Mutual Funds Research Newsletter
http://funds-newsletter.com
Copyright 2010 Tom Madell, PhD, Publisher
Feb 2010

Contents:

-New Research Shows 2000-2009 Stock Losses Could Have Been Avoided

-Fed Inaction Will Have “Massive” Repercussions for the Economy: True or False?
  by Steve Shefler   (on separate page - to view, click here)

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New Research Shows 2000-2009 Stock Losses Could Have Been Avoided

By Tom Madell, PhD

The last 10 years have been dubbed the "lost decade" for stock investors as trillions of their dollars vanished. But, in newly conducted research, it has now been shown that any investor who used a rather simple approach to stock market investing would not have been part of the carnage. To the contrary, by using a buy and sell strategy based on a series of fixed steps, one could have actually grown their overall investment by over 40% over the decade vs. about a 10% loss incurred by the major stock index.

The study's findings are surprising enough to perhaps appear too good to be true. Granted last decade's results may not turn out to be similar to those during any future decade. And even a straightforward approach to stock investing may not always be easy to implement, especially when it involves having to make purchases after serious stock market losses. But the research data for 2000-2009 do not lie - a systematic approach to when to sell and when to buy an S&P 500 index fund can give ordinary investors a big advantage in succesfully buying low and selling high.

In our Jan. newsletter we suggested that even though we are quite positive on the stock market's prospects looking several years out, we think it may be wise at this point only to buy when there is some sort of moderate dip.

The S&P 500 Index began the year going higher, near its highest point since Sept '08. But in order to do well as an investor, it is best to follow the often touted, but ever so hard to implement, mantra of "buy low/sell high." What follows will illustrate why focusing most of your actions on market pullbacks as well as big surges may turn out to be crucial over the next 10 years, just as it was during the previous decade.

As 2000 began, stocks were also in a bull market just as they are now, although it was a much better founded one which dwarfed the present one both in terms of longevity and the magnitude of gains realized. It should not have taken a genius to realize that, overall, stocks were high-priced as we entered 2000. Over the prior five years (1995-1999), the S&P 500 was up an astonishing 28.6% per yr., and over the decade (1990-1999) 18.2% per yr. So fear levels were low and it might have seemed crazy to sell anything. But the real stumbling block was that no one could predict where the top would be, with some people perhaps forgetting (or at least willing to chance) that one was certainly overdue. In fact, the S&P did reach a peak in March 2000.

By the time the decade ended, 2000-2009 turned out to be what some have called "lost decade". The total return for the S&P 500 Index, excluding dividends was -24.1%; including dividends, it was -9.5% (neither figure annualized). Of course, this return was for "buy and hold" investors who would have kept an unchanged position from start to finish. But unfortunately, even investors who purchased or sold stock funds at whatever time they deemed suitable did no better, and likely, considerably worse. For example, Morningstar "investor returns" in the Vanguard 500 Index Fund which closely parallels the S&P 500 lost 9.9%; investor returns in the great majority of stock funds were worse than buy and hold returns.

Our newsletter has long advised investors that to do better than the Index's average, they need to try to put aside their fears and buy when prices are relatively low; likewise, they also should buck the crowd by lightening up when prices are rising, knowingly risking missing out on even more gains. OK, you might say, but can we be more specific? Let's set some concrete guidelines that could be used for this purpose.

--In a rising stock market, buy a fund only after a 10% drop from a high.
--Thereafter, keep buying upon any further 10% drops from the high.

--Sell some of your position after a 25% rise from a low.
--Thereafter, sell after any additional 25% rise from the low.

Of course, other similar guidelines could be selected using different cut-offs; the ones above should lead to a minimal amount of trades and are similar to ones we have at times recommended to subscribers as well use ourselves.

Sound simple? Yes, except, that is, for human nature. When you own a position in stocks, and you risk repeatedly losing 10% of that position, sometimes within a short period, it is difficult to have enough confidence (and perhaps, enough other assets) to not only hold on, but to go ahead and add more. And as stated above, it is also almost as difficult to sell an asset in the midst of what appears to be a great opportunity for further gains.

How Would You Have Done vs the S&P 500 Index During the Last Decade?

If you had followed the above strategy, you would have done considerably better than the figures reported above during the "lost decade," as you will be able to clearly see below.

Note: Although we obviously don't know what the markets have in store for us during the just begun 2010-2019 decade, if stocks are as prone to both sharp downturns and upturns as during the last decade, such a strategy will likely win out again. (Is there anyone out there who still believes any market will mainly just go straight up without corrections? This would seem to be the main scenario under which restricted purchases and "automatic" selling upon big gains would fail to be a winning approach. Of course, poor results could also occur if the market significantly trended downward over the entire decade, compounding your losses each time you bought on weakened performance. However, it would certainly seem much more likely that stocks act like they do in most decades, that is, with at least a moderate degree of up and down volatility.)

Data Showing the Advantage of Buying on Pre-Defined Drops and Selling on Surges

As the 2000 decade began, assume that you were on hold with whatever stock position you might already have had, including a zero position. Your next move would have depended upon whether the Index met our above guidelines measured from the start of the year.

The Index started 2000 at 1,469 and initially rose 5.7%. From the high of 1,553 on Mar. 24, 2000, your first buy would have been after a drop of at least 155 points to 1398 or less. Since one cannot directly buy the Index, assume you bought the Vanguard Index 500 Fund instead.

The amounts of your purchases might vary, but let's assume every one of your purchases or sales were for a flat $3,000. The following tables showing how your position would have changed as you continued to buy on weakness and sell on strength throughout the decade, as well as how much of your money was invested in the fund after a purchase or sale.

Table 1. Initial Stock Fund Purchases During First Severely Declining Market
(2000-2002)
Date S&P Index
at
Percent Drop Sur-
passed from High
Share Price of
Vanguard 500 Idx
Cumulative Cost
of Investment
04/14/2000 1357    -10% 125.07 $3,000
02/28/2001 1240 -20 114.65 6,000
09/7/2001 1086 -30 100.47 9,000
07/10/2002 920 -40 84.98 12,000
10/09/2002 777 -50 71.75 15,000

Note 1: The Vanguard 500 Idx share price at the start of the decade was $135.33
Note 2: None of the tables show div. and cap. gain reinvestments within the Fund.

Table 2. Initial Stock Fund Sales During Bull Market (2003-2006)
Date S&P Index
at
Percent Gain Sur-
passed from High
Share Price of
Vanguard 500 Idx
Cumulative Cost
of Investment
05/30/2003 964    +25% 89.19 $12,000
01/26/2004 1155 +50 106.74 9,000
10/04/2006 1350 +75 124.40 6,000

Table 3. Subsequent Stock Fund Purchases During Another
Severely Declining Market (2007-2008)
Date S&P Index
at
Percent Drop Sur-
passed from High
Share Price of
Vanguard 500 Idx
Cumulative Cost
of Investment
11/21/2007 1417    -10% 130.84 $9,000
07/07/2008 1252 -20 115.32 12,000
10/03/2008 1099 -30 101.23 15,000
10/09/2008 910 -40 83.84 18,000
11/20/2008 752 -50 69.57 21,000

Table 4. Subsequent Stock Fund Sales During New Bull Market (2009)
Date S&P Index
at
Percent Gain Sur-
passed from High
Share Price of
Vanguard 500 Idx
Cumulative Cost
of Investment
04/02/2009 834    +25% 76.82 $18,000
08/03/2009 1003 +50 92.54 15,000

If you merely bought the Index fund on the last day of 1999 (or carried a prior position into 2000) and waited 10 years for "stocks to do their thing," that investment would have lost 10.3% (not annualized, including distributions). If, instead, you had used a simple buy only on weakness, sell only on strength strategy, your investment would have gained 22.2%. Thus, your return would have been 32.2% greater than buy and hold.

Yet this big improved result alone doesn't capture the full extent of what you could have gained using the above strategy. In the above example, by using the buy and hold strategy, you would have had your entire stock investment locked up for the full 10 years. Let's assume that by the end of the decade, you would have invested the same total amount, $15,000, regardless of which strategy you used. So, $15,000 was your net cost.

With our strategy, much of the time you had less than $15,000 of your money invested in the fund, specifically, for most of the first 9 yrs. of the decade! For less than about 1 yr. (late 2008 and about 7 mos. of 2009) you would have invested somewhat more. In fact, you would have had an average of about only $9,500 invested in the fund over the entire decade. This means you could have been investing the remaining $5,500 instead in something like bonds (or cash) and making better returns than stocks during 2000-2009.

Whatever money was not invested in the Index, you could have had in one or both of the variants of of my two most highly recommended bond funds, PIMCO Total Return (e.g. PTTRX) or Vanguard Total Bond Market Index (e.g. VBMFX). The 10 yr. annualized return for each, respectively, was 7.7% and 6.1%. (If you had invested in a good money market fund instead, such as Vanguard Prime (VMMXX), the return would have been 3.0%.) Assuming that the 5,500 was earning around 5% yearly, or 50% cumulative over the 10 yrs., in addition to your Index fund holding's 22.2% annualized return, your combined 10 yr. return would be lifted to an annualized 4.1 % vs the ann. -1% return for the buy and hold approach. That represents a 5.1% better annualized return, or more specifically, you would have wound up with more than $7,500 for each $15,000 invested buy and hold. That represents a 51% advantage!

While investors might have hoped for annualized returns closer to perhaps 9 or 10%, such "typical" returns for US stock funds would have been nearly impossible for most during "the lost decade." Doing 5.1% better on one's investments typically set aside for stocks would have made the last decade far less painful than implied by the term "lost decade."

Of course, the S&P 500 Index (large cap US stocks) was not the only choice you had when investing in stock funds during the last decade. By choosing some other types of funds for a good portion of the last decade, such as small/mid-caps, international stocks, value funds, real estate, and energy funds, to name some other possibilities, you could have likely achieved an even better return on the stock portion of your portfolio.

Note: Are these 10 yr. performance results for stocks vs. bonds why mutual fund investors are currently pouring so much more money into bond than stock funds; we think so. But the poor 10 yr returns for stocks are more suggestive of considerably better performance in the next decade, based on stock market history.

If one applies the same strategy described above at the start of the 2010 decade, it suggests that if the S&P 500 continues up without a 10% correction, you should sell some of your position if the Index reaches at 1168. (That would be up 75% up from the March '09 low.)

But if there is a 10% correction from a high (most recent high was 1150 on Jan 19, so a 10% correction would be 115 points lower at 1035), that is when you should strongly consider adding to your stock position.
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