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Buy, Sell, or Hold? Data Derived Signals Can Improve Investor Success

In an Aug. 2008 article on SafeHaven.com, we presented data going back as early as Apr. 1990 on what our research showed was a promising way to make Buy, Sell, and Hold decisions.

That data clearly showed that when we went back and designated mutual fund categories, or the stock market as a whole, as either a Buy, Sell, and Hold based on prior return patterns, we saw marked differences in how the categories performed over the following 5 years.

Specifically, for fund categories we classified as Buys and Holds, the 1, 3, and 5 year annualized returns averaged between 11 and 15%. For fund categories we classified as Sells, the annualized returns averaged between about 2 and 6.5%.

Our classifications were for fund categories through June, 2007, prior to the onset of the Oct. 2007-2009 bear market. For the signals to prove their forward-looking worth since then, it would be highly supportive for such signals to have predicted the very poor returns that lay ahead before they actually occurred, or at least, very early on in the decline. Furthermore, evidence that they were also able to predict the turnaround in stocks that occurred early in 2009 would add greatly to confidence that the signals were indeed a useful decision-aiding tool for mutual fund investors.

I can now provide that evidence, further substantiating the value of our Buy, Hold, or Sell signals using predictions made quarterly starting at the end of Sept. 2007 and continuing through the beginning of 2009.

Data Over the Last Two Years Supports Our Sell Signals

What did our signals show at the end of Sept. '07 at a time when we were still in a bull market? For 7 of the 9 major Morningstar categories, and also the international category, for a total of 10 signals, our signals would have suggested Sell. (Additionally, our signal with regard to the broader market, that is, the S&P 500 Index, also showed Sell.) Only two categories, Large Growth and Large Blend, were classified as Hold. Eventually even these 2 Hold categories registered as Sells before the brunt of the bear market hit.

Since each of these categories have gone down substantially since Sept '07, 8 out of the 10 predictions from Sept '07 turned out to be correct, or an 80% success rate. (Most categories are down in the vicinity of 25% or more, through 11-27-09.)

Data Over the Last Year Supports Our Hold and Small Growth Buy Signals

Our signals continued to predominantly show Sell until the end of Oct. 2008. At that point, while we still deep in the bear market, all previous Sell signals changed to Hold. (In our Nov. '08 as well as Jan.'09 Newsletters, published on my website, we strongly argued for investors to hold on to their stock fund positions.)

So how useful were these new Hold signals? As of one year after (thru the end of Oct. 2009), the table below shows that 9 out of the 10 predictions from the end of Oct '08 turned out to be correct (defined as showing a double digit return), for a 90% success rate.

Category Performance (Total Returns)
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

In our Feb. 2009 Newsletter, we informed our readers of our switch from Sells to all Holds, with the exception that Small Growth had now become a Buy. From that date, the category returns thus far through 11-27-09 have been:

Category Performance (Total Returns)
Category Return
Large Blend +32.4%
Large Growth +35.5
Large Value +31.0
Mid-Cap Blend +37.0
Mid-Cap Growth +36.3
Mid-Cap Value +36.4
Small-Cap Blend +32.2
Small-Cap Growth +32.9
Small-Cap Value +33.1
International +39.3
Note: Returns beginning 1-31-09 (not annualized).

Thus, while the returns shown are for nearly a 10 month period (and might not hold up as well after longer periods), for now at least, it appears they are easily on track for a 100% success rate.

Using Our Signals as a Decision-Making Aid Can Improve Investor Returns

As you can see, we now have substantial further evidence that not only our Sell signals were on target, but that our recent Hold signals (and single Buy signal) were providing useful decision-making aids to investors.

Just a few weeks ago, we emailed subscribers that ALL of the above 10 categories (which would also include the stock market as a whole) became Buys. Obviously, it is far too soon to tell if these predictions of future stock market performance will be correct. However, if as time passes these predictions turn out as well as the above recent predictions, in addition to those already described in our Aug. '08 article, investors who use our new Buy signals as one element of their decision-making process will likely be happy they did.

Although we have confidence that our signals are likely to continue to suggest when, and in what types of stock funds an investor should be buying, selling, or just holding, we don't advocate using them exclusively as one's source of such information. Rather, we recommend our signals should supplement additional data available on the economy and the prospects for how various investments will perform. After all, our signals are derived from how the universe of funds have performed in the past. So if there were, for example, world events that caused an upcoming, renewed, and prolonged crash in most stock markets, our recent Buy signals might prove much too premature. Thus, there is no guarantee that performance patterns will behave identically in the future, although our data supports the notion that funds do generally give out reliable performance signs indicating relative undervaluation, fair valuation, or overvaluation which form the basis for our empirically developed signals.


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