Insightful Investing Newsletter October 2011
3rd Quarter 2011 Financial Market Review
The best thing we can say about the third quarter of 2011 is that is was not as bad as the fourth quarter of 2008, but that is not much of a comforting thought for investors. As bad as August was for stocks, September was even worse. The anxiety in the markets pushed up volatility to its highest level since the 'flash crash' in May 2010, a level that is bad, but not quite as bad as the financial crisis in 2008.
The quarter got started off on the wrong foot thanks to the battle between the President and Congress over the Federal Debt Ceilings. Then came the downgrading of US government debt by Standard and Poor's. Not to be outdone by domestic issues, sovereign debt worries in Europe only added to investor angst during the quarter. As this distressing quarter came to an end, there was still considerable concern that the efforts of European central banks may not head off a default by Greece, an event that some think could lead to the eventual fall of the Euro.
With all of the doom and gloom in the air, the flight to safety once again led to an incredible performance for Long Term Government bonds, which were up almost 25% in the third quarter of of 2011, an even stronger performance than the fourth quarter of 2008. What a difference a little duration makes, as TIPS were up only 4.5% and Intermediate Government Bonds were up only about 4.0%. If these results don't speak to you about the benefits of having some Bonds in your investment portfolio, you have not been paying attention.
At times like this, we often wonder where to start with the bad news, so this time we start with the worst end of the scale. Emerging Market stocks were down 22.6%, Small Cap stocks were down 22.2%, Mid Cap Stocks were down 18.9%, Value stocks were down 16.6%, REITs were down 14.5%, Growth Stocks were down 13.9%, and Large Cap stocks were also down 13.9% for the third quarter of 2011.
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3rd Quarter 2011 Mutual Fund Performance and ETF News
Even though the third quarter of 2011 was the worst for the stock market since the fourth quarter of 2008, having a reasonable allocation to Bonds and Hedged Mutual Funds helped some investors reduce their losses. Our leading Hedged Mutual Funds were Hussman Strategic Growth (HSGFX) which gained 7.3% and Invesco Balanced-Risk (ABRYX) which added 2.5% this quarter. Most domestic bond funds had respectable results for the quarter, especially those with an emphasis on longer term US Treasury Bonds. Fidelity Inflation-Protected Bond (FINPX) added 4.6%, Wells Fargo Advantage Government Securities (STVSX) picked up 4.0%,and Fidelity Intermediate Government Income (FSTGX) earned 3.1% for the quarter.
As we would expect during a difficult time for the stock market, our High Yield Bond funds were poor performers, although Well Fargo Short Term High Yield (STHBX) hung in their fairly well, thanks to its short duration, by losing only 2.2%. Also hanging in there well were recently added Hedged Mutual Funds hedge funds Highland Long/Short Equity (HEOZX) and Marketfield Fund (MFLDX), both losers of only 4.6% over the last three months.
As was the case in 2008, our best performing Stock Mutual Funds were run by managers that pay more attention to capital preservation than topping the charts during a raging bull market. Once again leading the charge were Forester Value (FVALX) which fell only 4.4%, Intrepid Small Cap (ICMAX) which lost 9.1%, and Yacktman Fund (YACKX), which dropped 9.4%. Interestingly, while domestic Small Cap Funds performed worse than Large Cap Funds, overseas Small Cap Funds held up better. Our best performing International Funds both fall under this category as Westcore International Small Cap (WTIFX) fell 15.1%, and Wasatch Emerging Markets Small Cap (WAEMX) dropped 16.6%.
Treasury Bonds and Gold were the strongest ETF performers this quarter. Our biggest winner was iShares Barclays 7-10 Year Treasury (IEF)which gained 10.1% and iShares Barclays TIPS Bond (TIP), which picked up 4.5%. SPDR Gold Shares (GLD) gained 8.3% this quarter, even after an 11.1% drop in September. Another good performer was iShares Barclays Aggregate Bond (AGG) which earned 3.8%. Thanks to the inverse correlation of Long Treasuries to stocks during a market crisis, we have decided to add iShares Barclays 20+ Year Treas Bond (TLT) to our watch list. A gain of 29.1% by that ETF this quarter would have made investing in that ETF a great way to celebrate the 4th of July this year.
There were a few stock ETFs that outperformed the stock market in general, led by PowerShares Nasdaq 100 (QQQ) which lost only 8.0%, thanks to the relatively strong Technology sector, and SPDR S&P Dividend (SDY) which fell just 9.4% thanks to a strong dividend yield. iShares MSCI Japan Index (EWJ) was the only International ETF with a single digit loss, dropping 9.3%.
Those of you who are inclined to do a little trading, the iPath S&P 500 VIX Short-Term Futures ETN (VXX), an ETF we track only to watch the amount of volatility in the stock market, was up a stellar 152.5% in the third quarter of 2011, but is amazingly still down 22.8% for the last 12 months. Now that’s an ETF that has far too much volatility for a long-term investor!
Portfolio Changes and Asset Allocation for 4th Quarter 2011
Markets reached extreme levels in September, led by Long Term Treasury Bonds, which skyrocketed last quarter in a flight to quality. A move similar to this has not been seen since it happened twice in the 1980’s. The extent of this move is somewhat a surprise given the fact that Treasuries did not move up this much during the Financial Crisis at the end of 2008. On the other side of the scale Large Cap Value Stocks have taken the worst of it for equities. The best thing we can say about the third quarter of 2011 is that is was not as bad as the fourth quarter of 2008, but that is not much of a comforting thought for investors. As bad as August was for stocks, September was even worse. The anxiety in the markets pushed up volatility to its highest level since the ‘flash crash’ in May 2010, a level that is high, but not quite as severe as the financial crisis in 2008.
A couple of points to make when comparing today’s market with the past: Both times in the 1980’s when Long Treasuries were making highs, stocks were also making highs, which is not the case today. One explanation for this difference may be that in the 80’s inflation moved from high to normal, while now inflation has moved from normal to low. The current relationship looks more like 2008, but at this time the move up by bonds is stronger, while the drop in stocks is weaker.
It has been only 6 months since we suggested you rebalance your portfolio to its target allocations. This time, however, we are coming at it from the opposite direction. It is at times like the present, when anxiety levels are high and prices are low, that you should be increasing your allocation to stocks. That being said, we are not suggesting that you increase your equity target, but rather that you take the profits you have made from the bond side of your portfolio and use those dollars to increase your stocks back to their target allocation. Our overweight to Long/Short equity helped our portfolios lose less during the market's recent downturn. Time to reverse course here too, by equally weighting that with Large Cap, Mid Cap, and Small Cap at 8% of your portfolio.
We have no additions to our Mutual Fund list this quarter, but we continue to reduce the number of funds in order to simplify your choices. We are replacing Elements Rogers Intl Commodity Agriculture ETN (RJA), Elements S&P CTI ETN (LSC) and iShares Dow Jones US Basic Materials (IYM) with iShares Barclays 20+ Year Treasury Bond (TLT), Vanguard Total Bond Market ETF (BND) Barclays S&P 500 Dynamic VEQTOR ETN (VQT) in our ETF Watch List.
Mutual Fund Portfolios October 2011
ETF Investment Portfolios October 2011
