Stock Funds' 5-Year Track Records Set to Double


1.Stock Mutual Funds’ 5-Year Records About to Soar

2.Why Mutual Fund Returns Are About to Skyrocket

3.Will Investors Understand Why This is Happening?

4.The Bottom Line For My Clients & Readers

5.This Week isALL About FedDecision Tomorrow

6. Larry Summers Bows Out as Next Fed Chairman


Many investors focus on the previous five years annualized return when analyzing which mutual funds to buy. We also pay a good deal of attention to the 5-year performance number when analyzing mutual fund and ETF returns at Halbert Wealth Management. And currently the 5-year average returns for most equity mutual funds are not all that attractive.

But what if I told you that between now and the end of the year, most funds’ 5-year track record willdouble or more! And that will happen even if the funds don’t make another penny this year. How can this be, you ask. It just so happens that some of the worst losing months for stocks occurred during the latter part of 2008 when the Dow and the S&P 500 were on their way to 50+% drawdowns (losses). We all remember that gut-wrenching period!

But guess what? Those terrible losing months in late 2008 will steadily be falling off of 5-year performance recordsbetween now and year-end. As a result, most 5-year performance records are about toskyrocket due to nothing other than the passage of time. You can bet the mutual fund companies are licking their chops in anticipation of new brochures showing the much higher 5-year returns! I will explain how this will happen in detail below.

Finally, I would be remiss not to discuss the key Fed policy meeting that starts today and ends tomorrow. It is widely expected that the Fed will announce plans to “taper” its monthly QE purchases of Treasury bonds and mortgages. That decision could have significant market implications, which I will discuss as we go along today.

Stock Funds’ 5-Year Returns Set to Double

In myAugust 20 E-Letter, I discussed why almost all mutual funds avoid telling you about their worst losing periods, or “drawdowns” as we refer to them. Well today, I have even more interesting news about mutual funds that will play out over the next several months, and I want my clients and readers to know what is happening and why.

Last Sunday marked the five-year anniversary of the collapse of Lehman Brothers – the signature event of the financial crisis of 2008. At the time of Lehman’s demise, the stock markets were plunging. The financial crisis actually sucked over 50% of the value out of the Dow Jones Industrial Average and the S&P 500 Index over an 18-month period from October 2007 through early March 2009.

DJIA Daily Value

Some of the worst losses occurred during the months from September 2008 until the end of that year. But when we get the fund returns for September 2013, then September 2008 falls off of the 5-year rolling return. Ditto for October, November, December, etc. As these really bad months in late 2008 and early 2009 fall off, the new 5-year annualized return improves dramatically.

The chart I have included below shows just how dramatically the 5-year returns are about to go up. You will be surprised! Mutual fund companies are already preparing to reprint their marketing materials showing the much higher 5-year returns.

Many investors will have no idea why the 5-year returns jump so sharply in a very short period of time just ahead, and they may decide to invest their hard-earned money in light of the greatly increased 5-year annualized returns. But I want all of my clients and readers to understand why this particular performance benchmark is set to improve so significantly.

Most importantly, I don’t want any of my readers to decide to invest in any particular mutual fund or ETF just because its 5-year average return goes through the roof just ahead. In fact, the sudden jump in returns should haveno bearing on whether you invest or not!

Why Fund Returns Are About to Skyrocket

The last few months of 2008 and the first couple of months in 2009 saw the major stock indexes plunge in value before the markets bottomed in early March 2009. So, for the next five months, we will see the worst months of late 2008 and early 2009 fall off of the 5-year average returns. Nothing sinister here, it’s just the passing of time.

However, by removing those huge losing months from the 5-year track record, it creates abefore-after picture that’s as startling as the sudden transformation of a 98-pound weakling into a pumped-up, sculpted contender for Mr. Universe.

Here’s a specific example. The average large-cap growth fund entered September with a 5-year annualized return of 6.38%, according to Morningstar Inc. If the market simply stays flat and the average fund stands still to the end of the year, that 5-year average will be 9.2% once September 2008 rolls off the 5-year period. It will reach 15.16% by the end of the year when October, November and December 2008 all fall out of the 5-year record.

Put another way, when you take the fall of 2008 off the books, the cumulative return of the average large-cap core fund since August 31, 2008 would go from 37.82% as of August 31 to a whopping 94.14% by the end of the year – again, that’s assuming no additional market gains for the rest of this year.

Here’s another example: The typical financial-services sector fund, which now reports a cumulative gain of 27.5% since August 2008, will see its five-year results shoot to roughly 106.5% by year’s end, simply by holding steady through December – and even more if the market continues to rise.

Here’s a great chart showing the stark difference that is likely to occur in the months ahead, even if stocks go flat for the balance of this year. This chart was created by Chuck Jaffe, senior writer for Market Watch, a Wall Street Journal publication, based on data from Morningstar.

What a difference a few months make

Because the financial crisis spared no sector or category from its misery, virtually every category is slated to seemassive improvement by year’s end, barring another market catastrophe. Even some bond fund sectors are in line for a significant 5-year boost.

Will Investors Understand Why This is Happening?

Two questions this sudden change brings are: 1) Will investors recognize that the big jump in 5-year performance is due to the elimination of some very painful losing months in late 2008?; and 2) What will mutual fund companies do with thesesuddenly sexy 5-year track records?

“Equity funds are still bleeding assets from the 2008 crisis, so one would have to think fund sponsors will jump on the improvement in the five-year records and turn up the heat in saying how well they have done since the market stressed funds back then,” said Geoff Bobroff, an industry consultant based in East Greenwich, R.I. I think we can assume that will be a given!

David Trainer, president of New Constructs Inc., a Nashville-based market research firm, warns about mutual fund companies: “They’ll use their five-year record—or whatever record they think looks good to investors—when it suits them, and sweep it under the rug when it doesn’t. … Now they will say their five-year performance is good; we’ll see if people believe them and act on it.”

The upcoming jump in 5-year performance doesn’t change anything regarding investor risk tolerance. Most investors haven’t forgotten the 50% losses in stocks during late 2007 to early 2009, even if the worst monthly losses will be dropping off the 5-year average just ahead.

Investors have good reason to be skeptical, noted Trainer. If the average large-cap value fund is going to see its five-year annualized performance jump from 6.2% entering this month to 13.4% at the end of December (again, assuming no more gains between now and year-end), it’s only a mirage that makes it look like performance is twice as good.

Trainer goes on: “That change in what the five-year numbers look like is so big so fast, but it’s not like the funds actually got better overnight. They just don’t have to look back on what was hurting them in that time frame any more. … It’s not like you have any reason to believe they will avoid whatever could hurt them next.” I couldn’t agree more.

That’s why it’s important that investors not only mark the anniversary of the financial crisis, but remember it. Having seen funds at their worst, investors can factor future market meltdowns into their planning; forgetting that pain – or ignoring it based on recent positives – is a good way to ensure that they will feel it again, the next time there’s a market crisis.

With that word of caution, let me encourage you to read my latest Special Report:The Secret That Mutual Fund Companies Don’t Want You To Know. It includes information you really do need to know, about how mutual funds show you only the statistics they want you to see.

The Bottom Line For My Clients & Readers

In the months just ahead, some of the worst months of stock market performance during the late 2007 to early 2009 severe bear market will be dropping off of the last five years performance records. This will make upcoming 5-year track recordsimprove dramatically. However, investors should not forget what caused this significant improvement in 5-year performance. Perhaps we would be wise to look instead at 10-year performance stats.

Unfortunately, many funds and especially ETFs do not have 10-year track records. In that case, all we can do is keep in mind that 5-year averages will increasingly be buoyed by the fact that the worst losses in late 2008 and early 2009 will be dropping out of the data just ahead.

Fortunately, at Halbert Wealth Management we have sophisticated software that allows us to slice-and-dice fund performance data in many different ways that are not available to many individual investors. We have an ongoing commitment to maintain such analytics to help us in determining what investments to recommend to our clients, and those which do not meet our strict due diligence requirements.

This Week isALL About FedDecision Tomorrow

The Fed Open Market Committee (FOMC) began its much anticipated September 17-18 policy meeting this morning. Based on comments by Fed Chairman Ben Bernanke back in May, the markets have been widely expecting the Fed to announce a plan to reduce its massive monthly QE3 bond and mortgage purchases tomorrow afternoon after the meeting is adjourned.

While Wall Street is betting on an announcement to “taper” the bond and mortgage purchase program tomorrow, there is no guarantee that it will happen – although I, along with most analysts, will be surprised if the Fed doesn’t announce something regarding tapering tomorrow. Assuming that is correct, let’s look at what the market is expecting.

The consensus expectation is probably best described by a recent USA TODAY survey of 44 economists taken on September 11-13. Some 61% of economists believe the Fed will start tapering its $85 billion in monthly purchases of long-term US Treasuries and mortgage-backed securities in September. Nearly nine of 10 economists (89%) also expect the Fed to at first be cautious, reducing monthly asset purchases by $15 billion or less. A majority of economists also believe it makes sense for the Fed to cut back on Treasuries first.

But group-think is often wrong. So what Fed surprise could cause markets to gyrate violently? Let’s start with the obvious:

  • No tapering announcement. If the Fed opts to delay tapering, that would almost certainly be apositive surprise for both stocks and bonds. Most analysts believe that both markets have already priced-in a taper of $10-$15 billion a month. Stocks had a downward correction in August, and 10-year Treasury yields have risen a full percentage point since May. So if there is no announcement tomorrow, both markets will very likely get a bounce.

  • Larger than expected taper. If the Fed cuts monthly QE purchases back by more than $10-$15 billion, say to $20-$25 billion, stocks and bonds probably drop on fears of higher interest rates that could hurt the economy, and especially the housing market.

  • Taper mortgage paper first. Only 2% of economists polled by USA TODAY think it’s a good idea for the Fed to reduce its purchases of mortgage-backed securities in the first round of tapering. Such a move would likely cause mortgage rates to rise even higher than they have since May, which would not be a good thing for the delicate housing market.

  • Change in interest rate policy. Fed policy to keep short-term interest rates near zero is widely expected to continue for at least another year. If the Fed were to announce a change in that policy tomorrow, that would be a definite negative surprise. Yet I don’t know of any analysts that expect such a change.

At this point, I would have to say that if the Fed announces tomorrow that it is tapering QE purchases by only $10 billion a month, it may have only a minimal effect on the markets. Yet if the taper is above $15 billion a month, I would expect some negative blowback in the markets at least temporarily.

In any event, the whole world will be watching tomorrow afternoon.

Larry Summers Bows Out as Next Fed Chairman

Finally, it is worth noting that Larry Summerstook his name out of the running for the next Fed Chairman last weekend. Summers had become President Obama’s favorite to succeed Ben Bernanke at the Fed in January, rather than current Fed Vice-Chair, Janet Yellen, who has long been considered the most likely candidate to replace Bernanke.

It’s no secret that Larry Summers, a Democrat, is considered by many in Washington to be an arrogant and unyielding political player. He served as Treasury Secretary under President Clinton from 1999 to 2001. Following that, he was the president of Harvard University from late 2001 to 2006.

Summers is perhaps best-known for comments he made in late 2005 while at Harvard regarding why there are fewer women than men in the fields of science and engineering. In a speech, he made a comment that the reason might be that women generally lack the aptitudes to succeed in science and engineering. He was blasted for this comment and was forced to resign from Harvard in 2006.

For over a year now, Ms. Yellen was thought to be a shoe-in for Bernanke’s job when he leaves in January. Ms. Yellen, also a Democrat, has been a big supporter of Bernanke’s “quantitative easing” and will likely go easy on tapering it, whereas Summers was not a big fan of QE. So after Summers dropped out on Sunday, the stock markets boomed on Monday and are up again so far today.

For now, it looks like Yellen will get the nod to replace Bernanke. Yet there is some reason why Obama wanted to pass her over and appoint Summers. Now there is some talk that he might nominate former Treasury Secretary Tim Geithner – let’s hope not. It will be interesting to see what happens next.

Best regards,

Gary D. Halbert

© Halbert Wealth Management

© Halbert Wealth Management

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