Economy

Famous hedge fund investor Stanley Druckenmiller is known for his assertion that it is liquidity that moves markets, not earnings.  If that is the case, the current debacle in Turkey should be watched carefully.  Turkish President Erdogan’s efforts to control rising inflation have blown up in his face.  The Turkish lira has declined sharply over the past two weeks.  Whenever you see major losses like this, you should ask yourself “who else is exposed?”  Obviously Turkish consumers are hurt by a plunging currency because that will lead to soaring inflation on anything that needs to be imported.  Turkish businesses that borrowed in dollars (most of them) are going to have a hard time.  German and Italian banks, which are the biggest lenders to Turkey, are also understandably having a very difficult time.  The currencies of other emerging market and frontier market countries continue to be hurt because in a crisis, investors tend to prefer the U.S. dollar and the Japanese yen.  Even other developed markets have been losing ground over the past few weeks.  Despite stabilizing over the past three trading days, we are not out of the woods yet.  All eyes are on the Federal Reserve which has repeatedly signaled its intention to raise rates in September.  This may very well spark a renewed run in the dollar and out of more vulnerable markets.

So far, the U.S. has by-and-large avoided the contagion that has engulfed most of the rest of the investment world.  I cannot predict how long investors will continue to shift assets to the U.S.; I can only say that in the short term it makes sense from a tactical standpoint as both technical and fundamental trends are supportive.  Valuations are not, of course, but valuation has never been a good timing tool.  You may want to own emerging markets because they are currently priced to return much more than domestic stocks over the longer term, but you have to deal with the fact that every day other advisors and investors are throwing in the towel, depressing your share price.  How much pain (underperformance) are you willing to withstand?

I would always rather buy an inexpensive asset with momentum than an expensive asset with momentum, so if I can offer any good news from a valuation/regression-to-the-mean standpoint, it is that growth, with its heavy tilt toward technology, has cooled off a bit lately.  Investors have been willing to look at more cyclically driven shares this month, including industrials, transportation, and retailing.  On the more defensive side, pharma and real estate are doing better.  I feel much better about investing today (at less than 1% below January’s all-time high) knowing there are other pockets of strength outside big tech.  I believe the S&P 500 will break the January high this week, for what it’s worth.  There is still so much liquidity out there, and it continues to look for a place in U.S. stock and bond markets.  That said, I expect a pullback in September because it is a traditionally weak month and there will probably be jitters around the Fed and the midterm elections.

Jeffrey Gundlach of Doubleline recently articulated that there is too much money shorting long-term treasury bonds.  I agree.  Whenever there is a big speculative imbalance, something has to give.  The short speculators in gold were recently proven right, but I agree with Jeffrey that the logic in the case of long bonds is flawed.  The Fed can raise short term rates to a point where the yield curve inverts because inflation is still largely contained and because an inversion isn’t as predictive as it was in the days before massive central bank intervention.  If you are a bank in Germany or Italy right now and you are concerned about your balance sheet, the 3% you can earn on a  30-year T-Bond is AAA-rated, yields much than 30-year European sovereign debt, and is likely to appreciate (at least near term) versus the euro.  I believe demand is going to keep long rates under control unless our economy slows dramatically (and I don’t see that happening in 2018).

Mutual Funds

This is a good time to remember that when you invest with the American Funds family, your equity funds typically have more international exposure than their peers.  Growth Fund of America has 13.3% in foreign stocks, almost exactly double that of large cap growth competitor T. Rowe Price Blue Chip Growth.  Not a judgement on either fund, just a heads up for those that might be interested in their total foreign exposure.

The strength in the economy has really helped high yield municipal bonds outperform higher grade munis.  The latter offers more inflation risk and less credit risk, but credit has been surprisingly strong this year so investors have been generally rewarded for taking that risk.  I believe that will continue.

Mairs and Power, a St. Paul Minnesota based investment management firm focusing on companies in the upper Midwest, got stomped by their peers over the last several years due to their overweight in industrial firms (which are more prevalent in this part of the country).  The Growth fund (MPGFX) is putting up some category topping numbers this quarter.

Lastly, you may consider hedging some international exposure by using IHDG (Wisdom Tree Hedged Quality Dividend Growth ETF) in place of a non-hedged international ETF (VEA or SPDW) or a blue chip foreign fund like Europacific Growth.

Source: Morningstar Adviser Workstation

Disclosure

Past performance is no assurance of future results. Trademark Financial Management, LLC (“Trademark”) is a registered investment adviser with its principal place of business in the State of Minnesota. Trademark and its representatives are in compliance with registration requirements imposed upon investment advisers by those states in which Trademark operates. Trademark may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration. This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. Any subsequent, direct communication by Trademark with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. A complete list of all recommendations will be provided if requested for the preceding period of not less than one year.   It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.  Opinions expressed are those of Trademark Financial Management and are subject to change, not guaranteed and should not be considered recommendations to buy or sell any security. For information pertaining to the registration status of Trademark please contact Trademark at (952) 358-3395 or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). For additional information about Trademark, including fees and services, send for our disclosure statement as set forth on Form ADV from us using the contact information herein or by calling 952-358-3395. Please read the disclosure statement carefully before you invest or send money. Any reference to a chart, graph, formula, or software as a source of analysis used by Trademark Financial Management staff is one of many factors used to make investment decisions for your portfolio.  No one graph, chart, formula, or software can in and of itself be used to determine which securities to buy or sell, when to buy or sell them, or assist any person in making decisions as to which securities to buy or sell or when to buy or sell them.  Any chart, graph, formula, or software used is limited by the data entered and the created parameters. The data was obtained from third parties deemed by the adviser to be reliable. Nonetheless, the adviser has not verified the results and cannot be assured of their accuracy

Liquidity and the Fed Balance Sheet

Over the last several years, advisers have been subjected to article after article saying the market is expensive and therefore stocks should be sold. And yet stocks have made new high after new high.  At this point advisers do not need to be reminded that stocks are expensive.  What would be helpful, obviously, is some guidance on either when, or from what level, stocks will begin to meaningfully decline.  As long as the Federal Reserve and other Central banks can effectively freeze the business cycle in mid-uptrend, the “when” is not going to be anytime soon.   It therefore makes sense to make sure the business cycle is not advancing to the point that central banks are forced to meaningfully tighten in order to head off inflationary pressures.

Right now we are facing a situation of mild concern.  The point of maximum liquidity appears to be passing.  The U.S. Federal Reserve is set to begin shrinking its balance sheet in October, and it plans to raise interest rates again in December.  This has started putting mild upward pressure on interest rates, since today’s very favorable bond supply-demand condition will get modestly less favorable.  The more interesting dimension to this move is its impact on the stock market.  We have written several times about the three scenarios the markets currently trade on (most recently on August 30th).  The somewhat hawkish turn by the Fed in theory marks a shift away from Scenario 1 (lower for longer) industries like technology and factors like low volatility, large cap, and growth in favor of Scenario 2 (cyclical expansion) industries like financials and materials and factors like small cap and value.   In and of itself this is fine and healthy.  Hopefully, the market can spend significant time rewarding Scenario 2 stocks.  At the very least, portfolios today should not have an overweight to growth relative to value, and low volatility as a factor should be de-emphasized. Emerging Markets

If global investors begin to believe that the interest rate cycle has indeed turned, emerging markets are going to feel the pain as well. Rising U.S. interest rates usually (but not always) are accompanied by a stronger dollar, which reduces global liquidity.   You can see this in emerging market debt prices in September.   This bears watching.  The long term bull case for emerging markets is intact, but EM funds are taking in a lot of money right now just as short term conditions as deteriorating.  It’s our opinion that now is not the time to be adding to EM.

PIMCO’s Raising Fees

PIMCO has announced an 11 basis point hike in fees on its Income Fund Class D (PONDX), and a 5 b.p. hike to other classes of that fund. Given that the fund has just under $96 billion in assets, and that PIMCO is cutting fees on some of its other funds, the firm is indirectly telling investors, “We have more money in this fund than we want.  Please move some to our other funds.”  As annoyed as I am with PIMCO’s action, I do not have a suitable substitute.

Trends Don’t Last Forever

Just keep this in the back of your mind: The fact that the world central bankers have been unsuccessful in stimulating inflation in the post-crisis environment does not mean inflation is dead. Structural issues like an aging global population and a dramatic decrease in oil prices have been headwinds to inflation in recent years.  However, it is not a given that those forces will remain strong three or five years from now.  This bears watching because with the amount of debt the world has outstanding even a 100 basis point move higher in interest rates could negatively affect stock and bond prices.

The market has shifted emphasis back and forth between scenario 1 and scenario 2 stocks for most of the past five years. By far the bulk of the time scenario 1 stocks outperformed, save the seven month mini-correction from June 2015 to February 2016 when investors shifted to scenario 3 (recession) – favoring high quality bonds and high dividend large cap stocks.

Disclosure

Past performance is no assurance of future results. Trademark Financial Management, LLC (“Trademark”) is a registered investment adviser with its principal place of business in the State of Minnesota. Trademark and its representatives are in compliance with registration requirements imposed upon investment advisers by those states in which Trademark operates. Trademark may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration. This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. Any subsequent, direct communication by Trademark with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. A complete list of all recommendations will be provided if requested for the preceding period of not less than one year.   It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.  Opinions expressed are those of Trademark Financial Management and are subject to change, not guaranteed and should not be considered recommendations to buy or sell any security. For information pertaining to the registration status of Trademark please contact Trademark at (952) 358-3395 or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). For additional information about Trademark, including fees and services, send for our disclosure statement as set forth on Form ADV from us using the contact information herein or by calling 952-358-3395. Please read the disclosure statement carefully before you invest or send money. Any reference to a chart, graph, formula, or software as a source of analysis used by Trademark Financial Management staff is one of many factors used to make investment decisions for your portfolio.  No one graph, chart, formula, or software can in and of itself be used to determine which securities to buy or sell, when to buy or sell them, or assist any person in making decisions as to which securities to buy or sell or when to buy or sell them.  Any chart, graph, formula, or software used is limited by the data entered and the created parameters. The data was obtained from third parties deemed by the adviser to be reliable. Nonetheless, the adviser has not verified the results and cannot be assured of their accuracy.

As we wrote last month, the most prudent course of action statistically is to assume any particular decline in a bull market is a “correction” and not the start of a new bear market.  Bear markets are only revealed over time.  As of August 20th, stocks as a whole have recovered the entire -4.1% drop from July 24th to August 7th.  The exception would be smaller companies, which have made up only a little over half of the -8% plunge they experienced earlier in the quarter.  Through August 20th, the S&P 500 is up 8.8% year to date, while the small cap oriented Russell 2000 is down -2.1%.  See Figure 1. Yes, stocks are expensive, but with the economy growing and companies continuing to buy back shares, the path of least resistance is still upward.

Figure 1

Source: Stockcharts.com

Internationally, markets are mixed.  Investors are clearly picking winners and losers.  Emerging market stocks are up more than 4% on the quarter, while “developed” foreign markets are off 1%.<1>  Europe has been the worst performer, as sanctions against Russia have hurt a number of exporting firms.  Many emerging markets have been helped by looser monetary policy in China, but that may be a sign of Chinese economic weakness so one should not necessarily see it as a green light.  On the other hand, the Persian Gulf region, believe or not, has seen very strong economic performance lately.

Bonds benefitted from the “flight-to-safety” buying in the first five weeks of the quarter, but have cooled off somewhat of late.  Of course this applies to high quality government and corporate bonds.  Municipal bonds have the best return so far this quarter because they have rebounded with risk appetites this month without having sold off in July.  High yield and international bonds dropped considerably in July and their recovery in August has been modest.  Gavekal has pointed out the high correlation over the last five years between Federal Reserve policy and junk bond spreads.<2>  The more active the Fed is, the narrower the spread gets because financial institutions take the low cost Fed money and buy higher yielding bonds.  As the taper winds toward its conclusion, the risky bond “carry” trade becomes less attractive.

One of the worst performing U.S. sectors this quarter has been energy.  Energy is almost always volatile, and even with the -2.6% quarterly loss the sector is up 10.3% year-to-date.  That said, supplies are quite plentiful these days despite the conflicts in the Middle East.  Demand is slipping as Europe-Russian trade dwindles and that is putting downward pressure on prices.  With Germany, France, and Italy each failing to grow in the second quarter, I have to wonder how long the Europeans will go along with the Russian sanctions.  As long as they remain in place, however, it is hard to be bullish on energy.

Fund Notes

One of the most successful funds over the last one, three, and five years from a risk versus return standpoint is the Deutsch Global Infrastructure Fund.  It combines electric, gas, and water utilities, energy pipeline companies, and telecommunications.  It has more or less matched the S&P 500 with a standard deviation of just 11, giving it a Sharpe Ratio (excess return per unit of volatility) of 1.59.

Past performance is no assurance of future results. Trademark Financial Management, LLC (“Trademark”) is a registered investment adviser with its principal place of business in the State of Minnesota. Trademark and its representatives are in compliance with registration requirements imposed upon investment advisers by those states in which Trademark operates. Trademark may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration. This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. Any subsequent, direct communication by Trademark with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. A complete list of all recommendations will be provided if requested for the preceding period of not less than one year.   It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.  Opinions expressed are those of Trademark Financial Management and are subject to change, not guaranteed and should not be considered recommendations to buy or sell any security. For information pertaining to the registration status of Trademark please contact Trademark at (952) 358-3395 or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). For additional information about Trademark, including fees and services, send for our disclosure statement as set forth on Form ADV from us using the contact information herein or by calling 952-358-3395. Please read the disclosure statement carefully before you invest or send money.

<1> As measured by the MSCI Emerging Market Index and the MSCI EAFE Index, 1/1/14 – 8/20/14

<2> 5 Chars Showing the Taper Effect, Advisor Perspectives, August 20th, 2014

Market Perspective

Bear markets are a “when”, not an “if”.  The goal is to go into one without being overly aggressively positioned, so you don’t have to sell into a declining market.  If you can’t achieve the former, the next best thing is to be able to discern when you are truly in a bear market, as opposed to the far more common short term pullback.   Many investors mistake the first 1% drop as the beginning of the next bear market.  That is almost always wrong.  Markets drop 1% or more frequently.  Bear markets are never revealed on Day 1.  The subsequent market activity reveals the bear.  For example, the last bear market began on October 10, 2007.   Investors didn’t really realize a bear market had begun until perhaps June 2008 because stocks had more or less moved sideways from November through May and while financial stocks were clearly signaling distress, other industries (energy for example) had been doing quite well.  See Figure 1. In the previous cycle, stocks peaked on March 24, 2000, but the superior performance of real estate and consumer stocks masked the deterioration in the technology sector until late in the year.

Figure 1: S&P 500 August 2006 – September 2009

Source: Stockcharts.com

Stocks have made another very strong run, and investors are understandably worried about getting caught in another bear market that cuts markets averages in half.  However, attempts in 2012, 2013, and earlier this year to “call the top” have been unsuccessful because tops don’t happen simply because the market has become expensive.  What usually happens is that a long period of higher highs and higher lows gives way to a period where highs are no longer higher – the market cannot meaningfully break above its previous high.<1>  Then the declines start making lower lows.  Finally, the last rally falls well short of the previous rally high (as if there was simply no buying demand left).

Looking at our current situation, we haven’t had the first lower high yet on any average except the Russell 2000 small company average.  Obviously, that bears watching.  On the other hand, mid and large company stocks made new highs here in July.   I re-iterate my concern regarding the shorter time horizon of today’s investors in comparison to years past.   The natural result of a compressed investment horizon means that when the Federal Reserve is forced to remove the punch bowl (so to speak) the market’s reaction could be surprisingly swift and not all that pleasant.  That said, neither the Federal Reserve nor the market’s technicals are at this time signaling a change in the bullish paradigm.  Therefore, the bulls should continue to be given the benefit of the doubt.

Fund Notes

Emerging markets have been the best performing area of the market this month.  China reported June economic growth above expectations, India continues to benefit from optimism tied to Modi’s election victory, Indonesia recently completed an election that the market likes, and the frontier markets of the Persian Gulf region and Africa continue to rise (go figure)!  Morgan Stanley Frontier Emerging Market Fund (MFMPX) is a solid frontier fund due to an experienced manager, high active share and a tremendous resource base supporting the team.  Matthews Asia has a very good India fund (MINDX) with a long track record.  T. Rowe Price New Asia fund (PRASX) is worth a look due to the fund’s consistent long term performance and a low expense ratio.  I would increase my exposure in these areas at the expense of Europe, which I believe got a cyclical respite after Draghi’s 2012 promise.  The problems in Europe have been largely swept under the rug (I don’t mean you Ireland – keep up the good work) and could resurface at almost any time.

I have used the Sequoia Fund (SEQUX) extensively since it temporarily re-opened in the wake of the brutal market decline of 2008.  Its long term track record is highly enviable.  I know that if I sell out of this fund, it could be another 20 years before it reopens again.  That said, I am extremely uncomfortable with its’ 18% position in Valeant Pharmaceuticals, a Canadian pharma firm with an aggressive growth-by-acquisition strategy.  Sequoia now reminds me of Fairholme (FAIRX), another non-diversified fund that doesn’t shy away from controversial positions.  All of this may be well and good for the speculator, but I am questioning its place in the portfolios of moderate risk investors.

This has been a fairly rough month for high yield bonds.  By the end of June yield spreads versus Treasuries had just about reached all-time lows.  Many funds were advising reps to continue to buy them because they still yielded well above Treasuries and default rates would likely remain low.  The problem with this “picking up pennies in front of the steamroller” approach is that a small reduction in liquidity can wipe out the yield difference.  In July investors started to become concerned about the health of the stock rally in light of the Fed’s continuing taper.  High quality bonds are “ballast” – they usually move opposite from stocks on economic concerns, so they reduce overall portfolio volatility.  High yield bonds, of course, are pro-cyclical.  They typically move in the same direction as stocks.  The strong performance of higher quality bonds relative to lower quality bonds this year has nothing to do with inflation expectations and everything to do with ballast; there just aren’t many investments with extremely favorable risk/reward ratios left anymore.

Past performance is no assurance of future results. Trademark Financial Management, LLC (“Trademark”) is a registered investment adviser with its principal place of business in the State of Minnesota. Trademark and its representatives are in compliance with registration requirements imposed upon investment advisers by those states in which Trademark operates. Trademark may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration. This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. Any subsequent, direct communication by Trademark with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. A complete list of all recommendations will be provided if requested for the preceding period of not less than one year.   It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.  Opinions expressed are those of Trademark Financial Management and are subject to change, not guaranteed and should not be considered recommendations to buy or sell any security. For information pertaining to the registration status of Trademark please contact Trademark at (952) 358-3395 or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). For additional information about Trademark, including fees and services, send for our disclosure statement as set forth on Form ADV from us using the contact information herein or by calling 952-358-3395. Please read the disclosure statement carefully before you invest or send money.

<1>    If it does so, it is by a small amount, or on weaker volume, and fewer stocks are part of the advance.

The Economy

The economy continues to improve, if slowly.  243,000 new jobs were created last month, continuing the positive trend.  Investors are showing a fairly significant increase in confidence, enough to push U.S. stocks within a couple of percent of their April 2011 recovery high.  Earnings season is nearly complete, and we have seen a lower rate of upside earnings surprises than at any time in this recovery.  This had created an interesting paradox where company analysts (bottom-up) are getting more conservative in their forecasts while at the same time market strategists (top-down) are raising their numbers.  Two more things to note:  One, consumer spending is increasing; two, the latest ECRI (Economic Cycle Research Institute) numbers continue to back away from the outright recession they have been forecasting since late last summer.  We are left with two conclusions:

1)      We are not on the edge of recession. Apparently, quantitative easing does something to the models that makes them less reliable.  Absent a crisis triggered from outside our borders, the U.S. economy should continue to grow this year.

2)      Stocks are generally overvalued.  Unusually high corporate profit margins are beginning to regress to the mean.  Call it the “Amazon-effect”, in which increasing price competition means more sales at less profit.  Growth stocks should be better choices in this environment, because they tend to have sales and/or profit margin growth such that they can grow into their valuations.

The Big Picture

The big picture, both here and in Europe, hasn’t changed.  Investors cannot lose sight of this fact.  Europe and America continue to, in the words of John Mauldin, kick the (debt reduction) can down the road.  We thought we had reached a point last summer where there were only two choices – a) deep budget cuts and recession, or b) a credit market strike, sharply rising interest rates, and a deep recession.  Instead, world central banks figured out a way to expand their balance sheets even further without provoking a political or economic crisis.  Today the mood is generally upbeat, but in no way have the real problems been addressed either there or here.  We just made the eventual Day of Reckoning that much worse.  There is a certain “make hay while the sun shines” attitude in the market right now.

Undervalued markets don’t necessarily go up and over-valued markets don’t necessarily go down.  I wrote last month that the risk-reward trade-off was not very good.  Today, with stocks up close to 7% on the year, that trade-off is awful.  The upside of the S&P 500 to its post-recovery high of 1364 (4/29/11) is less than 2%.  The downside to the last significant support line (1200, touched 12/19/11) is almost 11%.  It is hard to sell a market where the short term technical indicators are so positive (and they are!), but in the investment world you don’t get paid for doing what is easy. Fund News

Most of the winners so far in 2012 are those funds that take on economic risk (i.e. overweight materials, industrial, and consumer discretionary stocks).  One exception obviously is Fairholme, where Bruce Berkowitz is trying to bounce back from a disastrous 2011.  FAIRX has over 78% of its assets in the financial services sector, and little of that is in what would be considered blue chips.  I’m not tempted by the fund’s 16.9% YTD gain.  I’m somewhat more intrigued by the turnaround Brett Lynn has going on at Janus Overseas (JAOSX, up 23.1%).  Last year was forgettable, but the portfolio is not relying on a few names or a single sector to make its recovery.  It’s the kind of concentrated fund that AGGRESSIVE long term investors might want to consider.  Actually, there were a lot of growth funds that lost 10% or more in 2011.  If you didn’t own AAPL (Apple, Inc.), that was surprisingly easy to do.

For those interested in more aggressive funds that out-performed both last year and in the first six weeks of 2012, consider Putnam Equity Spectrum (PYSAX), a concentrated all-cap value fund; Touchstone Select Growth (PTSGX) an earnings momentum-oriented large cap growth fund with very strong performance over the last 5 years, and Wasatch Emerging Market Small Cap (WAEMX), a very diversified fund working in an “under-fished” area of the market.

Past Performance is no assurance of future results Trademark Financial Management, LLC (“Trademark”) is a registered investment adviser with its principal place of business in the State of Minnesota.  Trademark and its representatives are in compliance with the current notice filing requirements imposed upon registered investment advisers by those states in which Trademark. Trademark may only transact business in those states in which it is notice filed or qualifies for an exemption or exclusion from notice filing requirements. This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. Any subsequent, direct communication by Trademark with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of Trademark please contact Trademark at (952) 358-3395 or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). For additional information about Trademark, including fees and services, send for our disclosure statement as set forth on Form ADV from us using the contact information herein.  Please read the disclosure statement carefully before you invest or send money.

Here is a short comment on the markets, because what I really want to do is comment on funds:

The global economy is slowing down.  We all know this, and it is well factored into stock prices.  Europe has some major issues to face in terms of how it deals with EU members that do not (or cannot) maintain the fiscal discipline required of the pact.  Like the situation the US faces with regard to the debt ceiling showdown, there is a potential for the powers-that-be to screw this up in such a way that markets may sell off sharply.  That said, any sell-off would likely be a buying opportunity because at the end of the day the politicians (here and there) know what they have to do.  With the S&P 500 currently 7.3% off its April 29 highs, it’s time to be a modest buyer.

Notes on funds:

1. American Funds.  With the environment becoming more cautious and larger cap stocks and dividends moving to the fore, this should be a time for American to shine (if not now, when)?  Washington Mutual and Income Fund of America seem to be doing pretty well, but others so far not so much.  I would point especially to Investment Company of America.  That is $63 billion+ that has not meaningfully beaten its benchmark since 2002.  Growth fund of America has been almost as disappointing.  Money has left in droves, either to sister funds AMCAP and New Economy or to another fund family.

2. Dodge & Cox.  Perhaps I should have prefaced my Fund Notes with two facts.  One is that fund families with very solid long term track records have lagged for the most part over the last 12 months.  The other is that over the same time frame, fund families with lower expense ratios have no performance advantage.  Dodge & Cox, like American, is at the nexus of strong 10,15, 20 year returns and low fees, but none of their 5 funds has done well both in the 3-5 year time frame and also the 3-9 month period.

3. Fidelity.  Excels at large cap growth for the most part, but has so many funds in this area that investors can’t help but be confused.  In all other areas, they are hit or miss, with the positive exception of Low Priced Stock.  Their foreign funds should be avoided.  I no longer use Will Danoff (Contrafund, New Insights) anymore because frankly Growth Company and Advisor Growth Opportunities (since Wymer took over) seem to be better.

4. Fairholme.  I’ve always been a big fan of Bruce Berkowitz but you have to understand the nature of his fund.  At the conference he let us know his advantage is time arbitrage, or his ability to buy and hold stocks that the market hates now but will like 3-5 years from now.  The risks are always 1) that what he buys as bargains will either not turn out to be bargains (he seldom gets this wrong, historically) and 2) that his companies go from mildly disliked to universally despised before ultimately getting “re-discovered”.  Most people don’t have this kind of patience.  I have scaled back my positions from 6% to 3.5%.  Others may prefer instead his Focused Income fund (FOCIX), which is less risky.

5. First Eagle.  Just consistently give you 75% of the upside and 55% of the risk.  There are times (mid 2009 thru the end of 2010) where you don’t want to give up that much upside potential but for most people this family should be a core holding.  Fund of America (FEFAX) has been especially overlooked.

6. Franklin Mutual Series.  Would like to have First Eagle’s low risk, moderate return profile but doesn’t.  80% of the upside, 80% of the downside.  Why?  Mutual Series gained fame restructuring industrial and financial firms in bankruptcy.  There just aren’t enough bankruptcy opportunities these days and much more hedge fund competition.

7. Janus.  Too much internal turmoil.  Everybody likes a good turnaround story but generally you are only allowed one.  They still do a pretty good job in the small-to-midcap area, but as far as anything else (esp. Overseas) is concerned, I’m done.

8. Loomis Sayles.  Buy the bond funds (LIGRX, LSBRX, or NEFZX) and forget about them.  Yes they are more volatile.  You get paid in the long run for accepting that.  In this low return environment, you get paid especially well.  But seriously, train yourself not to look at short term performance; it is scary at times.  And don’t buy if 12 month returns are over 15%.  (That goes for ANY bond fund).

9. Artisan vs. Oakmark.  Two very good niche fund managers.  Morningstar and other fund services also think highly of these groups.  My personal experiences have been better with Artisan, but the statistics favor Oakmark.  Again, if your patience runs to three years or longer you almost always outperform either way.

10. PIMCO.  They are not knocking it out of the park this year, but they remain a solid fixed income choice.  Bill Gross’ bearish on treasuries was not well timed, and that has landed his fund in the 84th percentile year to date.  That said, they have done a good job of leveraging their expertise in TIPs to boost the returns on their stock, real estate, and commodity funds.  Go anywhere funds like the All Asset & All Authority fund and Mohammed El-Erian’s Global Advantage Strategy are well worth a look for those who want a decent absolute return with the risk profile of a mid-grade corporate bond fund.  They do not do munis or high yield bonds well.

11. T. Rowe Price.  Right now perhaps the best low-load active managed large fund complex.  169 funds with a 3 year track record.  All but 22 in the top half in performance.  Very good small and midcap manager, plus strong sector funds (Health, Media, Natural Resources.  I also recommend their asset allocation fund (Capital Appreciation-PRWCX)

12. Sequoia. This fund has been open for about three years after having been closed the previous 24 years.  Pounce on it.  This fund has occasionally been a relative laggard, but it has never underperformed in a down market! From a financial planners perspective, what more can you ask for than above average long term performance and possibly no down market unpleasant surprises?

13. Thornburg.  Making a name for themselves in the overseas area, with International Growth (TIGAX), International Value (TGVAX), and the global balanced fund Income Builder (TIBAX).  Worth checking out.

14. Vanguard.  Since past performance has been less indicative of future performance lately than it has typically been, Vanguard funds and ETFs look especially attractive right now.

15. Wells Fargo Advantage.  The best by far of the brokerage-owned fund families.  The Advantage series has performed quite well, led by Growth (SGRAX) and Premium Large Co. Growth (WFPDX).  Again, well more than half of their funds are above average.
    Other notes from the Morningstar Conference:

    Too much bearishness.  Booths were talking up their alternative funds and downplaying their stock funds.  If these alternative funds had long or impressive track records, I could understand but they have neither!  Commodities breakout sessions were standing room only.  That has to be a contrarian indicator.

    Retail investment flows have reflected concerns that we are going to have another 2008.  The world doesn’t work that way.  The next crisis will not affect the markets in the same way the previous one did.  Investors have accepted the notion that bonds and stocks will provide mid-single digit returns going forward (hence the appeal of alternatives) so there is room for an upside surprise.

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