Mutual Fund Trends & Research Newsletter

In this Newsletter:

• Should You Be Listening to Everyone's Pessimism?
• Our Model Portfolio Shows Only Modest Loss for 1st Qtr!
• Strategies for the Current April - June Qtr.
• New Model Portfolio
• New Allocations
• Our Long-Term Recommended Funds

• Rate this Issue

The Market's Current Pain Is the Long-Term Investor's Future Gain

Pessimism Is Not Usually an Attitude You Should Give In To

This publication has since its inception in May 1999 always focused heavily on investor psychology. This is because we believe that one of the biggest factors that drives investment markets, aside from economic fundamentals, is the way in which individuals, as influenced by the behavior of others, respond either optimistically or pessimistically.

Clearly, the current prevailing psychology is one of significantly high pessimism as judged by my conversations with both ordinary investors and non-investors alike.

As the predominant mood tends to psychologically infiltrate to more and more people, the cycle can become more and more deeply entrenched and therefore self-perpetuating.

With market psychology now decidedly negative and perhaps becoming even more so in the near future, relatively few people are able to transcend the aura of gloom and recognize the outstanding opportunities that now exist for long-term investors.

Of course, there is another facet that makes this even more complicated. If you "believed in the market" back before all the current trouble started, you probably already invested what spare cash you had at that time. This may have left you relatively cash poor now making it difficult to invest any further even if you wanted to.

Why Many People Fail to Do Well

Relatively new investors tend to underperform primarily because they often join an uptrend too late in a rising price cycle. This was certainly the case for many back in the "boom" years of 1998 through early 2000.

But there is another reason that many investors don't do particularly well. It's because directly opposite to the above, they stay out of the market, or fail to add a little to their existing positions, when things look "just too awful" (as is the case right now.)

We believe that the most successful investors recognize the "counter-intuitive" nature of the markets. We discussed this in detail in Newsletter #9. But to briefly explain this, suffice it to say that due to the cyclical, up and down nature of most investments, most of the money flow that determines an investment's future performance has already been invested at the time when stocks, for example, seem most particularly appealing. When all the indicators (and most analysts too) are saying "Buy", the outlook is probably not particularly good at all because most of the money that drives an investment higher is already there. And, with a cyclical economy, when things have already gone extremely well, there is much more room for things to turn the other way than to continue to improve.

Likewise, just when you (and most others) size up the data and determine that this is not the right time for stocks, bonds, real estate, etc., it is probably in reality a far better time than if all the data were extremely positive.

This is not to say that stocks can't go lower from here; in all likelihood, they will because trends tend to persist. But it is a long-term investor's job to make sensible decisions about the long-term future, and if you believe that what we are experiencing now will, as measured by other modern downturns, not last for more than perhaps another 6 to 12 months maximum, then it makes sense, we feel, to continue to invest modest amounts in spite of the falling prices.

Our Model Portfolio Shows Only Modest Loss for 1st Qtr!

We provide what we consider to be a "Model Portfolio" at the beginning of each quarter. For the just ended Jan to March quarter, we recommended to go with a majority of one's stock fund investments in value-oriented funds and a fairly large allocation in bonds.

As a result of this strategy, our recommended stock portfolio lost only 6.6% as compared to the average loss of over 12% for stock funds in general (as reported by Morningstar) and losses of 12.1% for the S&P 500, 25.5 for the Nasdaq, and 8.4 for the Dow Jones Industrial Average.

When our Model Portfolio for last Qtr, which recommended a 35% allocation to bonds and a 15% allocation to "non-stock" fund categories is considered in total, our overall portfolio loss is reduced to 2.7 for the quarter.

Thus again, as has been true for 4 consecutive quarters, by approximating our suggested guidelines, either using our specific recommended funds, or other similar funds from the same fund categories, the average mutual fund investor would have been much less likely to experience the poor performance suffered by the typical "stock only" fund investor. Our model is updated quarterly. Below are the specific data and our recommendations for the current Qtr.

Strategies for the Current April - June Qtr.

The following are the fund categories we feel will relatively outperform in the 2nd Qtr:

• Large Cap Value
• Mid Cap Value
• International, especially with a value orientation
• Bonds

Our Model Portfolio for the 2nd Qtr. of 2001

Here are our specific model portfolio recommendations and allocations for the current Quarter:

Note: All returns in this Newsletter are shown as of 3-30-01.

Stocks

Note: The following funds from last Qtr's Model Portfolio, with their previous category and allocation shown in ( ), have been removed for this Qtr:

Templeton Foreign Fund A (Foreign - Large Value 10%)
Vanguard Index 500 (Large Blend 10%)

Bonds

Other Categories

Our Suggested Allocations for the Current Qtr.

We have slightly reduced our stock allocation from last quarter and likewise increased our bond allocation.

Class	Current Qtr	Previous Qtr
Stocks	47.5%	50%
Bonds	40	35
"Other"	12.5	15

Our Long-Term Recommended Funds

Our Model Portfolio as reported above is designed to highlight those funds we feel have the best potential on a shorter-term basis. However, for most investors who are looking out at least 3 to 5 years, it will be impractical to shift funds to maximize short-term trends. Therefore, our longer-term recommendations represent a set of funds we believe are suitable for good future returns. The 5 yr return for these funds is shown along with the 5 yr return for this fund's average category member as reported by morningstar.com. As can be seen, in most cases, our recommended funds, which we picked years ago, have been able to best their category averages.

In the table below, we show our projected outlooks for the last and current quarters. Although the stock market obviously performed more poorly than almost anyone anticipated, we were quite accurate on a relative basis in most of our predictions for those funds we felt would do positively (bonds, value funds, although not correct about Europe) and those that we thought would do negatively (growth oriented funds).

Stocks

Bonds

Other Categories

Tom Madell, PhD

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