top 10th percentile for returns. The fund already has made back its modest bear market losses. The fund’s value is at a new high, and it is racking up solid gains in the new bull market. Most other funds continue to struggle to overcome their steep market losses.
The first principles of successful investing are to maintain a margin of safety and avoid large losses. Matching or beating an index and investing for the “long term” are secondary goals at most. Follow the valuation cycle with your portfolio, and invest with money managers who will do the same with their portfolios. Your short-term portfolio returns won’t make headlines or exciting cocktail party chatter, but you will be better off.
Now, let’s take a look at our recommended portfolios. As always, the portfolio allocations, sell signals, and other details are on page 10.
Sector and Balanced Portfolios
We continue to enjoy profits in these portfolios. We’ve had particularly strong gains in TCW Galileo Select Equity and Cohen & Steers Realty Shares in our Managed Portfolios.
The TCW fund stumbled a bit from mid-November through mid-December as the market-leading stocks the fund owns modestly declined. Even with the almost 3% decline in the last four weeks, the fund still is up over 40% since we purchased it in March 2003. Glen Bickerstaff and his team have a history of finding the leading growth stocks and beating the market indexes in bull markets. I’m keeping a sell signal that will trigger an exit from the fund if the Nasdaq has a correction of more than 10%. We won’t want to sell the fund in a modest correction but do want to preserve our profits if a more substantial move occurs.
Cohen & Steers Realty Shares continued to rise in the face of negative forecasts from analysts. For at least six months there has been an almost uniform opinion that real estate investment trusts were over-valued and that the economic recovery would not be strong enough to increase rents or reduce vacancies.
So far, the analysts have been wrong. CSRSX has beaten the major market indexes and even kept pace with TCW Galileo Select Equity. The fund also logged a small gain in the last four weeks while other market leaders were declining.
I recommend keeping the fund in the portfolios. In view of the fund’s large rise in the last few years, especially this year, and the negative outlook from many analysts, I’m keeping a sell signal in place. If the fund falls below the sell price on page 10, sell the Managed Portfolio holdings and put the proceeds in a money market fund.
Hussman Strategic Growth remains the anchor of these portfolios and reflects my own cautious position on the stock market. The fund still is fully invested but has about half the portfolio hedged against a possible market correction. Manager John Hussman continues to believe that the stock markets as a whole are over-valued and due for a correction. But he also notes that the market trends are positive. Despite the conservative posture, the fund has returned over 20% since last March and has just over a 1% gain for the last four weeks.
The laggard in the portfolio remains AXA Rosenberg Global Long/Short Equity. The fund finally sparked some positive returns in September through November. Yet, the first two weeks of December saw the fund give back those gains. The fund still provides us a good hedge against a market correction, and its losses are modest. It follows our policy of balance and diversification. My plan is to keep the fund in place through the next stock correction.
Income Growth and Income Portfolios
The past few months actually have been good ones for income investments. After interest rates rose sharply last summer, investors realized that they had over-reacted. Interest rates declined from their August peaks. Most bond funds are showing nice, positive returns for the last couple of months.
A six-month look back, and a look forward, really shows the benefits of our current allocations. Long-term bond funds still have significant losses from the summer’s interest rate increase. Even intermediate bond funds show modest losses of 1% since the interest rate lows. Our recommended bond funds are registering positive returns because they are less damaged by interest rate increases and have some inflation protection.
Vanguard Inflation-Protected Securities continues to build on the gains it had earlier in the year, returning 4.5% in the last 13 weeks. This fund will continue to rise if commentators keep pounding on the theme that inflation is going to come roaring back. It is the ideal fund for an income investor to hold at this point in the market cycle.
Vanguard Short-Term Corporate Bond provides solid income. Because it invests in corporate bonds, and short-term bonds at that, its value declines much less than that of other bond funds when interest rates rise. The short-term nature of its bonds also provides a better opportunity to invest in higher-yielding bonds as interest rates rise.
Cohen & Steers Realty Shares also is in both of these portfolios because of its high income and also to provide some capital gains growth. As in the other portfolios, we’ll keep a sell signal on this fund to preserve gains in case of a correction.
Dodge & Cox Balanced fund is in the Income Growth Managed Portfolio to provide safe growth along with income. I’m not putting a sell signal on the fund, despite its stock holdings. The value stocks held in the portfolio are conservative and they are balanced by the fund’s bond holdings. It is an excellent complement to the rest of the portfolio.
We were early in expecting the bond bull market to end and were positioned for the change. In the next year or two, don’t reach for yield. Instead, seek safety and inflation protection. Our current positions will provide income and price stability for some time.