FOMC Announcement: Is Failing to Plan the same as Planning to Fail?

There’s a little known fact about the Yinzer Analyst, he loves FOMC announcements although not for the usual reasons. I’ve never built an investment strategy around an FOMC press release, but I love watching the market reaction as those strategists and economists digest the release in thirty seconds or less and broadcast their expert opinions to the financial masses. Once upon a time I was planning to be a history professor but decided there wasn’t much excitement in the history of European banking. Say what you will about the equity markets, the efficient market hypothesis or “investment strategists” in general, the stock market is never boring!

Before getting into the meat and potatoes of today’s FOMC announcement, let’s start by keeping our the technicians among us happy:

Starting with an intraday chart; you can see that it was pretty much back and forth all day until the FOMC announcement at 2 p.m. After the initial release action, it only took a few minutes to digest the report, which to be honest, was largely vague with the exception of the upgrade to the language describing the U.S. economic outlook. What was more likely was that it only continued the uncertainty over the first Fed rate hike, which added to the relatively weak earnings reports minus Apple and the uncertainty in the EU over Greece made it easy to justify selling and protecting gains. Protecting gains was key today and I think directly influenced the gold miners, but we’ll talk more about that later.

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Moving on to the daily chart, you can see that we’ve decisively cracked the wedge pattern and can call it dead, but you knew that already because you’ve been coming here faithfully right? The weak purchasing power oscillator and CMF scores never confirmed the bounce in early December so it’s not surprising we’re heading back to the December lows. Moving on to chart 2 were you can see a clear consolidation trend going on, it could extend for another few days unless volatility picks up over Greece or earnings reports here at home.

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Longer term, the S&P is back to prior support/resistance although a move back to 1975 wouldn’t be unexpected. Between the current levels and the next strong support around 1880-1900 are the last legs of the 2012 uptrend and the 50 week moving average that converge around 1950.

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What’s more interesting to the Yinzer Analyst is that the breakdown on the FOMC announcement has introduced a new dynamic into the momentum model I’ve been developing. Each relatively low point around our current momentum levels in 2014 was met by a sustained bounce of somewhere between 4%-8%, but the game has changed since the end of QE3. The bounce in mid-December after a momentum low on December 16th is all but gone and rather than our scores entering positive territory like in past rallies, the mid-January bounce never got my momentum scores into positive territory, they just became slightly less weak. Unless a new market dynamic enters the game soon, more weakness is in store for us.

Last chart of the day is the MarketVectors Gold Miners (GDX), which saw a steep 3.98% drop on the day although it’s still positive for the week. What’s surprising to me is the reaction to the FOMC announcement…it’s sort of having your cake and eating it too moment. While rate hikes are still potentially on track for this summer and will have a serious impact on real interest rates and opportunity costs, the likelihood of rates rising by more than 100 bps is fairly low while uncertainty in the broader equity markets will likely remain high. This smacks more of profit taking or closing out positions to cover cash calls elsewhere.  Fortunately, GDX is close to prior support and with the FOMC statement out of the way, the next few days might see a bounce as investors focus on equity risk rather than potential rate hikes.  But how certain is the FOMC statement?

GDX

Planning for the Fed:

If there was one thing I took away from my past life as an investment analyst, is that planning your trades around FOMC press releases is an exercise in futility. The FOMC statements aren’t clear, will never be clear and there’s no point in praying/hoping/demanding otherwise. Your best plan is to work your own long-term game and use the FOMC statements as a signs of twists and turns in the road. The FOMC has been signaling for some time that it wants to hike rates and end what it considers to be “extraordinary monetary policy” so why are investors so surprised when they confirm this at every meeting?

Yes, they upgraded their language on the strength of the U.S economy, saying that output is now expanding at a “solid” pace, up from “moderate.” Remember, there using recent data to forecast the future, so who knows how they viewed the recent durable goods reports? What they’re more concerned about is the employment situation. National unemployment rates are back to averages typically seen just prior to a rate hike. Yes, participation is lower, but the Fed has viewed this as a long-term structural trend and more importantly to the Fed, gas prices are low and falling. Think of it as a huge bump in potential consumer spending that doesn’t require a big growth in wages.

And what about inflation? Yes, its low and yes it’s going to stay low as long as the dollar continues strengthening and guess what? As my old hunting buddy used to say “I care, but only so much.” The Fed cares about inflation, but has never been serious about letting it go above 2% or even getting it close to 2%. As soon as inflation expectations reached 1.7%, Chairman Bernanke started talking the end of QE3 and the potential for policy normalization.

So does that mean rate hikes are guaranteed? Absolutely not and the two year bond yield dipped 4 bps on equity weakness as concerns over Europe and earnings took precedence over rate hikes but what does that mean for you? That’s up to you decide, just remember, the Fed is not now, nor has ever been your friend. If you’re a long-term investor; make your plans around valuations, future earnings and relative momentum, not what a bunch of bankers in Washington are planning to do with interest rates.

Sunday Night Recap: Dogs of the Dow Part II and the Return of the Goldbugs?

It has only been three weeks since our posting on SunAmerica Focused Dividend (FDSAX) and while the ‘Dogs of the Dow’ may have continued to slumber since then, something is definitely working for the fund. In the 7th percentile on a YTD basis, the fund has delivered a solid 2.79% return since our posting compared to 1.55% for the S&P 500 and .82% for the Russell 1000 Value iShares. While we always like to see ourselves proven right (who doesn’t?), the reasons why FDSAX has outperformed so far in 2015 could spell more trouble for active management in the year to come.

The secret to FDSAX’s strong performance in 2015 really isn’t that hard to figure out; just head over to Morningstar.com and check it out. What’s in the secret sauce? Well it’s not the Dogs of the Dow although only 4 of the Dogs it holds are underperforming the Dow Jones Industrial Average so far this year. The secret to their success; video games and cigarettes or put another way a deeply discounted retailer (Gamestop) and the 4 largest remaining cigarettes manufactures in the world, the foundations of the consumer staples category. What’s made FDSAX so successful is that incredible difference in performance between the different sectors of the market with a spread of nearly 800 bps between utilities (XLU – up 4.07%) and financials (XLF – down 3.88%) in 2015. For the same period of 16 trade days at the start of 2014, the spread between healthcare and consumer cyclicals was only 594 bps. If the trend continues, 2015 is shaping up to be another year that separates the true active managers from the closer indexers.

Let’s start by taking a look at the broader market to see what we can make of the situation. Starting with a daily chart, the S&P 500 was pulled back into the late 2014 ascending wedge on the promise of the new ECB QE program along with a spate of negative economic reports here at home that lite the hope that the Fed’s anticipated rate hike program is on hold.

SPX

While Thursday’s price action was a welcome change, all things considered the weekly action was unimpressive. The volume heading into Thursday was steadily diminishing and Friday’s close just off the lows failed to confirm the move higher. Today’s election of a new leftist government in Greece probably won’t help the open on Monday. As of press time (10:30), the VIX futures had jumped although we backing off the highs.

On a weekly basis, you can see the S&P bounced off the first potential stopping out point, but we’ll need to see follow through this week to confirm whether this is just a bounce off one day’s positive news. The fact that the news that lifted the market originated overseas rather than here doesn’t strike me as particularly positive.

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What’s more worrying for trying to separate the closet cases from the true active managers is that the internal make-up of the market doesn’t show any signs of improving although the recent trend towards defensive sectors might be running out of steam.

First let’s start with this chart showing the % of stocks above their 200 day moving average. You can see that the percentage is way off, even after Thursday’s big one day spike but you have to consider what did well versus what lagged last week.

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Sector wise, Healthcare and Financials make up nearly 30% of the S&P 500 and both lagged noticeably; the financials have been hit hard on weak earnings and healthcare stocks are showing signs that they’re running on fumes after so many years of strong performance. That strong performance is probably the biggest detractor to stronger returns going forward as long term investors have serious gains to protect.

Consumer defensive’s and healthcare stocks also underperformed for the week although they make up a much smaller portion of the index at a little more than 12% while high flying REIT’s make up only around 2%.

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XLU

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For the S&P 500 to really breadth stabilize and give the market a fighting chance to making serious gains, the last need to become the first. Consumer cyclicals and industrials make up over 22% of the S&P 500 and have had…well mixed performance following tough 2014’s. And the best that can be said about energy stocks is that they haven’t gotten lot worse. This is why market prognosticators always say defensive-led rallies are doomed to failure in the long run. They make up such a relatively small part of the market that as long as they’re pulling the market higher, the advance will be tepid and unstable.

Goldbugs Take Heart:

What about the Yinzer Analyst’s favorite wager of 2015, European equities? Well you can see that unhedged EZU managed a decent advance for the week although it underperformed SPY, up 1.36% to 1.66%. On a daily chart basis, the advance off a retesting of the downtrend line was confirmed by a shift in momentum and the sharp rise in the CMF (20) score although the failure to break above the 50 day moving average was disheartening.

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On a weekly basis, the sharp uptick in volume was offset by a middling CMF score for the week leading to a decline in the CMF 20 and failing to confirm the breakout. With Sunday’s election in Greece, the most likely direction will be lower to retest the downtrend line.

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Who has enjoyed a seriously strong and undeniably positive start to 2015 are the gold miners. After so many bad years, could the global uncertainty over deflation and equity weakness here at home be ready to push the miners back towards their 2014 highs? Take a look at the daily chart below, you can see GDX managed to push back into its 2014 trading range before getting stuck at the 200 day moving average, but the real handicap for the week wasn’t profit taking (we hope) or covering old losses, but a positive week for the S&P 500. Despite the best efforts of the Permanent Portfolio Fund (PRPFX) which is killing it in 2015, gold has lost its luster for most investors and the miners especially aren’t playing a big role in their portfolios anytime soon. But hey, room to grow right?

GDX1

Longer term, the miners are still stuck in the falling wedge pattern that has been guiding its destiny ever downwards since 2012. This week GDX ran smack into the upper boundary and managed to push through it before running out of steam and closing below the trend line. For those gold bugs out there, take heart. Volume was lower on the week and didn’t damage the uptrend line while the MACD seems to be in the early stages of rolling over to turn positive. Even if the move turns out to be another false rally, take heart goldbugs, the pattern continues to narrow indicating a breakout could be in the cards later in 2015.

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That’s it for the Yinzer Analyst tonight; he’s going to need his rack time before getting up to clear some snow. But tomorrow is a new day and another change to make some money, make sure you’re ready for whichever way the market bends.

Monday Night Quarterback: Looking For a Great European Manager

Last Friday’s strong showing by the S&P 500 led by underperforming energy stocks may have felt like a “last shall be first rally” but one ETF we’ve paid close attention to, the iShares MSCI EMU ETF (EZU), took off with nearly a 2% gain to an already strong week.  While EZU didn’t close above it’s downtrend line on a weekly basis, it certainly is showing the sort of strength that gets the Yinzer Analyst’s blood rushing.

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While there’s a lot of uncertainty about the upcoming ECB announcement on the 22nd where a long-anticipated QE program should be unveiled, it’s time to get off the sidelines and get into the game. For me, I want true EU exposure without a lot of British or other non-EU equity exposure, but what about those investors out there who’s portfolios are U.S. heavy and just need foreign equity period? Well you’re in luck because the Yinzer Analyst, instead of spending the entirety of the holiday catching up on Brooklyn 99 instead sought out five great funds that can add value to your portfolio.

For those readers who are new to the process; I first began by deciding what exposure I wanted, narrowing it down to the benchmark and Morningstar sector and then zeroing in on funds that I feel have the potential to outperform an index fund over a three to five year time frame. Without access to a data service like Morningstar Direct, it took a lot of time to piece together different sources but having used a few international funds in my day (although I currently have no positions in any of these funds), I do have some short cuts to the process.

First, I want exposure to large-cap developed stocks, not a 75%/25% developed/emerging market blend. This is key; after seven months of underperformance and with the ECB announcement coming up; my goal isn’t to gain Russian exposure or Brazilian exposure. My goal is to add European exposure plain and simple. Now there are a wide variety of funds that are Europe specific and we’ll talk about those later this week, but this exercise is for those investors with a U.S. centric portfolio who after five or six years need to rebalance and want to add international exposure. So this rules out benchmarks that include emerging market equities like the MSCI ACWI ex. USA or MSCI World; instead we’re going old-school with MSCI EAFE which has a 99% allocation to developed markets with Greater Europe making up 66% of that.

So heading over to Morningstar, I used their Premium Screener function to search for funds with a European heavy portfolio (greater than 60%) along with an initial investment at or below $2500 and still available to new investors (so long Oakmark.) If you don’t want to pay Morningstar prices, check out the new FundVizualizer tool from Putnam Funds. Yes, the focus is obviously on getting you to use Putnam funds but it has a lot of capability for a “free” service. Anyway, once you get rid of multiple share classes, you have a short list of about 75 funds split between the Foreign Large Blend and European Equity categories but our focus on a strong correlation to MSCI EAFE keeps the list below short and direct. Remember, these are the Yinzer Analyst’s recommendations but you still need to do your own research and check out the funds for yourself before you choose to invest in any fund. Read our disclosures for more details.

EuropeLet’s start with our top three funds by addressing the elephant in the room; it’s a pretty Pittsburgh heavy list but that was entirely a coincidence. FGFAX is one of the strongest performers in the Foreign Large Blend space over the last sixteen years since March Halperin took over as fund manager, placing consistently in the top five percent of funds in its category every year over the 3,5,10 and 15 year trailing periods. The fund has always held larger allocations to European equities, so much so that while MSCI EAFE is the official benchmark, Morningstar recognizes MSCI Europe as being the “best fit” benchmark to evaluate the performance against.

The story has changed somewhat in 2015 as the fund is down 2.38% through 1.16 compared to -.8% for MSCI EAFE and -.33% for the category. The main culprit seems to Swiss stocks including a 4% allocation to Credit Suisse that’s taken a nose dive since the start of 2015. One other feature to watch for in all active managers is a tendency to hold onto positions (campers) and FGFAX is no exception with an average turnover of 5% a year.

Next up is MFS International Value (MGIAX), which like FGFAX has placed in the top decile for active fund managers in the Foreign Large Blend space over the last fifteen years although unlike FGFAX is outperforming the benchmark handily this year with a return of .76% YTD. The fund recently had a change in management with long-time manager Barnaby M. Wiener (right?) appearing to have left the fund at the end of 2014 although he was replaced by another manager, Benjamin Stone, who has been with the fund since 2008. Normally this would put the fund on a watchlist, but MFS’s international funds have a strong reputation plus the prior service record of Mr. Stone is worth the benefit of the doubt.

Like FGFAX, MGIAX has a relatively low turnover ratio at 18% so again, expect somewhat cyclical performance but the fund has only underperformed EFA once in the last five years, delivering a five year annualized return of 9.36% compared to 4.45% for EFA. More impressive is that it did it with lower volatility than EFA and thus earned a suitably high information ratio although I’m sure my more cynical counterparts will point out that rarely do high ratios persist for long periods.

Finally, another strong candidate from the hometown team is the relatively small (less than $600 million in AUM) PNC International Equity Fund (PMIEX.) Normally, I wouldn’t look twice at a bank fund for the sole reason that banks usually haven’t the least incentive to actually spend money on active management. Historically the focus has been on providing a portfolio solution for in-house trust or wealth management accounts where the pressure to deliver performance has been somewhat less than you would expect to find with an independent advisor so active management fee’s for close indexer performance.  Always a bad mix.

What makes PMIEX different? Like crosstown rival FGFAX, this fund has a strong history of outperformance delivered under one manager who has been with the fund since 1998 although the turnover ratio is significantly higher with PMIEX at around 31% to FGFAX’s recent 5%. The fund also has more holdings, giving it a broader focus and lower tracking error relative to MSCI EAFE but helping it avoid some of the pain inflicted on Swiss equities although PMIEX is also underperforming the category so far in 2015 with a YTD return of -.75%. Investors can expect more “even” performance than FGFAX but if the focus is on really picking up Europe exposure, PMIEX has a significantly smaller positioning in the region relative to FGFAX but might offer a better solution for investors who need a “one and done” solution.

With three great options like that, why am I also giving you two “also rans” that at best have delivered market-like performance over the last several years? Because as great as the first three funds are, you never want to slavishly follow just one manager and both of these funds have had management changes in the last three years that can hopefully offer better performance going forward. How did I find them? I would have discarded them after my initial scrub but decided to do some digging for one reason; both funds are positive and in the upper quartile in 2015.

Let’s start with Goldman Sachs where a new manager took over the tiny Focused International Equity Fund (GSIFX) in early 2012 and proceeded to take it from a consistent underperformer to beating EFA in both 2012 and 2013. So why is he still managing a $200 million dollar fund? Because he was absolutely crushed in 2014, down nearly 13% to EFA’s 6.2% loss as heavy losses on BG Group and Banco Popular Espanol combined with a concentrated portfolio (hence ‘focused’) to kick him when he was down. Even with the shellacking, GSIFX’s performance was strong enough over the last three years to slightly outperform EFA.

So why do I like the fund? Because the manager’s a true active manager (underperformance is a risk you take moving away from the herd) who’s not afraid to take large positions and best of all, has shown he can outperform. Best of all, he’s willing to trade with highest turnover ratio in this class at a 121%.

Finally, mid-sized life insurance companies are historically as bad as mid-sized banks at running mutual funds, but I have high hopes for Sentinel International Equity (SWRLX). Not just because the Vermont based fund family once sent me five pints of Grade A medium amber maple syrup as a gift or because I still watch Super Troopers whenever it’s on Comedy Central. Like GSIFX, this fund added a new manager in late 2012 who delivered tremendous performance in 2013 with more middling performance in 2014. He’s managed to deliver solid performance with slightly less volatility, has a higher turnover ratio than the top 3 funds at 52%, has concentrated positions showing active management but most of all, what I like about this fund is what it doesn’t have…assets. There’s enough literature pointing out the historic outperformance of smaller funds with new managers to larger, more established funds constrained by liquidity concerns.

No matter which fund you choose, if any, remember that you always have options and it can’t hurt to start your search with some of Pittsburgh’s finest.

Is the End of the Fed Bull Cycle at Hand?

While the Yinzer Analyst may had done a magnificent job muddling his case for investors to start shifting their focus to overseas markets where a year of bad news had led to depressed prices but higher return potential going forward. Well someone must have been reading our updates because after a back and forth week, there was a clear shift in momentum today towards international equities while the domestic equity outlook became increasingly muddled as more signs of slowing economic activity ran headfirst into an increase in core PPI here at home.

Staying in the U.S, the Yinzer Analyst’s own momentum models showed a serious breakdown that confirms the end of the great 2012-2013 bull market. We’ve discussed our model previously (here) and while scores haven’t reached their 2014 lows registered on October 13th, or even the December 16th lows, they have recently pulled off something not seen since mid-2012. In a bull cycle, readings as low as we registered on January 6th (97th percentile) should have been meet by a multi-week rally, instead we had a 2 day rally and have found ourselves nearly back to the January 6th lows. It’s tempting to say that a rally is now overdue, but truthfully the market will need some sort of outside factor to give it the shot in the arm it needs. The October momentum lows were only the ‘lows” because comments from St. Louis Fed President Bullard supported the idea of an indulgent Fed same for the short lived rally off comments from Chicago Fed President Evans last week.

But moving beyond the momentum and the Fed, let’s inspect the technical outlook for the S&P 500. Starting with a daily chart, you can see the S&P broke through the rising wedge pattern on heavy volume today, confirming the weakness seen in our momentum models and the divergence in the percentage price oscillator that formed in early December. Even with today’s weakness, the CMF score has continued to improve but largely due to the dropping of the first half of December.

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Moving to the weekly chart, you can see the market has continued its breakout from the 2012-2013 Fed inspired uptrend and confirming the end of the bull cycle (whether cyclical or secular remains to be seen.) Having broken below the 20 week moving average on Thursday, it’ll take a major reversal for the market to fight its way back into the uptrend for a third time and seems unlikely at this point.

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While a great deal of technical damage has been done, investors with a long term focus and relying on the simple 2/10 simple monthly moving average crossover will not that a sell-signal has been sent yet. If you stay focused on the intermediate term chart with weekly data, we’re already fighting with the first potential point for the pullback to die out, followed by the 20 week moving average and a second stopping out point just below 1900. If we do break through Stopping Point 1, and find ourselves at Stopping Point 2, the risk becomes the S&P will be stuck in a trading range that could persist until the Fed offers reassurances to the market or raise rates sending sentiment even lower.

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Back to the Old World:

Shifting our eyes to the east, both the iShares MSCI EAFE ETF (EFA) and iShares MSCI EMU Index (EZU) continued their December weakness in early 2015 and made new lows on January 6th but since then have managed to hold onto their gains while U.S. equities have rolled over. We talked extensively on Monday about why we think European equities could outperform in 2015 and the ECJ’s lead investigator certainly delivered on Wednesday with an opinion that the ECB’s OMT program is legal and although a formal verdict isn’t expected for several months it surely added more lift to the market. Next up is a potential ECB QE announcement next week followed by the Greek elections on the 25th.

Starting with the broader EFA, you can see that while it remains stuck below its 2014 downtrend line while the PPO looks to be turning around. Shifting the focus to relative momentum versus the S&P 500, you can see that today was a stunning reversal out of a seven month long downtrend. For the Yinzer Analyst, stunning reversals are sexy as they get but need confirmation. I wouldn’t mind seeing a strong finish to tomorrow (or even a weak one) but with relative momentum retesting the downtrend line at some point soon.

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Moving to just EZU, you can see that its managed to get back above the 2014 downtrend line on a daily basis although like EFA it’ll have to retest it on a weekly basis before investors should get too optimistic. For now EZU is fighting hard to close above prior support and that’s fine in my book. It’s going to be a struggle but we should know within a week or so whether the ETF has what it takes to move forward.

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On a relative momentum basis, EZU is still within the downtrend formed in mid-2014 although this week looks to reverse the lackluster performance of the last two. If the trend continues, EZU could potentially breakout next week and signal a major shift in market dynamics is upon us.

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Finally, the Yinzer Analyst momentum models show changes underway for both ETF’s although we’re still waiting for confirmation. Like the S&P 500, EZU and EFA made historic momentum lows on October 10th but that only sparked a 2.4% gain for EZU and 4% for EFA over the next 30 days. In the eight days since coming close (but not retesting the actual lows) to the October momentum lows, EZU and EFA have managed a 2.08% and a 2.62% gain compared to a .5% loss for the S&P 500. Still within the realm of horse shoes and hand grenades but worth noting for asset allocation purposes going forward.

One final chart for investors to consider is the performance of the iShares Currency Hedged MSCI EMU Index ETF (HEZU) since that momentum low on October 10th. While HEZU might be a relatively new product, you can see that it has already found favor with investors as it outperformed both EZU and the S&P 500 since 10/10. Clearly investors want exposure to European equities, just not to their currency. But could a QE announcement change investor sentiment on the Euro in 2015?

HEZU

Monday Morning Quarterback: What’s your risk tolerance?

(A portion of this posting was adapted for my weekly piece at ETFG.com which can be found here)

It’s a shame that investors often have such limited memories, not just when it comes to recent events but to the wisdom of that can be gleamed from some of the investing greats. For those investors who are looking to outperform, either in 2015 or beyond, they should consider one of Sir John Templeton’s famous quotes: “People are always asking me where the outlook is good, but that’s the wrong question…. The right question is: Where is the outlook the most miserable?”

Starting here at home, Friday’s Employment Report seems to have knocked the nascent “Evans Rally” off its track as a better than anticipated report has been interpreted as binding the Fed’s hands over a potential 2015 rate hike. The upcoming week is fairly light here in the U.S until Friday’s CPI report, which means that now is a good time to take a baseline on equity sentiment. We spoke last week about which equities outperformed/underperformed during the short-lived rally on Wednesday and Thursday; a quiet week should let us see how confident investors are feeling so far here at home. While it’s tempting to say that there might be more value in U.S. equities, the Yinzer Analyst would recommend caution before jumping in with both feet.

Looking at the daily charts, the S&P 500 has been stuck in a rising wedge pattern while negative divergences have been forming with weaker momentum scores and reduced buying pressure. The S&P 500 may continue advancing but the new “highs” should be watched carefully, rules that have been in place since the S&P 500 fell out of the uptrend channel that formed back in late 2012.

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Looking out longer term on a monthly basis, the uptrend that began on the back of the Fed’s commitment to QE in 2011 has been broken yet again. Unless that S&P can close above the line, close to 2100, before the end of the month, investors should start preparing for a new period of prolonged weakness. Not necessarily a sharp correction, but an extended consolidation.

The crisis of faith in domestic equities, not to mention concerns over a European QE and declining inflation, has continued to spillover towards U.S. treasuries. Both the ten and thirty year yields have broken through their 2014 downtrend channels.

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The biggest winner so far in this global crisis of faith are the gold miners. Repeating a familiar pattern from early 2014 when investors were concerned about an early end to QE3, the miners again have benefited from their traditional role as the traditional safe haven during periods of equity weakness.

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Now at the risk of repeating myself, the Yinzer Analyst still feels that the epicenter for global risk isn’t in the emerging markets but in Europe. Since making a new high on June 6th, the iShares MSCI EMU Index ETF (EZU) has declined over 17.78% compared to an 11.65% loss for the broader iShares MSCI EAFE Fund (EFA) while the Currency Shares Euro Trust has dropped 13.5% in the same period and back to levels not seen since late 2005. The 2012 playbook continues to be followed close to the letter with another potential Greek exit from the Eurozone looming with the Global X FTSE Greek ETF (GREK) down over 47% since June 6th, even outpacing the disastrous showing by the Market Vectors Russia ETF (RSX) down 38.73% in the same time period while several ETF’s linked to Northern European Union member states as well as unaffiliated European nations have seen better (less negative) performance. But have investors taken their case too far?

First let’s consider the technical case before moving to fundamentals. While we’ve advocated European equities almost since the beginning of this blog, we’ve also pushed caution on purchases and so far haven’t been disappointed by it. On a daily basis, EZU has seen a recent improvement in its CMF score as the days of heavy selling from early December fall off and reveal the lack of further selling pressure.

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On a weekly basis, EZU the PPO has been, if not improving then at least not getting worse while the CMF score again improved from the dropping off of the dismal summer weeks. To earn our support, EZU needs to close above $35.50 and then make a successful challenge of its summer downtrend line.

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When it comes to the fundamental case, Gavyn Davies outlined in the January 7th FT that the next few weeks could be critical to the success of failure of the great EU project beginning with a potential opinion from the European Court of Justice on Germany’s challenge to the ECB’s “Outright Monetary Transaction” program, begun in 2012 as part of his “promise anything” campaign that has yet to be used. Davies notes that, spoiler alert, the Court of Justice has shown an inclination towards favoring programs that reinforce European integration, but even then Germany will only take their opinion under advisement. Next is a potential QE announcement from the ECB on January 22nd as low inflation becoming deflation seems to be giving the ECB the cover necessary to start a QE-like program. Finally there’s yet another round of Greek drama on January 25th.

For those truly brave investors who are willing to bear more risk than most, shifting your focus to the Global X FTSE Greece 20 ETF (GREK.) Concerns over the future of the EU project had already led to a punishing six months for the Currency Shares Euro Trust (FXE), now back to 2005 levels while the political situation in Greece seems to only go from bad to worse. In 2012 it was a challenge from the far-right with Golden Dawn, in 2014 the threat to the status quo is coming from the far-left where the Syriza party led by Alexis Tsipras seems poised for victory on a platform built around the need to write-down existing debts while alleviating the on-going fiscal austerity that has been mandated as part of the ECB/IMF led bailout. Polls at the start of January showed Syriza with a commanding lead and have sparked reports that Germany is quietly preparing for a Greek exit from the EU. With that backdrop of more uncertainty after the election and a possible “Grexit”, is it any wonder that the only Greek-related ETF available to U.S. investors, with a 30% allocation to Greece’s largest banks, is now trading at a P/B ratio of .41 according to parent Global X? Investors are clearly prepared for the worst.

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With that, I’ll leave you to consider your portfolio’s, your positioning for 2015 but most importantly to consider just how much risk you’re willing to take going forward.

Jobs Report Friday: Time to Love the Miners?

Another Friday, another Jobs report showing 200K+ jobs created. Doesn’t this ever get old for anyone else? While December’s gain of 252K was a drop from the revised 351K in November, the big jump in construction related employment along with the fall in the headline unemployment rate from 5.8% to 5.6% was sure to give some more levitation to equity futures. The overnight weakness was wiped out at the report’s release although since then, the anxiety has begun to creep back into the market.

After all, the first question being asked on every trading desk is whether this is a “good” report that could signal changes in rate expectations or a “really good” report that could give the Fed the ammo it needs to keep rates low indefinitely. Wage growth on a year-over-year basis was an anemic 1.7% while average hourly earnings fell .2% bringing the average weekly earnings for all employees down slightly in December. Not exactly the sort of awe inspiring economic growth you want to see going into a rising rate environment which has all of the financial interwebs aflutter; will rates start rising this summer?

The unemployment rate has dropped to a level that most people would consider being “average” despite the drop in the participation rate and typically would see the potential for rising rates, especially after the 3Q GDP report although 4Q is sure to come in a lot lower with some estimates at half of the prior period. And with the sustained drop in oil prices, the Fed is surely having visions of the 1980’s where a combination of falling oil prices, strong economic growth and a lax Fed saw inflation pushing nearly 5% by 1990. Not that anyone would consider the economy to be growing nearly as strongly as in the 1980’s and with the global economy facing a higher prospect for deflation than inflation, the Fed might decide waiting and seeing is the best approach.

So what does that mean for your portfolio? Probably just more of the same as visions of 2012/2014 come back to haunt the more active market participants. Every economic report will carry more volatility than it did for the same period in 2013 when everything as A-okay! But the Yinzer Analyst checked his charts last night and came up with a few things that he thinks bear watching.

First we’ll start off at home where the S&P 500 seems to be stuck in a rising wedge pattern; while the rally over the last two days was impressive, it only alleviated some of the prior selling pressure and momentum off the 2000 level has been fairly weak. New highs are still possible, but unless we can clear 2100 on strong volume, it’s likely we’ll be coming back down to the 2000 level.

spx

What has been stronger this week are the gold miners, take a look at the daily and weekly charts below:

GDX

GDXW

GDXL

I wrote about this over at ETFG.com earlier this week, but there are any number of reasons why the miners could be doing well but the most important for me is broad equity market weakness. Remember, during the long gold miner bear market of the 80’s and 90’s, the miners typically only made gains when the broader indices ran into trouble.  I did a study on that at my last employer, I can recall the exact specifics but typically when the broader market was going through a cyclical bear cycle, the gold miners outperformed 50% of the time on a monthly basis.  And by outperform, I don’t mean “were less negative” I mean “were positive when the S&P 500 was negative.”  Food for defensive thought.

Staying at home for the moment, the weakness following the Jobs Report has hit the energy sector hard this morning as XLE doesn’t seem like to soon challenge the weekly downtrend line. Hopefully it can at least hold on to the 200 week moving average. And while Healthcare stocks may be suffering slightly more than the broader market today, this weekly’s rally left the XLV/SPY relative momentum relationship firmly in the upper half of the uptrend angle. So the take away, when investors are feeling confident (or at least positive if not in a big risk taking way), it’s back to old favorites like healthcare stocks.

XLE weekly

XLV

XLVSPY

Going overseas, its consolidation time in China as ASHR begins to consolidate after breaking through December’s resistance. Normally, over the last six months this would have been a perfect time to add exposure but for now, I’m not so sure. Looking at the weekly chart, we did manage to get above the high of last week but will likely close down on heavier volume. I think a retest of $36 is in order to confirm the bull case.

ASHR

ASHR Weekly

And finally we’ll leave you with European equities where the Yinzer Analyst is extremely glad he advised caution before buying the mid-December rally.  Who say’s technical analysis doesn’t have its uses? EZU has broken below the summer’s downtrend line on a daily basis and doesn’t seem to have the buying pressure necessary to break above it again anytime soon. Until the chatter about a Greek exit from the EU dies down, EZU could be heading for a weekly close back to $34 unless Draghi can pull a seriously fat rabbit out of his hat with European QE.

EZU

EZUweekly

Thanks for stopping by and starting your morning with us!

Sunday Night Recap: Does Every Dog Have Its Day?

The Yinzer Analyst is a simple man; he likes his beer cold, his Bills winning and his mutual funds simple so you can imagine over the years he’s found himself increasing disappointed, and not just by the Buffalo Bills.  The trend among mutual funds has been to develop increasingly opaque strategies as a way to justify high management fees for subpar performance when compared to index funds or ETF’s. From years of researching equity mutual funds I can tell you there are essentially three models; indexed, active managers who are actually indexers, and true active managers; and at the heart of every successful equity mutual fund is a process to find and select individual securities. Some are incredibly complex while others are simply the result of one manager’s particular process. One fund that has eschewed complicated strategies and has still managed to deliver superior returns is the SunAmerica Focused Dividend Strategy (A Share-FDSAX), once the darling of Barron’s magazine and that has since fallen on rough times.

Now when I say FDSAX has an easy to understand strategy, I mean it’s so easy that even someone relatively new to investing should be able to follow the logic behind its construction. Simply put, it’s something I like to think of as “Dogs of the Dow +” in this case actually the 10 highest yielding stocks in the Dow Jones Industrial Average plus 20 stocks from the Russell 1000 (which may also include the Dogs of the Dows.) The stocks chosen from the Russell 1000 are selected based on a screening process that looks at valuation, profitability and earnings growth. The portfolio is put together annually and with the positions more-or-less equally weighted with no concern towards sector weightings and held for an entire year. That’s all there is to it. Now I choose to call it the “Dogs of the Dow +” given that I think it’s fairly reasonable to assume that the 10 highest yielding stocks are likely to be the ten worst performers over the previous year and while the specific metrics used to pick the stocks for the Russell 1000 aren’t publicly disclosed, my assumption is that the system used by SunAmerica would be recognizable to stalwarts of the investment profession like Benjamin Graham.

At its core, the investment theory governing the portfolio construction process (as well as any valuation based investment strategy) isn’t quite reversion to the mean but something close; the idea that stocks will gravitate around an intrinsic value, occasionally becoming too expensive or too cheap relative to that value. Over time, investors will become reluctant to pay for already “overpriced” stocks and begin seeking out “cheaper” securities and as the Dow components are some of the largest and most widely followed stocks in the world, they’re a logical place for investors to start their portfolio construction process. As one of the most well-known relative valuation strategies, The Dogs of the Dow Theory has been used for decades, often with mixed results but typically over a long-time period it delivers returns in-line with the broader Dow Jones Industrial Average and often with the benefit of reduced volatility.

FDSAX is a good example of relative valuation strategies at work; after underperforming during the latter part of the mid-2000’s bull market, the FDSAX outperformed for 5 of the 7 years between 2007-2013 and in its worst year (2012) only lagged the S&P 500 by 320 basis points but something changed in 2014. Despite the strong outperformance by large-cap value stocks, FDSAX lagged the S&P 500 by 463 basis points and the fund dropped to almost the lowest quartile within the Large Value category. While the trailing three-year annualized return is still 19.84% compared to 20.41% for the S&P 500 and 18.33% for the category as a whole (with less volatility-win/win), it got me thinking…is there a problem with the Dogs of the Dow?

The general rule of thumb taught in business schools is that any moderately successful trading strategy that generates excess returns relative to the benchmark is bound to be copied and thus eliminating any further potential for oversized gains. But despite 6 years of college, one more and I could have been a doctor; the Yinzer Analyst has always been something of a heretic. Even after the popularization of the Efficient Market Hypothesis, there’s been ample evidence that shows some individuals can outperform the market both consistently and over sufficiently long periods to prove that there’s more to their outperformance than simple luck. Some degree of skill or investor psychology makes certain trading strategies repeatedly profitable.

So lacking anything better to do on a Saturday, I decided to slap together a quick experiment to test the Dogs of the Dow Theory and see if you can reasonable expect that the worst performers from one period (year) will outperform in the next. Now it’s been a long time since I studied statistics, so this is a fairly basic test and just to avoid being called a complete crack-pot, let me outline my process:

After pulling the performance data for all Dow Components from 2008-2014, I set up my worksheets to test whether a stock that outperformed (underperformed) the rest of the Dow Jones Industrial Average would outperform (underperform) in the next. So every year is really a two-period test. If you outperformed in 2009 (period 1) did you outperform again in 2010 (period 2.) To be included in the test, the stock had to be present in the Dow for the entire time frame in question. As an example, on 9/24/12, Kraft foods was replaced in the Dow Jones by United Healthcare and then on 9/23/13, Alcoa, Bank of America and Hewlett Packard were dropped and replaced by Goldman Sachs, Nike and Visa. So when I was looking at the period of 2012-2013, there were only 26 stocks to test (no United Healthcare, Alcoa, Bank of America or HP) while in 2014, I only had 27 Dow components to test (no GS, Nike or Visa since they weren’t included for all of 2013.)

I also only went back to 2009 as I was both pressed for time and not willing to beg someone with access to Direct or Bloomberg to pull additional return data for me. Still, I think the results in the table below are very illuminating:

FDSAX

As you can see at the bottom of every column, I choose to interpret the results with two basic formulas asking, “If you outperformed in period 1 (example 2009), what were the odds you outperformed in period 2 (2010?) In the 2009-2010 period, of the 16 stocks that outperformed in 2009, 8 outperformed in 2010. For 2010, the 12 Dow components that underperformed the total index in 2009 (P1) were equally as like to outperform versus underperform the benchmark in 2010 (P2). Although there are too many variables to count as to why one stock outperforms and another doesn’t, and there’s a host of ex-ante versus ex-post issues to consider, if you were simply picking the worst performing Dow stocks for your portfolio, it was a coin toss whether one outperformed the benchmark and another didn’t. While the odds worsened slightly in 2011 and 2012, they were only slightly worse than a coin toss and picking a prior winning stock to keep winning sure didn’t guarantee anything in 2010 or 2012.

What’s interesting to me is how the odds have worsened over the last two years to reach the sample extreme in 2014. If at end of 2013 you picked one of the 12 Dow components that underperformed that year, you had a ¼ chance of picking an outperformer in 2014. Only Cisco, Proctor&Gamble and Wal-Mart pulled that off. The other 9 underperformed for a second consecutive year or in the case of Coca-Cola, Chevron, IBM, McDonalds (all currently held by FDSAX) and Exxon Mobil for the third consecutive year in the row. Caterpillar (not part of the fund) has now underperformed for four years in a row, some global recovery. Of you could look at it in a different manner; there were 27 stocks in the Dow Jones Industrial Average in 2013 and 2014, if you had picked one at random on 12/31/12, there was a 1/3 chance that you would have underperformed the index over the next two years! No wonder FDSAX underperformed the benchmark in 2014 although it only underperformed the larger category of Large Value funds by 116 basis points. Assuming that most of the outperformers were index funds and that fee’s were a major determinant of outperformance last year, I might have to compare the fund’s performance to other active managers in the space to determine whether FDSAX is a Yinzer Analyst Best Buy, or at the very least how awful active management really was in 2014.

If you were part of the management team at FDSAX and if you selected 10 Dow Jones Industrial underperformers on 12/31/13 to include in 2014 and the relationship held, 7.5 (let’s round up to 8) of those stocks would likely underperform in 2014 and with an average weighting of 3.4%, 27.2% of your portfolio was going to underperform in 2014. That’s putting a lot of pressure on the rest of your portfolio to outperform so you can keep yourself around benchmark. If a similar relationship held for stocks within the broader Russell 1000, your chances of performing in-line with the benchmark were slim-to-none while outperforming after fee’s wasn’t even within the realm of possibility.

The question is what happens in 2015? Given the extremes between persistence in outperformers and underperformers in 2014; is it reasonable to assume that mean reversion might kick in and see the Dogs of the Dow finally have their day again in 2015? If so, thanks to its formulaic nature; FDSAX could find itself very well-situated to take advantage of that trend. Keep your eyes on those persistent underperformers like Chevron and IBM to see if they can give SunAmerica a happier New Year.

New Year, New You: Don’t pull a Costanza

New Year’s Day is traditionally the time to make resolutions on how you can improve yourself in the coming year but instead of making some grand promise that you’ll finally lose those ten pounds, or stop drinking with lunch, why not focus on your financial future instead? Americans probably spend a fraction of the time focusing on their financial futures that they devote to avoiding Cool Ranch Dorito’s when they go to the market and yet most New Years Resolutions end in failure because people aren’t willing to put the time and mental energy into them to be successful. So to celebrate our first New Year’s resolution at the Yinzer Analyst, we’re going to share one of our biggest “d’oh” moments and the lesson we’re resolved to take forward in 2015 and by making my shame a matter of public record, you can all help me avoid repeating the misfortunes of 2014.

Like many of the Yinzer Analysts’ biggest regrets, my worst moment in 2014 involved an ill-timed mutual fund investment in one of the year/s biggest losers and one of the worst “campers” I’ve ever invested with, Mainstay Marketfield (MFADX). At the start of the year, I had a minor “Hugh Hendry moment” and decided to up equity exposure but instead of loading up on some large cap core fund, it was time to go hunting for “alpha” instead. Now alpha has to be one of the most widely used yet incredibly vague terms in existence. Everyone knows what it means but damn if they know how to go about getting it, just ask any of the 86% of core managers who underperformed their benchmark in 2014. In this context, I was focusing on managers who could deliver a healthy “risk-adjusted” return with low correlation to the S&P 500. My market expectations for the year were not TOO far off the mark; mid-to-upper single digits with higher volatility than in 2013. My goal was to find managers who could deliver a somewhat like market return with less drawdown. I didn’t expect market like performance, but I was hoping I could get 60% of the upside with less volatility.

Being the Morningstar Direct wizard that I was, I naturally went through the category data until focusing more specifically on the Long/Short field. Now you couldn’t have found a bigger crop of losers than in long/short; as of 12/31/14 over the last five years they’ve managed to capture around 38% of the upside for about 51% of the downside for a five year annualized return of 6.85% compared to 15.45% for the S&P 500 TR. Not too impressive, especially given the relatively high fee’s charged by most managers. Now there were a select few managers I decided to pursue and ultimately focused on two names. The first was Mainstay which is really a global macro outfit that positions itself around global trends. Mainstay appeared to be the gem in the rough for a host of reasons:

  • MFADX had a lower R2 to the S&P 500 but had managed to generate impressive performance through 2013 although it returned roughly half of the S&P 500’s 32% for that year. The subsequent beta it generated for to calculate alpha was then essentially worthless, but the positive return and lack of a reliable relationship to U.S. equities was a win in my book.
  • Long Manager Track Record: The fund had a consistent management team that made itself readily available to answer questions. Part of my due diligence included a conference call with part of the management team.
  • Global Focus: Much like the Yinzer Analyst, the fund looked favorably on Japan and Europe’s growth prospects versus the U.S. although it remained heavily invested at home.
  • Information Sharing: One of the true hallmarks of a good fund is how much information its managers provide. When I was researching the fund in late 2013, you could access statements showing the monthly position in both long/short positions by market.

But as I was going through my due diligence process, a few cracks in the story began to emerge that caused me more than a little hesitation:

  • Prior Record: When going through the historical allocations, the first thing you would notice is how little their allocations actually changed from one period to the next. The fund was only down 12% in 2008 versus 37% for the S&P 500 but should have done even better. From what I can recollect, the fund had actually been adding equity exposure in late 2007 and was only saved from more serious losses by managing their inverse allocation. Over the next several years they made only small changes while leaving the core long equity allocation relatively unchanged. In 2009-2013 that was called prudent. Currently the fund has an annualized turnover of 32% and while not unusually low for long/short managers, MFADX does typically hold onto positions for extended periods. In other words, they’ve comfortable being wrong for a long period of time.
  • Asset Growth: MFADX had very quickly grown into one of the largest long/short funds in America and in fact had one of the most impressive growth rates in 2013. Strong asset growth like that isn’t necessarily a negative, but tends to reinforce the belief amongst management that their investment philosophy is beyond reproach while also acting to limit their ability to make investment decisions. It’s a lot easier running a $100 million fund than a $10 billion dollar one. Ask Peter Lynch about it.
  • Management: While having a long-term focus isn’t bad, that focus needs to be driven by a dynamic manager who can respond to changes in the market or their data but after 45 minutes of nonstop and entirely one sided dialogue, it became clear that intentionally unnamed manager, while very intelligent and well-spoken, was clearly locked into a specific market outlook. He was focused on a continuing global recovery that should see rates rise in the U.S. and abroad while focusing a large portion of the equity allocation on early global recovery leaders in the materials and capital goods fields. Think mining stocks and Joy Global while shorting Treasuries because you expect the ten year to burst through 3%. Oh, and also being long homebuilders and short utilities.

Now that sounded like a great story but that’s what global macro investing is; focusing on selling a great story. Look at the December 2013 commentary if you want an example of this; its six pages devoted to the failure of global monetary policy and inflationary forces. What’s the old joke about economists? If you were to lock 2 in a room for an hour and ask them to tell you whether the economy is growing they’d come out with 3 different opinions. GDP growth in the U.S. stumbled early this year but has since recovered but the growth has been uneven. Wage growth has been anemic and the housing recovery went nowhere in 2014, killing Mainstay on several of its long and short positions. Utilities were one of the biggest winners in 2014, so their short XLU position helped the fund stumble out of the gate.

mfadx

Meanwhile the global recovery was stillborn so European and Japanese positions continued to lose ground as did new positions in EM equities in select markets like Hong Kong, Mexico and Brazil. The downfall of Mainstay obviously wasn’t a 2% position in Brazilian equities but how they reacted to their underperformance. They didn’t adjust many of their long positions quickly enough to prevent serious losses in the first half of 2014 only to add to EM equity exposure in their summer, just in time to take part in the summer shellacking.

I would love to tell you more about their missteps and after their July/August commentary they stopped publishing further updates despite traditionally having done it on monthly basis. Never a good sign when a fund that loves to chat about their positions suddenly goes quiet. Once their portfolio holdings through year-end are made available I plan to do more digging, but it might be a lonely exercise this year. At the end of 2013, the fund had net assets of over $19 billion while according to Morningstar it’s now closer to $9.1 billion. Those wirehouse boys sure are a fickle lot.

While Marketfield may be a true global macro fund, my second choice was a very traditional long/short fund, Diamond Hill Long/Short (DHLSX.) I decided to pair a traditional long/short manager with a strict U.S. focus with a global macro manager both for diversification of return sources as well as a sort of academic exercise. Depending on how well they did, whoever performed the best would get the entire allocation. DHLSX had everything I liked; stable management, consistent returns in the top quartile of funds, they were very approachable when it came to answering questions and providing information but most of all, they had a specific approach to investing.

Let’s be upfront about this, the Yinzer Analyst is a simple man and he likes to keep things simple. The more opaque you make the process, the more likely I am to think that you’re hiding something and I hate having to dig through old allocation reports or do a returns based analysis. What I enjoyed most about this fund was that Diamond Hill had a very simple approach to investing. They were classic, fundamental bottoms up researchers who don’t care about how far their weightings might drift from the benchmark although they do emphasize risk control on their short positions. To put it simply, they bought what they thought was cheap and sold short what they thought was too expensive; essentially the most basic definition of a long/short fund. While they didn’t set the long/short world on fire in 2014, they did manage a respectable 7.55% which, while underperforming a traditional 60/40 portfolio, its returns did have a monthly standard deviation in 2014 approximately half that of SPY. Unfortunately, it’s July and September monthly losses were nearly as bad or worse than the broader market but with less upside in August and the late fall rally.

dhlsx

So by know you’re asking the obvious question of why I would invest in a fund if I had such serious concerns about it? For the same reasons that most investors wind up making REALLY bad decisions; because they feel they have to do SOMETHING! My mistake wasn’t talking myself into investing with a manager who wasn’t nearly as active as he claimed to be, stuck in his rigid outlook and charging a high fee for his performance. My mistake was going against my gut and investing in a fund I knew had issues, but I was going to pull a Costanza and do the opposite of what my gut told me and hope for the best.

Fortunately for me, I was able to trim my allocation after one quarter and sell-out completely after two, limiting my downside to less than 5% while the S&P 500 was up over 5%. If I have been stuck in the fund all year, I would have been drastically better of investing in what I call my naive portfolio of 60% SPY/40% AGG to the tune of 2178 basis points difference in performance.

So when the market opens tomorrow; what will you choose to do?  Are you going to hold your nose and hope for the best or are you going to put the time into to make your resolutions a success?