Stocks continue to see-saw between bear market and bull market. As I said earlier, expect this to continue for some time as the economy and markets recover from the extremes of the 1990s.
Several investment strategies are necessary to be successful in this environment. Careful buying and selling is one. I’ll keep sell signals in place on most funds in the Sector and Balanced Managed Portfolios. These will ensure that our wealth is preserved should any unpleasant surprises in politics or the economy arise. Sell a fund in the Managed Portfolio any time it falls through my sell price.
Buying investments that have margins of safety is more important than ever. In the rallies since the bear market began in March 2000, the best performers in most market rallies have been the technology and other growth stock leaders of the last bull market. These stocks also have dropped the most when the rallies failed and earnings didn’t match stock gains. Many of these old growth stocks remain over-valued and provide little protection for the investor.
Balance and diversification also are key strategies. Without a sustained bull market in U.S. stocks, investment money will seek other opportunities. As you can see on page 10, while U.S. stocks floundered last month we realized strong gains from international stocks and bonds and from high yield bonds. Other U.S. bonds held their value. Diversification did not pay much in the late 1990s, but it has paid off since and will continue to add value.
Now, let’s take a look at specific moves to make in the different portfolios.
Some of our fund companies were busy as 2002 ended, requiring a few changes in our funds.
Columbia High Yield was acquired by the Liberty group of funds. As a result, CMHYX no longer is a no load fund to new investors. The load is waived for investors who can show a relationship with an existing shareholder on the application. I rarely recommend a fund that imposes a sales load, so Columbia High Yield no longer will be recommended to new investors and will not appear in the recommended portfolios after this issue. If you are an existing CMHYX shareholder, continue to own it as long as high yield bonds are in the recommended portfolio you follow.
Alternatives to Columbia High Yield are Price High Yield, Vanguard High Yield, Fidelity Capital & Income, and Fidelity High Income.
Price High Yield is the best of the group and my top choice. It has not done as well as Columbia High Yield, but has not been far behind. Vanguard High Yield is the most conservative of the group. It tends to participate in high yield rallies, but not as much as other funds in the group. It compensates for this by losing far less when high yield bonds tank. The Fidelity funds are aggressive and volatile. Capital & Income is the more consistent performer. High Income is more aggressive. It did very well in the 1990s but performed poorly the last few years because it was loaded with the bonds of telecommunications companies. I don’t count out the Fidelity funds because of the firm’s research capabilities, but I prefer the consistency of Price and Vanguard. High quality alternatives that do almost as well as Price are Neuberger & Berman High Yield and Janus High Yield.
Cohen & Steers Realty Shares was a real boost to our Managed Portfolios after 1999 as it appreciated while the stock market fell. In the last year it has been flat, still much better than the stock indexes. More recently, the real estate investment trust shares it holds have declined. Investors are concerned that the sluggish economy is resulting in high vacancy rates and lower rents. To some extent lower interest rates offset these developments, but low rates cannot make up all the difference.
As a result, I’m reducing the Managed Portfolio holdings of CSRSX. The recom-mended reduction and new home for the cash depends on the portfolio. Details are on this page and page 10.
Sector and Balanced Portfolios
In these portfolios we see how diversification works.
We’ve benefited from the end of the dollar bull market with international bonds and stocks. American Century International Bond should continue to do well as the dollar stabilizes or declines and the European Central Bank engineers more interest rate cuts. Oakmark International also benefits from the falling dollar and gets a second boost from Oakmark’s famed ability to locate undervalued stocks before the rest of the market does.
Another bright spot is small international stocks. I identified these as the most undervalued sector of the world markets some months ago and recommended American Century International Opportunities (its ticker recently was changed to AIOIX). The fund is not available to all investors. Tocqueville International Value and Driehaus International Discovery are solid substitutes. Each of these funds has done well in recent months and even continued to gain while major market indexes in the U.S. and Europe had their problems.
Hold all these international positions. The trends from which we have profited should continue.
Changes also occurred in TCW Galileo Mortgage-Backed Securities. This fund now is a diversified, short-term bond fund. As a result, I’m dropping it from the Balanced Core Portfolio and replacing it with Dodge & Cox Income. Good substitutes for DODIX are Vanguard Intermediate-Term Corporate and Fremont Bond.
I recommend reducing the Cohen & Steers Realty Shares allocations in these Managed Portfolios from 10% to 5%. I’m impressed by the resilience and growth of the Asian markets and expect these economies to continue growing. My top choice is Price New Asia fund with Matthews Pacific Tiger as an alternative.
Income Growth Portfolio
The investments in this portfolio will become more profitable and popular if the proposed dividend tax exemption becomes law. In the meantime, reduce Cohen & Steers Realty Shares from 25% to 15% of the portfolio. Invest the sale proceeds in American Century International Bond. All other positions in the portfolio should be maintained.
Hold all positions in this portfolio, and no sell signals are needed on the Managed Portfolio funds.