I'll start with the good news. The overall market, including nearly all subcategories of funds, especially international funds, is no longer at what I previously felt was a dangerously high level.
One year of relatively flat, or even negative returns, have helped restore fund performance to more sustainable levels. (However, more traditional measures of stock valuation, such as forward-looking price to earnings ratios remain elevated - over 17, vs. the long-term average of about 14 for the S&P 500, according to bloomberg.com).
I look at both stock valuations and on-going momentum as important yardsticks in judging the relative attractiveness of a particular stock fund and its overall category. While over- vs. under-valuation tends to arise as a result of long-term factors, momentum (relatively positive or negative) can be regarded as more short-term in nature. Given this, I place somewhat more importance on valuation issues than momentum in determining which stock fund categories look the most and least promising over the next several years at any given point.
Now for the not-so-good news: Unfortunately, most stock fund categories, while not appearing excessively overvalued, don't appear particularly undervalued either. Of course, any time stocks are undervalued, they can be assumed to have much better prospects than if they are overvalued, or even fairly valued. At the same time, virtually every category of stocks has lost the momentum they exhibited in early 2015.
My most favored and least favored stock category selection procedures do not employ the use of economic variables, such as GDP, level of interest rates, etc. However, since stocks often become over- vs. under-valued or momentum-impacted based on investors' reactions to such variables, my procedures do, in a sense, indirectly reflect such variables.
Using my proprietary selection procedures has resulted in my specific fund selections outperforming an equivalently composed portfolio of benchmark index funds over the the most recently available 3 year period, 10.9 vs. 9.6%, as well as the entire 5 year period, 11.1 vs. 9.6%. (Data annualized thru Sept. 30, 2015; see here to review the data. Note: One, 3, and 5 year data that include the just completed 4th quarter will be published on my website during the 2nd week of Jan.)
Based on current valuation and momentum factors, the best that can be said is that the majority of fund categories are what we consider to be HOLDs. There are very few categories that exhibit the characteristics we consider as meriting a BUY designation, along with a few REDUCE/SELLs; for specifics, see the tables below.
All categories designated as HOLDs are expected to be worth holding over the next 3 to 5 years, generating decent returns if held over the entire period.
Here, then, are my current category recommendations for the nine most recognized U.S. fund categories starting with those with the most positive longer-term prospects near the top to those with least promising prospects near the bottom:
Note that none of the above basic fund categories show up as having particularly strong prospects over the next several years according to my research. While not currently overvalued, each of these categories has run up considerably over nearly the last 7 years, limiting, in my view, their future prospects.
The following table shows my current category recommendations for five international fund categories starting with those with the most positive longer-term prospects near the top down to those with least promising prospects:
My research shows that the first 4 out of the 5 international stock fund categories shown above show better prospects than any of the above U.S. fund categories. International stocks have had their problems in recent years, but looking ahead, I believe that prospects, including the economic fundamentals not directly considered in the above recommendations, will improve going forward.
While I am not a big advocate of sector funds, I present this data for those relatively aggressive investors who might be. Note that because sector funds can be highly volatile and relatively unpredictable, even when considered as longer-term investments, there is an above average risk that any sector forecasts, including mine, will not turn out as expected.
Additionally, while you may not choose to invest in sector funds at all, you may find that the non-sector funds you do invest in (or are considering) can have a sizeable proportion of their holdings within one or more sectors. To learn what the sector breakdown is, enter the fund symbol at morningstar.com and look for "Top Sectors." If the fund overweighs sectors that show up near the lower end in the table below, you may want to factor in this information when considering your ownership of this fund.
For example, PRIMECAP Odyssey Growth (POGRX), a fund highly recommended by Morningstar (see my Dec. Newsletter), has about 36% of its investments in the Health sector. Since this sector is one that my research does consider highly overvalued and a REDUCE/SELL sector, one might want to be cautious about owning this fund.
The following table shows my current recommendations for 14 sector fund categories starting with those with the most positive longer-term prospects at the top to those with least promising prospects near the bottom:
|Consumer Defensive |
|Consumer Cyclical |
|Global Real Estate||HOLD|
|Real Estate (US)||HOLD|