An expected $125 billion bailout of Spain, potential global monetary easing, and China’s surprise rate cut drove the Dow up over 3.5% for the week. Given our experience with the peaks and valleys of the European tragicomedy, I recommend maintaining higher than average cash/short-term bond positions, and on the equity side of the ledger, increase your holdings of conservative U.S. large caps. We are in a volatile global market environment, filled with uncertainties and an overall slowdown in economic growth, so protecting principal from a significant downward slide becomes increasingly important. The plan is to focus on short term bonds and large-cap products offering a combination of downside protection and dividends. (Note that dividends historically account for over 40% of total return.) The mix/allocation objective is to minimize volatile swings based on the global news of the day, as a Eurozone failure can potentially bring equities down 15% from current levels.
1 Week YTD
Dow (100% equity index) 3.59% 2.76%
S&P (100% equity index) 3.73% 5.41%
Conservative Portfolio #1 (50% equity) 1.52% 2.74%
Conservative Portfolio #2 (55% equity) 1.78% 3.42%
Marea’s Growth Portfolio 1.42% 7.20%
Presuming Euro leaders continue making strides to address debt related issues, you may want to consider adding to equity. Here is a comparison of large cap funds including large value (FDL and DIA), large blend (SPY and VIG) and large growth (VUG). The least risky of the group is clearly FDL which has a history of only capturing 30% of the market’s downside while generating superior three year returns.
As you can see from the exhibit below, the more conservative FDL large cap, with its 3.46% dividend yield, has outperformed the S&P and Dow over the last three years—with far less risk. A fund such as FDL becomes a leading candidate to anchor an investment program during volatile times. When global markets stabilize and begin to once again prosper with less volatility, SPY and VUG will likely outperform FDL. But until then, stay with FDL.
|3 yr. Return||14.44%||13.71%||16.38%||19.59%||15.50%|
|3 years %
Please allow me a moment to emphasize the importance of downside performance with a simple example: if a fund with a $100,000 investment falls 25% in year one and then generates a positive gain of 25% in year two, the investment will only be worth $93,750 at the end of year two.
Alternatively, if the market is down 25% in a particular year, but your fund only books 30% of the market’s fall in value, your investment is worth $92,750 instead of $75,000 (which assumes a 100% market hit). However, if the market is then up 25% in the following year, and your fund captures 74% of the upside, your investment is then worth $109,909—versus $93,750 if the fund had captured 100% of both the upside and downside of the market. Accordingly, historical upside/downside performance is a critical variable to consider when selecting securities.
As we move into the week, there are still serious issues in Spain, Greece, and China. Be cautious and wary of last week’s market performance. If Europe and China continue to make progress, stocks will rise. Any setback, and last week’s 3% to 4% gains are likely to quickly vanish.
My next update will be posted on 6/25/12.