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Tom Madell

Tom Madell

Mutual Fund Research Newsletter is a free newsletter which began publication in 1999. It has become one of the most popular mutual fund newsletters on…

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Selling Stock Funds: Smart in 2007-2008 But Not Now

Regular readers of my Newsletter are likely aware that we have a very good long-term record of successfully recommending stock fund categories which we believe will subsequently outperform the S&P 500 Index. As a result, going back to the start of 2000, our recommended Stock Model Portfolios have continuously beaten the S&P by an average of around 3 to 4% per year. In fact, remarkably since we started these portfolios, in no instance have they underperformed the Index when measured exactly five years later.

Two years ago, we set out to create an even more practical source of help for investors: Using research on past fund category performance, we wanted to develop what we hoped would be an effective way to identify when the time was right to either buy, sell, or just hold various types of stock funds within one's portfolio. For more information on how we did this, you may want to see the following Newsletters:

-Buy, Sell, or Hold? What Our Research on Performance Shows (Aug 2008)

-Making Buy, Sell, and Hold Decisions During Times Like These: A New Approach (July 2008)

At the conclusion the Aug. '08 article, we began using our new BUY, SELL, or HOLD recommendations. Here is what we said:

"At the present time, unfortunately, all the major fund categories would be classified as SELL, and the majority of them have correctly (thus far, showing double-digit negative performance) been SELLS since last Oct. (2007). This appears similar to the first two quarters of 2000 when nearly all categories were also SELL. (The performance results after those signals were indeed poor with just a few exceptions.)"

Editor's Note: Although our BUY, SELL, or HOLD recommendations were indeed new, we applied them to earlier data as well to see what they would have predicted at earlier dates.

In other words, we predicted that stock funds from all popular categories would not be rewarding for likely at least a year from that Aug. '08 date, and should perhaps be sold or lightened up on within investors' portfolios.

Let's take a look at how the 10 major categories of stock funds have actually done over the two years since we made our SELL recommendation: (Note: as reported in our May 2010 Newsletter, we had already called 8 of the 9 US categories as "unattractive" in a Jan. 18, 2008 Alert, 7 months earlier. This, too, was prior to our Aug '08 research and proved to be a highly accurate "warning" for our readers.)

Net Asset Values (NAV) for 10 Vanguard Index Funds
Representing the Major Fund Categories
Over the Last Two Years
(Fund Symbol)
on Aug 1, 2008
on July 30, 2010
Large Growth
29.69 26.86
Large Blend
23.04 20.26
Large Value
21.71 18.57
Mid-Cap Growth
22.25 19.64
Mid-Cap Blend
18.23 17.06
Mid-Cap Value
18.59 18.38
Small-Cap Growth
18.64 17.64
Small-Cap Blend
30.43 29.02
Small-Cap Value
14.51 13.88
16.87 14.04

As the table shows, each of the 10 funds, serving as proxies for their category, has declined in price, confirming the validity of our Aug. '08 SELL signal over the subsequent two years. (You should note that each of the shown funds pays out a relatively small dividend, and perhaps a small capital gain, which resulted in a reduction of the NAV when distributed. Thus, the performance of each of these funds, while still poor over the period, might not be quite as bad as it might appear. For example, VIGRX representing the Vanguard Growth Index, paid quarterly dividends only, adding approximately plus 1% per year to the loss shown in the NAV.)

But as you likely are aware, all stock fund categories have enjoyed a huge rebound since March 2009. Yet, in spite of the nearly one and a half years of rising prices since then, our SELL signal from 2 years ago still proved to be accurate! Had one adhered to its advice, one would have remained better off than merely holding these funds throughout the period.

But should the Aug. '08 SELL signal still be regarded as in effect today? In a word, "No."

What Our Signals Suggest Now

Our BUY, SELL, or HOLD classifications change periodically as fund categories become either under- or over-valued, or, reasonably valued enough to be included in one's portfolio. As a result of a shift away from over-valuation brought on by the 2007-2009 bear market, the above SELL signals are no longer in effect.

In fact, all of the above 10 categories have now become what we consider a BUY, with the following exceptions which are now just HOLDs: Large Growth, Large Blend, Large Value, and most International funds. This is an updating, then, of our Nov. 12, 2009 Alert where all 10 categories were BUYs. And for those who did make some purchases as a result of our previous Alerts, results continue to appear favorable as described in our May 2010 Newsletter, although all 10 categories have been in a corrective mode since late April. To meaningfully evaluate the long -term effectiveness of our Nov. '09 BUY signals, it will be necessary for at least a full year to pass.

So, all told then, over the first two years since we devised our BUY, SELL, or HOLD recommendations, they have proven thus far to have been a highly valuable tool for anyone interested in occasionally adjusting their portfolio, which includes "rebalancing," as opposed to merely buying and holding. While the signals should only be regarded as a guide, rather than a "can't miss" predictor, we believe that the reason they will likely continue to be successful is that they help investors avoid buying/adding to their stock portfolios when fund prices are unusually high relative to a consideration of both prior market ups and downs.

To the contrary, investors are most likely to achieve good returns when they can identify when chosen fund categories are moderately or unusually low priced, and often accompanied by an improving price trend.

Note: Our BUY, SELL, or HOLD signals do not cover bond funds. Generally speaking, we are positive on all types of bond funds for investors who are willing to settle for returns we project will average about 4-6% over the next few years depending on which type of bond fund. See our Model Bond Portfolio in our July 2010 Newsletter for our current specific category preferences.

New Recommendations Regarding Sector Funds

For those investors who opt to go beyond our current Stock Model " Portfolio with stock "sector" funds which concentrate within specialized areas or industries, our research suggests that the following sectors would also be considered BUYs: Financials, Consumer Discretionary, Communications, Real Estate, Industrials.

The following sectors we consider to be HOLDs: Health, Technology, Consumer Staples, Utilities, Energy, Natural Resources, Diversified Emerging Markets, Diversified Pacific/Asia, Japan.

The following sector fund category we regard as a SELL: Precious Metals.


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