FAQ PAGE
FREQUENTLY ASKED INVESTING QUESTIONS:
6. JD asks: "Why has your model continued to keep us in the market during this large downturn? Please explain your reasoning" (May 2008)
Answer: My model does long-term market timing only, and is tuned to catch only those long-term market movements that are expected to last many years and is a true bear market (meaning >20% drop). The current correction has seen a market drop of 18.7%, which makes it a normal correction (between 10% and 20% drop). The market has since recovered about 40% those losses. My indicators and model are forecasting that these losses will be completely erased and the market will move to new highs sometime in the first quarter of 2009. I am sometimes tempted to disregard or question the validity of the model during such corrections especially after big market drops. However, discipline insists that if I believe in the model then I should rigorously follow it, and I do.
There are also some interesting historical precedents for the behavior of the market during a Presidential Election year. There has never been a bear market (>20% drop) during a Presidential Election year since the end of WW2. There have only been 3 corrections (drops of 10% to 20%), in 1960, 1980, and 2008. This is because the incumbent president and his party put in initiatives to "goose" the economy so that it is humming along by the election date in November. The out-of-power party is also hard at work making election year promises and giving away our tax money like there is no tomorrow. As an example, note the haste and rarely seen bi-partisanship with which both parties rushed through the 2008 Fiscal Stimulus package earlier this year.
The data below shows the Presidential Election year details:
Year Decline Bottom Subsequent Months
to recovery Gain for Gain
1960 14.0% 4 months + 30% 14
1980 15.7% 3 months + 35% 12 2008 18.7% ?? ?? ??
We saw the bottom in mid-March, and this admittedly sparse history says we should be in recovery mode this summer in the June-July time frame (3 to 4 months after the mid-March bottom). The delayed effect of the cuts in the Fed Funds rate (started in Feb 2008) should work their way through the economy in 6 to 9 months, and be felt in the fall of this year. This should start to increase the GDP growth back up by year-end. This in turn should be reflected in new highs for the market in Q1 of 2009, as the model is predicting.
5. LB asks: "Which is more tax-efficient, a mutual fund or an equivalent ETF from the same company?"
Answer: ETF's theoretically have a tax-advantage over the equivalent mutual fund. ETF's are traded on the exchanges like a stock, so when you buy or sell, you are trading shares with other investors. By contrast, when you buy or sell your mutual fund shares, you are dealing directly with the fund, who have to buy or sell the shares of the underlying stocks to raise cash and pay you. This extra trading for a mutual fund generates gains (or losses), drives up the expenses, and places it at a tax-disadvantage versus the ETF's.
The ETF's also have a further advantage in that they use dividends and interest paid by the underlying stocks to pay the expenses of managing the fund. So they should also be distributing less taxable interest back to their shareholders.
However, in real life, it is not that simple. The data show that large-cap funds have been able to consistently be more tax-efficient than the corresponding ETF. By contrast, the opposite is true of small-cap funds, where investors trade in and out of the fund, and ETF's are more tax-efficient. There are numerous other explanations for this phenomenon, and I refer you to the link below for a detailed discussion of this topic.
4. JG writes: "Is there any chance that a firm like Vanguard would go belly up (short of a major disaster happening to the whole world) and, if so, what happens to my investments?"
Answer: Investor funds held by the large mutual fund companies, such as Vanguard, Fidelity, etc, are protected in several ways. Firstly, the funds are held in trust by a third party in the name of the investor, NOT in the name of the fund company. Assets are covered by the Securities Insurance Protection Corporation (SIPC), an institution set up by Congress 30 years ago. SIPC insurance covers assets up to $500,000 per customer. The balance above $500,000 is protected by insurance that the fund company takes out specifically for this purpose. Check with your fund company to make sure they have both levels of coverage (All the major ones do...).
The FDIC insures CD's and savings accounts, up to $100,000 for loss of principal and interest for any reason whatsoever. However, the SIPC does not cover fraud perpetuated by a broker, or losses to your account due to market declines or poor trading strategies.
3. PT writes: “I enjoyed your May 2006 History Lesson on selecting the best mutual fund. You stress that we should use long term data for return, risk and Sharpe ratios. But you used 3 year values in the article that change a lot from year to year. So, where can I find data for 5 and 10 year Sharpe ratio’s?”
Answer: These numbers are available at http://finance.yahoo.com. Enter the fund name in the “Get Quotes” box and the hit GO button, which opens the Summary page. On the left side pane, click “Risk”, and the data will appear.
2. JG asks: “I have a sum of money that I would like to invest in the stock market. Since your indicators are all bullish, should I just go ahead and buy a stock mutual fund? If not, give me some ideas on what to do.”
Answer: How you invest depends on two things, your “asset allocation” and the valuation of the market. Depending on your target asset allocation, i.e., what percentage of your portfolio you want in equities versus fixed income, dictates how these funds should be split between stocks and bonds.
Bond prices have gone down (i.e, yields have gone up), as the Fed has raised rates. I would have no problem buying a bond fund with the full amount earmarked for bonds. However, the stock market has had a significant rally since mid-2003, and is near its highs for this cycle. I would therefore dollar cost average the amount over 12 months. This means, take the amount earmarked for stocks, divide by 12, and invest this amount every month. Also, during a bull market it is normal and healthy to have pullbacks of 8% to 10%. Should such a drop occur, and the indicators are still bullish, I would invest the remaining balance all at once.
1. JS asks: “You seem very confident that the US stock market is headed higher. How can you be so sure, especially in the light of all the bad news of high commodity and oil prices, the huge US budget deficit, the housing bubble, and the threat of terrorism hanging over us?”
Answer: Events that affect the stock market fall into two categories, those that can be predicted and those that cannot. Terrorism and earthquakes are examples of events that can happen without any warning and we cannot therefore account for them in our model. Our only solace is that the market has historically recovered quite rapidly from such one time events, even huge problems such as with 9/11.
The usual events affecting the market, such as oil and housing prices, the budget deficit, inflation, etc, are accounted for in my indicators. Fortunately, I am merely a historian, and not in the business of forecasting the future. So we just follow what our model tells us to do. This has worked well for us in the past, but of course there is no guarantee that future results will be just as profitable.
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