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Top 912. Jul 17, 2000 3:44 PM

» Rande - Silly me, always thinking of the investor side of the equation.

Silly me, always thinking of the investor side of the equation.

-- posted by Rande

Top 913. Jul 17, 2000 4:11 PM

» Tweeter - Rande - Asset Allocation - Fixed Income

Rande – Recently I sold a significant position in the stock of my former employer. I wish to adjust my asset allocation, dedicating all the proceeds to the Fixed Income portion of my portfolio. I would greatly appreciate your recommendations for a reasonably aggressive allocation in this asset class.

The following information should help:

 Current Fixed Income Allocation:
46.7 % GNMA
2 % MM
.2 % Aggregate Bond Index (Current 457B contributions going here).
51 % New Money to apply to Fixed Income Portfolio.
 All Fixed Income monies are in tax deferred accounts.
 GNMA in Vanguard IRA and “New Money” in Vanguard IRA-Brokerage.
 All monies here are open to appropriate allocation recommendations.
 I’m 54 and still working (for now).
 Trying to move toward that “gone fishing” type portfolio you folks have been talking about.

From what I’ve read here on 101, sounds like I may have missed the good buying opportunities on the long bond and zeros (gift horse???). Look forward to your feedback.

Steve Bailey

-- posted by Tweeter

Top 914. Jul 17, 2000 5:45 PM

» Rande - Steve,

Steve,

I like the Total Bond Index for the fixed-income allocation in tax-deferred accounts -- that way you're not limiting yourself to any one sector of the bond market. The Vanguard fund has very low expense, high credit quality, low duration, and decent coupon. If you're looking for active management and don't mind paying the additional expense, the three I like are Harbor Bond, Fremont Bond (both managed by Bill Gross of Pimco) and Dodge & Cox Income. Wouldn't worry too much about where rates are -- there going to fall and rise and fall a lot over the rest of your life. Picking a top-quality intermediate-term bond fund or funds at low expense and holding over the long haul as part of the overall allocation means never having to say you're sorry (about the timing, or whatever).

-- posted by Rande

Top 915. Jul 17, 2000 5:51 PM

» Rande - Growth stocks both large and small rebounded in June as most of

Latest commentary from "No Load Fund Analyst," a newsletter I HIGHLY respect for its in-depth market commentary and original research on serious investment issues. Be sure to check out

http://www.nlfa.com/

Really appreciate the balance and objectivity here:

Growth stocks both large and small rebounded in June as most of the equity market performed well. Only large-cap value stocks struggled, with the Vanguard Value Index losing over 4%. With the year half over, the commonly followed indexes (Wilshire 5000 and S&P 500) are slightly negative on the year. However, with June’s reversal for growth stocks, growth is again outperforming value. As for the broader market, small-caps (and mid-caps) have performed well, with small-cap value and small-cap growth both delivering positive returns and outperforming their large-cap counterparts. REITs have also put up double-digit first half returns. International stocks have struggled with benchmarks negative on the year.

Despite lots of market volatility and concerns about growth stock valuations, investors have not (yet) paid much of a price for the huge move in growth stocks that led to the spring correction. At least this is true for those who participated in the move up. So is a more damaging decline inevitable? Or is the new era alive and well? As you’ll read below, though we don’t believe a growth stock bear market is inevitable, the risk is high enough that we are continuing to underweight this portion of the U.S. equity universe.

When it comes to investing there are not many things that can be said with certainty. However, one clear truth is that investors must constantly deal with uncertainty. When the good times have been rolling for a while investors tend to downplay the potential negatives and become overconfident with respect to the potential rewards. When times have been bad, investors are highly sensitized to the risks and tend to obsess on all that might go (or stay) wrong.

As investors who take the responsibility of managing other peoples’ money (and our own) seriously, it is important that we carefully and realistically weigh the unknowns, both positive and negative. In doing so, a critical part of our job is to stay rational—so we can base our assessments and ultimately our decisions on cold hard analysis as opposed to getting caught up in hype. To the optimists out there, we do have concerns. And to the pessimists, we see reasons to be positive. As we look ahead following a volatile but reasonably satisfying first half of 2000 (all our models are ahead of benchmarks) we’d like to share the uncertainties we are thinking about and how they feed into our decisions.

Risk: Things We’d Like To Know That We Don’t

We see two basic sources of risk today. First, there is macro-economic risk. Because there has not been a recession for a long time and the economy has been strong, it is easy to downplay the risk of a recession in the foreseeable future. However, it is not a risk that should be ignored. For one, the Fed has been raising interest rates. Over the past 50 years, on average, the economy has weakened significantly after the Fed finished tightening monetary policy. PIMCO’s Bill Gross, the fixed income guru to whom we entrust much of our taxable bond money, sees several possible catalysts for a recession.

a. The Fed could blow it by raising rates too much or not lowering them fast enough once the economy begins to weaken. Even Alan Greenspan is dealing with incomplete information as he and his associates attempt to manage inflation.

b. Emerging market contagion, a la 1998 could recur. Emerging markets are more fundamentally sound than they were but rising interest rates could still pose a problem that ultimately could feed back to the U.S.

c. Japan might submerge again given huge fiscal deficits, demographic constraints, lack of political leadership, etc.

d. The U.S. stock market could enter a bear market, stifling consumption and investment.

e. The dollar could decline resulting in foreign capital flight.

Gross, whom we greatly respect, puts the odds at over 50% that one or more of these events will serve as the catalyst for a recession within the next several years. Gross is a bond manager and perhaps that gives him a bearish bias, but at least several of his recession risks are possible enough that they shouldn’t be ignored.

Second, there is valuation risk. Despite the spring correction, growth stocks remain hugely overvalued based on any historical comparison. Many people say that we’re in a new era, and technology and telecom type companies will grow their earnings at an unprecedented rate. But while it’s true that analysts are forecasting very high rates of earnings growth, even factoring in this higher rate of growth, prices being paid for these expected high growth stocks are still out of whack with any historical frame of reference. The relationship between the P/E and expected five-year earnings growth rate is excessive.

If growth is lower than the level being forecast, or if investors decide that betting on unprecedented rates of growth is not prudent (they question the “new era” story), these stocks could decline significantly from current levels. Moreover, given today’s valuations, there is the risk that this becomes one of the relatively rare instances where it takes many years for prices to recover. And, if there is a major bear market in growth stocks, overall investor psychology may sour, resulting in a broad-based market decline (though this may not happen, and in fact did not happen during the spring tech decline).

Common Sense Investors

As common sense investors, we recognize that just because we want to see the glass as half full doesn’t mean that something could not go wrong. Optimism shouldn’t be the sole basis for an investment strategy. It is true that over a lifetime it pays for investors to be optimistic. But there must be a relationship between tolerable risks and investment strategy.

Even with the spring pullback, we believe there is an enormous amount of optimism built into the prices of many growth stocks (see above chart). It is possible that this optimism will be rewarded so a bear market in the foreseeable future is not inevitable. However, investors have a history of incorrectly buying into big stories. Consider:

In the late 1980s Japan was expected to dominate the world economy and the U.S. was considered to be in decline. Both expectations were widely held and wrong.

Inflation in the late 1970s and early 1980s was in the teens. A return to single-digit inflation was not expected. Inflation-hedge assets like gold were widely sought. Again, investors were completely wrong.

Small stocks in the early 1980s were considered a superior investment to larger companies because of their potential to deliver higher rates of growth. Since that time small companies have underperformed larger companies in the vast majority of years.

By the early 1990s value investing was viewed by many academics and a growing group in the investment industry and financial media as an inherently superior strategy. Since that time growth stocks have outperformed value stocks by an enormous margin.

In the early 1990s emerging markets were considered a good bet to deliver such high economic growth that their stock markets would significantly out-return developed markets. Over the past five years the reverse was true.

Professional investors all want to look smart, so the temptation to make predictions and ascribe a high probability to the outcome is often an overwhelming temptation. The record suggests that most investors (professional and amateur) should resist the temptation to act on these predictions except in unusual circumstances. So, being realistic and cognizant of past investor failings, a diversification strategy reflects common sense and reality. And today, despite our belief that generally it pays to be an optimist and that many stocks are reasonably valued, the considerable valuation risk in growth stocks coupled with the macro economic risk that many investors would like to ignore takes the argument for healthy diversification beyond common sense to prudence. Happily, since 1998 diversification has again paid off. In 1999 small-cap growth stocks and international stocks performed well and aided equity performance. So far this year real estate stocks and mid-caps have led the way.

Our commitment to diversification remains strong as does our belief that only when portions of the financial markets represent fat pitches should we pursue holdings outside of our neutral strategy. Today there are several such opportunities:

Real Estate Securities: This sector of the market was ignored over the past couple of years despite solid fundamentals. The result was price declines and valuations that reached bargain levels. Real estate stocks have since rebounded but (REITs) still offer a dividend yield of over 7% and decent cash flow growth (forecasted to be 9% over the next year). Our real estate exposure is via Longleaf Realty, which is not a REIT fund though it has some REIT exposure. It has not performed as well as the REIT market, though it has outperformed the broad equity market so far this year by a comfortable margin. We expect this fund to catch up to the REIT market if the sector remains strong since we now believe there are better values in the non-REIT portion of the real estate securities market.

High-Yield Bonds: The other area we view as a fat pitch is the high-yield bond market. We are highly confident that high-yield bonds, with their near-13% yields, will out-perform stocks in a market decline, even taking into account default risk. The interest rate that investors receive from high-yield bonds is much wider than the historical average compared to U.S. Treasury yields, and we believe it more than compensates for risk. However, over several years we are less sure that high-yield will beat value-oriented stocks in a positive market environment. The value stock universe is reasonably valued and we believe selected stocks are at bargain prices. Given the risk/reward trade-off we’ve decided to retain high-yield exposure in conservative accounts but not aggressive accounts. This month we are selling our Northeast Investors Trust in the Equity and Equity-Tilted Balanced Portfolios. The proceeds will go to value-oriented equity funds.

Our overweightings to real estate and high yield have come from the growth side of our benchmarks. We’ve discussed our concerns about growth and tech stock valuations repeatedly over recent months. In our view growth is, in effect, the opposite of a fat pitch. So we are underweighted to tech and telecom (the sectors that make up much of the growth stock universe), though our exposure to these sectors is still meaningful. The previous table estimates our tech and telecom exposure compared to our neutral benchmarks.

Our underweighting to growth/technology paid off recently, as technology stocks were hammered in the spring, making that the tech story of the first half of the year rather than long-forgotten Y2K. Even after the late-spring/early-summer rebound the NASDAQ is down over 20%. Some of the better-known names have been hit hard. As we look to continue to outperform our benchmarks we are in essence counting on our slight (current) domestic value bias (underweight in growth) and our manager selection. (Note: we include real estate securities in our value allocation.)

We have an extremely high level of confidence in the managers that run money for the funds in our models. They have delivered high returns in the past and our belief that they will continue to do so is a function of our knowledge of their disciplined processes, continued focus and their obsession with maintaining their edge.

As we look forward, despite our concerns, overall we continue be encouraged. Many parts of the market are reasonably valued and offer decent return potential. However, we also continue to believe that stock market returns in general will be significantly lower than during most of the past 20 years. Multiples are unlikely to expand further and earnings growth will not be high enough to deliver mid-teen returns over the next five to ten years. Still, the big-picture backdrop of low inflation and moderate growth, coupled with the productivity story, suggests there is a good chance that inflation-adjusted returns will be decent. So we remain cautiously optimistic.

-- posted by Rande

Top 916. Jul 18, 2000 5:39 AM

» Rande - 08:

08:32 JUNE CPI 0.6 VS. 0.4% EXPECTED

08:32 JUNE CORE CPI UP 0.2% AS EXPECTED

Oil and gas prices take their toll on the overall, but core tame as expected.

-- posted by Rande

Yes Virginia, There is a Slowdown

Top 917. Jul 18, 2000 7:07 AM

» Rande - Interesting piece by Bazdarich:

Interesting piece by Bazdarich:

Excerpt:

Still, there is good reason to believe that the second quarter GDP data will evince a sharper slowing. This is because the GDP growth data look to have been understated in the second quarter in each of the last two years, and there is evidence of similar understatement forthcoming for second quarter 2000. (By the same token, growth rates in first, third and fourth quarters have likely been overstated somewhat of late.) While the actual economy may have slowed only modestly, look for second quarter GDP data to come in at about 1.5 percent unless something radical happens within upcoming foreign trade and inventory data.

IF....GDP comes in at 1.5% when the preliminary report is issued on 7/28 and IF falling energy prices reverse course on the overall PPI and CPI numbers for July coming out in August, then what influence would it all have on the Fed? We will get another set of payroll and retail sales numbers too before 8/22, not to mention the 2Q ECI (employment cost index) on 7/27. Guess we'll have to wait and see.

-- posted by Rande

Top 918. Jul 18, 2000 7:31 AM

» JenL_2 - Another Rande Citing in TSC

Rande is cited in...

Tracy Byrne's 7/17 TSC Tax Forum at TheStreet.com:

Managed Account Fees

If I have a managed account and I pay 90 basis points to an investment manager, can my fee be deductible as an investment expense? I realize that commissions are added to the basis, but how do I treat the fees?

-- Dan Grant

Dan,

If you are an investor, the fees you pay to have your account managed or for investment advice are deductible as an investment expense, assuming they exceed 2% of your adjusted gross income. Report them on line 22 of Schedule A.

But if you qualify as a trader for tax purposes and you pay management fees, the Internal Revenue Service may question if you're trading for yourself or if someone else is doing the work for you.

To be a trader, you must make it clear that you are the one making the trading decisions, says Ted Tesser, trader tax specialist and author of The Trader's Tax Solution.

"So we put in all our clients' agreements that 'the client still reserves the right of final discretion' on the account and then take it as a trading expense on Schedule C -- Profit or Loss from Business," says Tesser.

Big note: Mutual fund expenses are not deductible since they reduce the fund's total return, reminds Rande Spiegelman, a senior manager in KPMG's investment advisory-services group in San Francisco.

.....Jen

-- posted by JenL_2

Top 919. Jul 18, 2000 7:54 AM

» Rande - Thanks Jen.

Thanks Jen. Not exactly earth-shattering. Tracy does a good job and always spells the name right. ;)

-- posted by Rande

Top 920. Jul 18, 2000 7:59 AM

» Mark_J - Diversify

Nice column from http://www.usnews.com

What new era?

Don't fight the Fed. Do diversify if you want some peace of mind

By Anne Kates Smith

The German word schadenfreude, roughly translated, means "pleasure in the misfortune of others." That's probably too strong to describe what I felt while the all-tech, all-the-time crowd got pummeled during the market's spring break. But I confess some satisfaction at the relearning of a few old-school lessons. It turns out that technology stocks are not immune to rising interest rates after all, as the "new paradigm" crowd argued vociferously last winter.

In the new era, the reasoning went, the once mighty Federal Reserve Board could do little to brake the tech-driven market. As an industry, technology may be less affected by higher rates. But as a market sector, tech stocks are as vulnerable as any to whatever drags the market down. Internet stocks as a group fell 42 percent. This correction started with higher interest rates and inflation worries. But a bear market could have been triggered by anything. What's clear is that when a market falls, the highest fliers have the furthest to go–just as they always have.

Technology stocks were not the new defensive stocks, as some argued. Old-fashioned defensive stocks, such as food companies, are actually the new defensive stocks. There was a theory that even if rates rose and the economy cooled, companies would still need to invest in new technology to gain productivity advantages. But, as research by James Paulsen, chief strategist at Wells Capital Management, shows, tech spending slowed enough in 1994, the last time rates were on the upswing, to contribute to recession fears in 1995.

Need for aspirin. Here's what you can be sure people will spend their money on, in good times and bad: food, soap, aspirin, and other basic needs. When stock prices collapsed last spring, food, household products, and drug stocks were among the sectors that prospered, along with utilities and other dividend-paying stocks. In the three months following the market's March peak, the established tech stocks in the S&P 500 fell 9 percent overall. But S&P food stocks rose 32 percent, and drugstore stocks rose 20 percent.

Don't misunderstand. I think investors should have a sizable portion of their portfolios in tech–at least a third, reflecting the percentage of the market's value attributable to tech stocks. But even in the 21st century, too much of a good thing is still too much of a good thing. The past three months show diversification is not the quaint, laughable notion some made it out to be. The same for investing in value stocks.

In the three months following the market's peak on March 10, value-style, big-stock funds rose 9.9 percent, while big-stock growth funds fell 5 percent, although they've come back a bit lately. Real-estate funds rose 14.4 percent. A big chunk (4.3 percent) of that gain came before money began to trickle into the funds in April–before anyone noticed, in other words. I'm not going to dump my tech holdings to stuff my portfolio with utilities, real-estate investment trusts, and food stocks based on three months of outperformance. But corrections like this spring's are reminders of what a full-scale sector rotation can look like. And owning at least something that zigs when the rest of the market zags is insurance both psychic and financial.

-- posted by Mark_J