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Investment Lessons From The Recent Past

Summary: Most investors have learned to make certain assumptions. In this article, I will present a chronology of events over the last few years which seem to demonstrate that it often pays to question such assumptions by looking at things from a different perspective. A few of the things to be learned from the events of the last several years are:

  • the consensus, as expressed by the current overall direction of the stock and bond markets and within the media, is quite often wrong.

  • one should not generalize very much at all from monthly economic data releases that can, at best, only reflect short-term trends; while such data may be important to traders, being swayed by it is likely to be counter-productive for long-term investors. Conversely, by gathering enough data to form a long-term picture, you have a considerably better chance of doing well.

  • do not assume that by just investing in "plain vanilla" or "conventional" stock funds, or with a portfolio consisting of 100% stocks, you will necessarily come out OK. Conversely, investing some of your portfolio in bonds, cash, as well as some specialized stock positions, is a far safer way for most investors to help achieve a reasonable degree of success.

  • in order to help ensure doing well in your investing, you should have at least enough time to occasionally monitor your investments, and the willingness to change course when sufficient data justify making such moves; otherwise, given the risks of investing, you may want to keep your money only in risk-free investments such as CDs.

  • finally, do not assume that there is little anyone can do to improve their results, nor that it will always turn out OK to put your investments "on hold" indefinitely; if you do not think you yourself can navigate the above channels, look for a source of help that has a good long-term track record, regardless of how "non-mainstream" that source might appear.

Year after year, going all the way back to 1999 when I started my free Mutual Fund Research Newsletter, I have attempted to give readers convincing arguments as to why they should "think outside the box." However, trying to change the way people think about investing has never been an easy task.

One of the best ways to illustrate thinking differently is to review a small sample of what has transpired over the last few years as presented in my prior Newsletters. This enables us to see directly how looking at things differently from consensus opinions would have assisted readers through what proved to be a series of "unforeseen" events. Some of these happenings were not nearly so unforeseen to those who, rather than accepting what most people believed, viewed events using "a different set of eyes".

Looking Back Chronologically

As recently as July 8, 2008, we were still officially in a long-running bull market. It was only until the S&P 500 Index finally reached a 20% drop the following day that we knew for sure of its end. Unfortunately, for many people whose thinking might have closely paralleled the consensus, the transformation from bull to bear, and subsequently, from good times to deep recession, seemed to catch them seriously off guard. As a result, their investments suffered far more than they would have had these investors been more able to part ways with the consensus, and by so doing, more accurately see what were detectable warning signs.

In fact, my Newsletters had already fully made the case for danger during the period beginning as early as July 2006. In order to have done that, it was important to have been able to free ourselves from some of the firmly held, but essentially wrong, views that are frequently held by investors. In what follows, we will use quotes from selected issues of this Newsletter to illustrate some of the events that transpired, what the consensus view was, and then update what subsequently unfolded. We will also add other updates for helping investors decide where we think things will likely go from here.

Note: Almost all forecasts we make in our Newsletters (unless we specifically state differently) refer to our opinion as to what might happen over the following several years. Given that some time has passed since we wrote the direct quotes shown below, each preceded by ***, the quotes allow you judge for yourself as to the usefulness of what we consider our "outside the mainstream" approach. You can click on the dates to review the entirety of each specific Newsletter.

July 2006

  • *** "Clearly, during the last yr. and a half, US domestic stocks have been disappointing. ... Does recent stock weakness...mean you should continue to be cautious about US stocks? My sense is yes. And should you continue to load up on cash? Yes ..."

  • (Note: Our July '06 recommended allocations to non-stock investments for moderate risk investors were EQUAL to that for our stock investments, specifically Bonds 27.5%, Cash 22.5%.)

  • *** " ... if you think you can make better returns by just being 100% in stocks, you may be right. But you should at least be aware of the risks you are taking, esp. if you are investing to achieve a specific goal such as an assured minimum level of retirement funds." (emphasis added)

  • *** " ... many investors are being far too speculative and optimistic about the favorable prospects for stocks in the year or two ahead."

  • *** "Invest in a 'long-short' fund [such as Hussman Strategic Growth - see our current recommendations below] if the market indeed turns bearish (or you believe it will)."

  • (Update: While the S&P 500 Index has lost more than 8% per year over the last 3 years, our recommended long-short fund has a slightly positive return over the same period.)

Oct. 2006

  • *** " ...we feel that neither stocks nor bonds will do as well as normal over the next few years. Why? Because there are too many risks out there, such as above average valuations, [and] a likely end to the current cycle of moderate or better economic expansion..."

  • (Update: While stocks did continue to do well for another year, the following Oct. (2007) marked the end of the line for rising stock prices. Bond prices had their ups and downs over the 2 years after we wrote this, although they have improved a good deal since Oct. 2008.)

Apr. 2007

  • *** " ...there appears to be too much confidence, most likely bred by 4 straight years of almost continually rising stock prices. ...[Not a place] where long-term investors should be buying. Yet, the latest reported data shows that apparently ordinary investors are pouring money into both stock and bond funds, especially international stocks."

  • *** "We have continued to highly recommend the international stock category raising our stake over the last few years. But we think a little caution is now in order. That's why we're reducing our recommended allocation here a little from last quarter. We have not specifically included emerging market funds in our model portfolios since the 4th qtr. of '04 although we have occasionally referred to them as a good place for a rather small percentage of your portfolio."

  • (Update: Emerging market funds and most international funds also topped out in Oct. 2007 and are currently down ranging from about 20% to 33% cumulatively from when we first wrote this.)

  • *** "If and when the Fed actually starts to lower rates, we will likely become much bigger bond enthusiasts since they will likely only do so, with inflation now still a threat, if they start to sense that the economy could be trouble. That would be an environment that is bad for stocks but very good for most bonds."

  • *** "And what form might that [above] trouble take? For approximately the last 2 years, ... [Steve Shefler, who seriously studies the housing market and who now writes columns for us as well as SafeHaven] has been telling me that the housing market will indeed cause significant trouble to the overall economy - far beyond what most people realize. Two years ago, it seems, not many people were even aware of a potential ticking time bomb. While a few now are, most are still not ready to acknowledge a serious, looming blow not only to the US economy, but possibly, to most of the international markets, due to the tendency for all markets to follow the presumptive leader in determining global economic health, that is, the US." (emphasis added)

  • Update: The Fed made its first cut of the current cycle in late Sept. 2007 and the stock market's demise followed less than a month later. Since then bonds have been a pretty good place to be, especially as compared to the stock market. As we now know, and warned you about well before the bear market began, the housing crisis did turn out to be the "ticking time bomb" that precipitated the crash of stock markets all around the world.

July 2007

  • *** "...what goes up like a rocket can (and usually) does come down like a rocket. And so, while my recommendations may not appeal to some aggressive investors, we feel we have a better chance of coming out ahead in the long run by helping people steer past the kind of investments that have the potential for serious corrections which can easily wipe out years worth of prior gains."

  • *** "[Investors should] continue taking some profits out of funds that have been going up at an annualized 20 or 25% rate over the last 4 to 5 years. These include, for example, emerging markets and European stocks.

  • (Note: This, essentially, was a repeat of the warning given (above) in Apr. 2007, but also would have included other fund categories such as Energy.)

On our Alerts page, we stated:

  • *** "As of July 2007, ... we [now believe] that "high yield" (also called junk) bonds [are] entering into an extended period where returns will be minimal, or worse, even leading to outright losses. Investors who want to avoid possible poor returns ahead might want to sell or reduce any current holdings."

  • Update: Since that time, these bonds have indeed shown negative returns and proven to be the poorest performing bond category to be invested in. Although these funds have bounced so far this year, we are currently advising waiting at least several months longer before possibly recommending them again.

Oct. 2007

Background: This was the month during which the market topped out, although the actual top occurred about a week after we published the Oct. newsletter. The Newsletter was headed "Change Is Upon Us" and focused on our outside the box view that "future fund category performance [eg. Large Growth, Small Value, etc.] is more predictable than the overall market." This led us to state:

  • *** "[The Large Growth category] (LG) is now likely to do significantly better than [Small Value] (SV) (and small cap in general) in the years ahead ... regardless of the market's overall direction..."

  • (Note: To get some idea of how this prediction has played out thus far, you can click here. The chart displayed shows that, in spite of bear market losses for both funds, Vanguard's Large Growth Index (VIGRX) is ahead of the Vanguard Small Cap Value Index (VISVX) cumulatively by about 14% over the last 2 yrs. Interestingly, while the Value fund did actually do better year over year between Oct. 2007 and Oct. 2008 during the worst of the bear market, since then, the Growth fund is now the one doing significantly better. We continue to favor the Large Growth category (as shown in our Model Portfolio below) and will likely favor it over the Small Value category and small stocks in general for at least more several years.)

  • *** "... you would likely do best of all if you can reduce your stock allocation upon correctly recognizing what turns out to be the start of a prolonged bear market, putting the transferred funds into either cash or bond funds, whichever appear to have better prospects. Right now it appears that bonds, esp. short-term high quality ones, would have better prospects if repeated Fed action takes place to reduce interest rates due to the housing crisis, financial market instability, and the possibility of recession."

  • *** "We are considerably more positive about bonds than we have been for quite a while because it appears fairly certain that the US economy will slow down which is good for most categories of bonds."

Update: At the time all these quotes from the Oct. '07 Newsletter were written, as mentioned above, the stock market was still in the 2002 - 2007 bull market and our current recession had not even been born. The US recession was only officially declared and announced to the world on Dec. 1, 2008, a full year after it was now acknowledged to have begun. (So much for counting on the reported news alone to help one decide about the appropriateness of one's investments!) By "thinking outside the box," well ahead of the crowd, we were better prepared than the consensus for the new investing environment that lay ahead.

Jan 2008

Background: Right near the top of this Newsletter under "Topics Covered", we wrote "2007 Returns Show Potential Warning Signs of a Bear Market." The gist of the article: "...the falling off in consistently positive performance in 2007 from 2006 may indicate that the best days of the 2003-2007 bull market are now history." Some further quotes:

  • *** "We think that this reversal of fortunes, if sustained, could carry over to international stocks as well."

  • *** " ... a bear market ahead seems to be a real possibility."

  • *** " ... if you don't think you will be able to comfortably accept the possibility of losses ... over a one or more year period, then perhaps it would be wise to begin making some adjustments to your portfolio." (emphasis added)

  • On our Alerts page dated Jan. 18, 2008, we stated:

  • ***" ... we believe that that virtually all 9 major categories of US stocks funds, with the possible exception of Large Growth, are unattractive based on the valuation data we monitor."

  • (Update: By 2008 year's end, as you are probably well aware, ALL categories of stock funds were pummeled by the bear market with an average loss of approximately 40%. However, since the start of 2009, Large Growth stocks have rebounded well and have been nearly at the top of the above 9 categories, second only to Mid Cap Growth, and significantly ahead of the S&P 500 Index.)

March 2008

Background: After dropping consistently since mid-2003, unemployment began edging up again in mid-2007 and has been rising ever since. As stated above, stocks had started falling in early Oct. 2007. This led us to uncover and make the following non-mainstream observations:

  • *** "EVERY recession since 1948 or earlier has occurred not long after unemployment began rising, and additionally, ended shortly before unemployment started to fall back again (emphasis added). All of this appears pretty ominous to me since ... it does not appear that we are near the end of that rise."

  • *** "... it seems likely that the unemployment rate will continue to rise over the next few years ... Bottom line: higher unemployment will lead to reduced consumer spending, both likely contributing to a longer than average (average being 6-9 mos.) period of recession." (emphasis not added)

  • *** "Some of the most highly regarded experts we follow suggest that the current downturn could last easily into 2009 or even longer.

  • *** " ... investors should not be ready to snatch up so-called (stock) "bargains" until the one year trend reverts from negative to positive and stays positive for many months, if not considerably longer."

  • (Note: We were correct in worrying the onset of a recession, and a long one at that - it too did start less than 6 months after the pickup in unemployment, although at the time we wrote this Newsletter, it was still

  • too early to be picked up by mainstream economists; see the "Update" above under Oct. 2007.)

Update: Since unemployment has continued to rise with no end currently in sight, unless a fall in the unemployment appears close, the implication is that the recession is not likely to end as soon as some now anticipate. Stocks, however, after hitting their lows on Mar. 9, 2009, appear have priced in that the recession will end within the next 2-3 mos. since stocks typically begin to recover as much as 6 months or so before a recessionary downturn ends. If the recession doesn't end by Sept., it would follow that stocks could fall back to their March '09 levels.

Apr 2008

Background: In March '08, the market seemed to be stablizing from its near 5 month drop, leading many to believe that the skies were clearing. We said:

  • *** "In spite of the emerging consensus that stocks may be set to climb from here on out, we are still in a negative period with many stock categories perched near a bear market, if not already in one."

  • *** "... the stock market appears likely to continue its downward trend."

  • Update: While things continued to appear brighter thru May '08, the several month improvement fizzled out, culminating in reaching a full bear market market in July, as already noted.

Are we still in a secular, long-term bear market? I don't know. Only time will tell, but IF the S&P 500 drops back down to where is was in mid-March (that is, around 764; it is currently at about 919, as of 6-30), we would again have dropped 20% into, at a minimum another temporary bear market, which would confirm that, very likely, we are still in a long-term bear market.

June 2008

Background: As stock prices had improved over the prior few months, prices for high quality bonds had begun slipping in spite of several further cuts in interest rates by the Fed. Many investors began to assume the "mini" bond bull that had started more than 9 months earlier was now history. But, based on our long stated view that once started, investment trends tend to last considerably longer than the majority expect, we wrote:

  • *** " ... we think it somewhat more likely that the nascent positive bond trend reversal that started in 2007 will continue to survive, perhaps for another year or more."

    (Update: Over the last 13 months, many high quality bond funds have shown returns for the period in the vicinity of 9% cumulatively.)

July 2008

Background: A year ago, we discussed on-going research to identify criteria for making successful BUY, SELL, or HOLD decisions regarding the major mutual fund categories. Although our research followed the start of the Oct. '07 bear market, we applied what we learned to judge what one might have done had they been able to use our current findings in deciding what to do at the beginning of Oct. 2007, a time when stock prices were touching new highs. Here's what we said:

  • ***"Last Oct (2007), our new approach would have identified all the major categories as SELLs, except Large Growth and Large Core which would have be classified as HOLDs. No categories would have been recommended as BUYs." (Note: Our recommended allocations to non-stock investments for moderate risk investors in the July '08 newsletter EXCEEDED those to our stock investments, specifically Bonds 35%, Cash 20%.)

Update: Obviously, stocks have been down considerably over the last year, many bonds up nicely, and cash only minimally positive. (See our comments about Large Growth performance above under the Jan. '08 Newsletter.)

Using our newly designed research tool, all the major categories of funds are, as of the end of June 2009, classified as HOLDs, except Energy, and most International stock funds, esp. Emerging Markets, which are currently viewed as SELLs.

Please visit our website to see our current specific recommendations in more detail.


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