Copyright 2012 Tom Madell, PhD, Publisher
April, 2012. Updated April 12, 2012


-New Model Portfolios for April 2012
-Past Performance Is Not Predictive, or Is It?

New Model Portfolios for April 2012

Overall Allocations to Stocks, Bonds, and Cash

In our quarterly updating of our Model Portfolios (see below), we are recommending our highest allocation to stocks for Moderate Risk investors going all the way back to April 2002, exactly 10 years ago, when we recommended a 70% allocation. So it follows that, overall, we haven't been as positive about stocks' relative performance vs. bonds and/or cash for an entire decade!

At that time, we were still suffering within the last decade's first bear market, a time when many investors would have shied away from stocks. While it didn't turn out well during the following 6 months of that year, by Oct. 2002 stocks began turning around and investors averaged excellent returns for the following 5 years. By the end of Sept. '07, the average stock fund had returned 16.1% annualized vs. only 5.0% ann. for the average bond fund. We cite this to show that while our overall recommended allocations might easily not pan out well for periods of up to 6 mos. or even a year, and thus are not intended for market timers nor for those looking for sure, secure bets without short-term risks, they are made with the idea of capturing good long-term performance, that is, up to 5 years later, or at times, even longer.

It is also important to realize that our allocation to stocks isn't meant to be used as a proxy for how the stock market as a whole will do, using for example, the S&P 500 Index as a point of reference. Back in early 2002, our Model Stock Portfolio was only 25% invested in the kind of large cap stocks that make up the Index. Rather, we saw excellent opportunities elsewhere such as in small and mid-cap funds (35%), international and emerging market funds (30%), and real estate funds (10%). Those opportunities contributed to our bullish stance at that time. As it turned out, our favored categories were highly on target. By exactly 5 years later (end of Mar. '07), while the S&P had returned 6.3% annualized (vs. 5.4% for a bond index), small and mid-caps were at 10.9 and 10.7 respectively, international and emerging market funds at 14.3 and 24.1 respectively, and real estate at 22.2. As a result, our Model Stock Portfolio returned approximately 12% per year, or double the Index.

Indeed, while much of the 2000 through 2009 period is sometimes referred to as a lost decade for stocks, it really could instead be viewed as a golden half-decade for investors. But obviously, this only occurred after a period of miserable returns, and mainly for investors who allocated carefully into undervalued corners of the market. Could now be another such period? Only time will tell, but we remain nearly as optimistic for the longer term, that is, for the next five years, as we were then.

You should also be careful to note that our high allocation to stocks comes with another "heads up." In setting our overall allocations, we are not just weighting how well we think stocks will do, but also, how well (or poorly) we think bonds (and cash) will do. In other words, stocks, we feel, should do relatively better than bonds or cash over the next half-decade with a high degree of confidence. In spite of this, we are fully aware that some investors, after reviewing historical data, are of the opinion that the risk/reward ratio suggests stocks will continue to underperform their historical averages for up to another full decade. We ourselves have frequently suggested that stocks may average somewhere in the 6 to 8% range per year over perhaps the next few years. But even if stocks only return say 4% per year, something we think is highly unlikely, such lower than usual returns are still reasonably attractive if the alternative is getting even less return in bonds or cash.

The following tables show how we recommend one divides one's assets depending on one's self-assessed view of the type of investor they are. Since not all investors are the same, we break our assessment into three categories. Experience suggests that most investors would fall into the Moderate Risk area. Note that, perhaps for the first time ever, we are recommending a higher allocation to stocks than bonds even for investors who consider themselves conservative.

For Moderate Risk Investors

Asset Current (Last Qtr.)
Stocks 67.5% (62.5%)
Bonds 25 (32.5)
Cash 7.5 (5)

For Aggressive Risk Investors

Asset Current (Last Qtr.)
Stocks 85% (80%)
Bonds 10 (10)
Cash 5 (10)

For Conservative Investors

Asset Current (Last Qtr.)
Stocks 45% (35%)
Bonds 35 (50)
Cash 20 (15)

Allocations to Specific Fund Categories/Funds

While 10 years ago, the majority of our stock portfolio was invested in categories away from the type of large cap stocks found in the S&P 500 Index, our current Model Stock Portfolio, shown below, is tilted in a much different direction. Now we recommend that roughly half the portfolio is tilted toward such stocks. While none of the stock funds shown below along with our recommended percentage allocations appear overvalued, small- and mid-cap stocks appear less attractive in terms of our research model than large-cap stocks. We continue to recommend the real estate and financial sectors for a small portion of your portfolio. Both should continue to do well in what we think will be a continuing-to-recover economy.

Although many US-based investors may not pay attention to this, it is a fact that most international funds will suffer adverse effects if the US dollar continues strengthening as it has lately. For the last 11 months, the dollar has gained approximately 9% vs. a basket of foreign currencies. This may represent a reversal of the phenomena of a significantly weaker dollar over more than a decade that has been one of the reasons most international funds have outperformed over the last 10 years with an international index returning nearly 6% ann. vs a little over 4% for the S&P 500 Index. Of course, a 2% difference in annualized returns over 10 years means a 20% difference in total cumulative returns.

While a strong dollar has been touted by politicians for years as a good thing, and it certainly would be somewhat beneficial to US citizens who travel abroad and want to get the most for their money spent overseas, a stronger dollar usually doesn't benefit US investors. For one thing, a stronger dollar means that US exports become more expensive against their foreign competitors, thus presumably reducing sales for US companies doing business overseas, and likely, profits as well.

But of even more "out of the pocket" significance to fund investors, it means that whatever returns you would have achieved in most international funds over the past year would have been reduced by approximately the amount the dollar has strengthened. On the other hand, some funds, so-called "currency-hedged" ones, are structured as to reduce or eliminate this effect. So, for the two international funds listed below, the hedged fund (TBGVX) has outperformed the more traditionally structured fund (VWIGX) by about 8% over the last year. We think that this strengthening may continue as the US recovery, as mediocre as it may be, still outstrips growth prospects in major developed countries, attracting great foreign flows into the US currency.

Stock Funds

Model Stock Fund Portfolio

Our Fund Recommendations

Fund Category

 Recommended Weighting Now 
(vs Last Qtr.)
 Fidelity Low Priced Stock (FLPSX) 


17.5% (20%)

 Tweedy Brown Global Value  (TBGVX) 
 Vanguard Internat. Growth (VWIGX)
(see text above)


22.5 (20)

 Vanguard 500 Index (VFINX)
 Yacktman (YACKX)

 Large Blend 

17.5 (17.5)

 Vanguard Growth Index (VIGRX) 
Fidelity Contra (FCNTX) 
 Large Growth 
12.5 (15)

 Vanguard Windsor II (VWNFX)

 Large Value 

15 (12.5)

 Vanguard REIT Index (VGSIX) 
 Amer. Cnt. Real Est. (REACX) 

 Real Estate (REITs) 

10 (10)

 Vanguard Financials ETF (VFH)


5 (0)

Note: ETFs (exchange traded funds) of the same category can be substituted for any of the above 3 index funds; eg. Vanguard S&P 500 ETF (VOO) can be substituted for Vanguard 500 Index.

Bond Funds

Our reduced overall allocation to bonds is, once again, because we believe that the US economy is recovering and will continue to do so over the years ahead. This means that interest rates will, at best, remain unappealing, and at worst, will rise. In particular, in the event of the latter, most bond funds will not do particularly well, except perhaps for the high yield ("junk"), multisector, and possibly, corporate categories.

PIMCO Total Return has started to redeem itself from its mediocre performance last year and therefore still merits what we feel should be a significant chunk of your bond portfolio. However, Bill Gross's fund is not really a fund you can rely on for a significant degree of outperformance, but maybe at best, for just about a percent or so. For more than that, one needs to try to identify which areas within the bond market can outperform by a significant degree while still allowing one to remain well-diversified. Currently, we recognize several such areas (and managers), mainly inflation-protected, high yield, and generally, funds with a corporate emphasis. For the latter area, we highly recommended Loomis Sayles Retail (LSBRX) which we feel will continue to do well so long as the stock market holds up - their emphasis on somewhat risky corporate bonds tends to do well in an improving economy. This fund has returned nearly 20% annualized over the last 3 years, close on the heels of the 24% ann. return of the S&P 500; PTTRX, on the other hand, has returned "only" about 9.5% ann. Obviously, though, no one should be complacent enough to expect forward returns anywhere near these levels.

Of course, the path that inflation takes going forward will have a significant impact on bond returns. For the time being, we are prone to believe the Fed's most recent take that inflation will only rise temporarily as a result of high oil prices, but will otherwise tend to stay in a quiescent state. However, maintaining a position in inflation-protected US government bond funds should continue to do better than other positions within the government bond arena. Our recommended such fund has returned nearly 12% over the last year, although frankly, if it can return 6% this year, it will be still be a reasonably good achievement.

Note: If, as we discussed above, the dollar continues its new strengthening trend, international bond funds that hedge their currency exposure will likely do better than unhedged such funds. Therefore, we suggest that if investors choose to hold an international bond fund, they strongly consider the hedged variety. Our recommended fund below, PFRAX, has returned approximately 9% over the last year, while a typical non-hedged fund such as RPIBX has returned only about 3%.

Model Bond Fund Portfolio

Our Fund Recommendations

Fund Category

 Recommended Weighting Now 
(vs Last Qtr.)
 PIMCO Total Return Instit (PTTRX) or 
 Harbor Bond Fund (HABDX)

 Intermediate Term 

32.5% (32.5%)

 PIMCO Real Return (PRRIX) or 
 Harbor Real Return (HARRX)


15 (15)

 Vang. Interm. Tm. Treas. (VFITX)

 Intermed. Govt. 

7.5 (12.5)

 Vang. state specific muni (see Note)  
Vang. Intermed. Term Tax-Ex. (VWITX) 
 Intermed. Term Muni. 
12.5 (15)

 Loomis Sayles Retail (LSBRX)


12.5 (0)

 Vang High Yield (VWEHX) 

 High Yield 

15 (10)

 PIMCO Foreign Bond (USD-Hedged) Adm (PFRAX) 


5 (5)

Note: Select a fund, if available, that has your own state's bonds for double-tax exemption.


Past Performance Is Not Predictive, or Is It?

by Tom Madell

While our current Model Stock Portfolio reflects our particularly favorable attitude toward stocks right now, the fact remains that we have been forecasting strong results for stocks continuously all the way back since Nov. 12, 2009. That is when we sent an Alert to our subscribers stating that, according to our empirically developed signals, all 10 major fund categories should be considered as Buys. And even before that, we had already Alerted our readers to strong Buy signals for two of these categories, one at the end of Jan. 2009 and the other in Oct. '09.

Perhaps there was mainly luck at work that resulted in the subsequent high degree of success of these calls, as many people would undoubtedly argue. After all, realistically, few predictions of stock market returns not involving sheer luck seem to be possible according to widely-held beliefs of many investors and experts alike. So it makes sense to view the success of our signals with a high degree of reservation, at least until more successes, or, not-so-successful outcomes are recorded.

In this regard, we just published an article on the popular investor website, explaining the rationale for our Buy signals, along with those for Sell and Hold. Among the many articles published that day, the article was featured as an Editor's Pick, helping it to have been seen by thousands of readers since then. But one reader commented that perhaps the success of our signals was merely due to "the business cycle recovery that's been lifting all boats." In other words, perhaps the signals merely reflect a single correct call on the end of the recession and the start of better economic data serving to lift all stock prices.

Perhaps. But our initial single Buy signal at the end of Jan., 2009 preceded any improvement in the economy. (In fact, the economic recovery really began weakly and unevenly in mid-2009, according to a report prepared recently for members of Congress.) The signal, for the Small Cap Growth category, being the earliest signal coming with stock prices very deeply depressed, has led to the strongest gains of all the major fund categories. My signals were designed to differentiate between the attractiveness of different categories, and in early 2009, they did just that specifying excellent prospects ahead, but only at that point, for that single category.

I personally followed what the signal suggested at that time, resulting in one of the best investing results I have ever had with funds, that is, well over a 100% return in a little over 3 years (see Table 2, below). And, of course, the article was not just concerned with the prediction of expected upcoming gains; our methodology had also predicted a period of relatively long-term losses. All three types of signals seem to have been proving their worth over a span of more than 3 1/2 years now: Sell signals were perhaps the most accurate of all being followed, as predicted, by highly negative returns.

It would be one thing for me, at a given moment of time, to size up the economic data and make a single correct judgment that things were going from bad for stocks to good. But that is not what generated the signals. They came without looking at the state of the economy at all, that is, from what you might call an "agnostic" approach to the economy which was merely based on a historical look at past returns of stock fund category performance; these categories were either still poorly placed, or now well placed, for future gains. In other words, what subsequently transpired was precisely what would have been predicted by past patterns of fund performance. This would not seem, then, to be merely the result of one lucky guess, but of years of research which had suggested that such patterns were likely.

For those who may have seen the article, or may have seen an earlier version posted on my website, I have updated the article to show not only the success of the Sell and Buy signals, but also the outstanding long-term results from the tool's Hold calls, including data thru the end of March 2012.

Here, then, is the updated article. Click here to jump ahead to the summary tables within the article.


This article explains why and how I created Buy and Sell (and Hold) "signals" to help investors make important action choices within their fund (and/or ETF) portfolios. Since the empirical groundwork for these signals was first completed back in July, 2008, the results in applying these classifications thus far have been so outstanding, it is important for readers to consider what the signals are showing now.

It is a well-established axiom that past performance should not be taken as indicative of future returns. However, while this suggests that strong past fund returns cannot guarantee good future performance, and vice versa, past performance data, when considered on broad investment classes and over the long term, can often provide some of the best data an investor has available to make decisions on the relative strengths and potential weaknesses of different asset classes.

Thus, whenever a broad asset class has performed poorly for a considerably long stretch, say 5 or even 10 years, investment experts have recognized that the investment class is more likely than not to do an about face. This is referred to as regression to the mean. Likewise, an investment class on a "tear," such as large cap US stocks between 1995 and 2000, are more likely than not to fall back to earth, as they did over the following 5 and even 10 year periods.

Having observed this happen so often, and given my background as a former research-oriented psychologist, I decided to construct an empirically-based scale which would try to weigh the likelihood of an asset class performing well or poorly based on the above premise. My assumption of an inverse long-term relation between returns and subsequent performance also assumed that an asset class doing far better than expected over a long period meant that the class had become overvalued. Likewise, poor long-term performance of an asset class tended to suggest it may now be undervalued.

Beyond this, however, we also know that momentum of an asset class seems to play an important role in that assets that are doing well seem to continue doing well. That is, if small-cap stocks for example, have been doing above average for say 6 months or a year, they tend to keep doing well significantly longer. Otherwise, established long-lasting patterns of upward growth would be hard to discern on a graph of a representative fund's net asset value (NAV, or price). But to the contrary, such trends are quite commonplace.

Given the importance of both over- and under-valuation and momentum, my challenge was to attempt to determine how important differing degrees of each of these two factors were to subsequent investment performance. A skeptic might assume that it would be next to impossible to develop a rating scale based on past performance of fund asset categories that could be useful in predicting how the same asset categories would perform in the future. They might say too many unpredictable variables influence stock fund prices, especially such things as interest rates, recessions, political considerations, etc., suggesting that future fund performance cannot be successfully predicted from a past performance composite no matter how one might try.

I looked at fund past performance patterns for a variety of broad stock asset categories going back several decades. I then looked at how the categories subsequently performed. This led me to create a numerical score for all possible combinations of long- and short-term performances, to reflect the sum of valuation and momentum attributes within a single numerical "score."

Based on past performances, ranges for scores were determined depending upon whether they tended to lead to good vs. poor subsequent total returns for the asset class. A "high" score meant that the asset category typically performed well; such scores were defined to be "Buy" signals. "Low" scores mean the category was mostly associated with poor subsequent performance and were presumably a poor choice for investors looking forward, that is, they were "Sells." Scores between the two extremes seemed to suggest from my study of prior returns that the investment class would do moderately well, but not as well as scores the data showed had been associated with Buy signals; these in-between scoring ratings were called "Holds".

While the data were all constructed from an analysis of past performance, and therefore only suggestive, I concluded that the only way to argue that the ratings could truly be considered valid is to apply them to more recent returns and future asset class performances. So, starting in Aug. 2008, I did just that. That is, I assigned scores, and associated Buy, Sell, or Hold designations, to 10 broad categories of stock funds based on their past long- and shorter-term performances and then waited to see if the results for average category performance were commensurate with the 3 designations given. The following three tables show the results.

Table 1: 1 Yr. Performance for 10 Vanguard Index Funds
Representing the Major Fund Categories
Following Sell Signal
(Fund Symbol)
on Aug. 1, 2008/
vs July 31, 2009
Large Growth (VIGRX) 29.69 / 23.89 -20
Large Blend (VLACX) 23.04 / 18.13 -21
Large Value (VIVAX) 21.71 / 16.66 -23
Mid-Cap Growth (VMGIX) 22.25 / 16.24 -27
Mid-Cap Blend (VIMSX) 18.23 / 13.92 -24
Mid-Cap Value (VMVIX) 18.59 / 14.83 -20
Small-Cap Growth (VISGX) 18.64 / 14.68 -21
Small-Cap Blend (NAESX) 30.43 / 24.01 -21
Small-Cap Value (VISVX) 14.51 / 11.44 -21
International (VGTSX) 16.87 / 13.14 -22

Note: Dividends are not included in percent changes.

Table 2: Performance for 10 Vanguard Index Funds
Representing the Major Fund Categories
Following Buy Signals
(Fund Symbol)
on Day of Signal/
vs Mar. 30, 2012
Large Growth (VIGRX) 25.61 / 36.54 +43
Large Blend (VLACX) 19.99 / 26.03 +30
Large Value (VIVAX) 18.35 / 22.51 +23
Mid-Cap Growth (VMGIX) 18.05 / 27.10 +50
Mid-Cap Blend (VIMSX) 15.61 / 22.27 +43
Mid-Cap Value (VMVIX) 16.78 / 22.62 +35
Small-Cap Growth (VISGX) 11.08 / 24.45 +121
Small-Cap Blend (NAESX) 25.92 / 37.68 +45
Small-Cap Value (VISVX) 12.46 / 16.85 +35
International (VGTSX) 14.63 / 14.62 0

Notes: 1. Dividends are not included in percent changes.
2. Small Cap Growth BUY Alert from Jan. 31, 2009.
3. Large Cap Growth BUY Alert from Oct. 8, 2009.
4. All other categories BUY Alert from Nov. 12, 2009.
5. Another BUY Alert for all categories issued on July 18, 2011.
    (S&P 500 up over 11% annualized since thru 3-30.)
6. All above categories are now Hold.

The following table, first published in our Dec. '09 newsletter, shows how our Hold signals generated "automatically" nearly 4 1/2 months before the end of the bear market in Mar. '09, performed.

Table 3: Category Performance (Total Returns)
Representing the Major Fund Categories
Following Hold Signals on Oct 31, 2008
Category 1 Yr Return
Large Blend +10.9%
Large Growth +14.7
Large Value +8.6
Mid-Cap Blend +17.5
Mid-Cap Growth +16.7
Mid-Cap Value +18.9
Small-Cap Blend +11.9
Small-Cap Growth +13.3
Small-Cap Value +12.6
International +26.2

Note: The results shown in this table are for category average performance,
not for specific funds as in Tables 1 & 2

Thus, while our signals continued to predominantly show Sell until the end of Oct. 2008, at that point within the deep bear market, all previous Sell signals changed to Hold.

As can be seen, the table shows that when signals switched from Sell to Hold, prospects for the category increased greatly, although it took some time to materialize.

The tables results are dramatic and speak for themselves: Sell signals were followed by drastic declines in average asset class prices over the following year. Then, when signals turned highly positive, in 9 out of 10 index funds serving as proxies for an entire fund category, longer-term returns were quite positive to varying degrees over the following 28 to 37 months, or roughly, two to three years.

In conclusion, although three and a half years is not a long time as far as investment returns go, the results presented here, based on two decades of prior studies of returns, are highly suggestive that my effort to design a tool to help investors determine whether an investment category might be considered Buy, Sell, or Hold, has been highly successful thus far in an up and down market environment. The results suggest that the signals should be considered for current and future use by investors in making important relatively long-term investment decisions, or even deciding where to rebalance within stock fund asset categories.

While current signals for all categories are no longer Buys, but rather Holds, my prior several decades of data show that returns associated with past Hold ratings are also quite positive, possibly reaching within the range of about 11 to 13% per year over the next several years. Past and current signals are discussed further within my website and updated ratings are reported whenever they change, which tends to be perhaps only once or twice a year.


Note: We have issued an update on how our prior Model Portfolios have performed which is accessible from our home page.


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Note: There will be no article this month by Steve Shefler.