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A Dirty Secret

            Why is it that Sept and October are two of the toughest months for investors with such radical differences between winners and losers?  It wasn’t until I ran my own mutual fund that I understood this little dirty secret.

 

Mutual Fund Bonus Time

 

            The end of the 3rd quarter is an important moment for mutual fund portfolio managers.  I didn’t realize how important until I stepped into the dark world of managing my own mutual fund  - the “Integrity All Season” mutual fund – back in early 2000s.  At the time, I thought it was a great idea.  I thought we could steam line our allocation process, cut some separate account costs, improve daily liquidity for our clients and maybe attract some new assets by offering an “alternative” mutual fund.  What I discovered was that most mutual funds are terribly inefficient and costly to run, more expensive than managing client assets through separate accounts in fact.  On top of that, I found myself jaded by the primary objectives of our host fund company.  Real wealth management, including risk and volatility reduction, and consistency of returns, were simply not important.  Beating the S&P 500 or a select benchmark each quarter or each year regardless of risk, was the one and only thing that mattered.  I voluntarily shut down our fund in 2007. 

 

          Judgment day for most mutual fund portfolio managers is the end of September, sometimes the end of October.  This period is also the fiscal year end for most shops and bonuses or termination warnings are often delivered at that time based on performance against your benchmark.  It’s just that simple and it doesn’t seem to matter if the trend is up or down.  If the benchmark is up 15% over the preceding 12 months and your mutual fund is up 15.5% - money and praise rain down.  If your benchmark is down -15% and you are down only -14.5% - you still get the bonus, maybe even a corner office!  But woe is the plight of the manager who underperforms in any way.  No soup for you!  Now imagine yourself in the manager’s seat approaching the end of September.  Are you going to go out on a limb and buy some sector or stock that is down hard on the year, out of favor and losing money?  No, in fact you’ll probably sell it quickly to get it out of your list of holdings.  On the other hand, you are very likely to sit on your 12 month winners and hope that they continue to reward you for another 30 days.  So the dirty secret is this; Going into the end of September, winning sectors stocks and funds will continue higher while those on the losing end tend to suffer greatly.  Beginning in October, managers (at least those who still have jobs) are now free to be more critical with their holdings often selling wildly overbought and overpriced stuff and reach for more attractively priced sectors, holdings and asset classes.

            So how can we use this little secret to our advantage?  Well obviously we want to hold CURRENT market leaders through the end of September but begin making a short list of things that are oversold, better values and likely candidates for the coming wave of reallocation buys come October.  We also want to be very careful about buying more “winners” at this very late stage of the game.  Lets take a look at the current winners and losers, which is now most easily recognized since the last peak on July 3rd.

 

 

 

Winners:

Long Term Bonds – way overbought and very ripe for profit taking in the next 30 days.
 
Emerging Markets – Not overbought by any stretch or metric and still leading.  Brazil, India and developing Asia look best.
 
China – Same, hard to say this is a developing country anymore.
 
Technology – Approaching over bought, especially among social media.  Stick with mega cap companies or large cap tech ETFs.
 
Healthcare – Core position for the next 30 years, but currently overbought
 
Transportation – Cyclical, overbought, expensive and ripe for profit taking

 

Losers:

Small Caps – Oversold, ready for a rebound associated with a stronger US dollar

 

Gold – Oversold but avoid – still no inflation in site and naturally fights the Fed as they end QE measures

 

Energy – Neutral but could be a rebound defensive sector, lots of cross currents

 

Europe –  Oversold but Avoid – messy and now recessionary

 

Wild Cards

 

            As a Wildcard play, I also like Japan for the remainder of 2014, possible longer.  I need to get a better understanding of the currency, carry trade happening but these are the nuts and bolts.  Japan is now under the regime of Abenomics who is taking his cue from the US Federal Reserve in printing great gobs of money and injecting it into their ailing economy.  Furthermore, as our own QE measures dwindle and money in US Treasuries begins looking for a new home (seen as rising rates) as we approach the end of the year, we can also expect downward pressure on the YEN, which is also good for Japanese stocks.  If we believe and understand the power of stimulus and the impact on currencies, interest rates and ultimately stocks, than Japan is in the early stages of a very profitable bull market.  We have a taken a small entry level position in Japan in our All Season and Foundations models as of this AM through the Wisdom Tree Japan Total Dividend ETF (DXJ)

 

And Wild Cars

 

            Still loving our automotive positions in our New Power strategy.  Could also be in the early stages of multiyear bull markets.

 

 

 

New cars from Tata Motors (TTM) in India, a country exploding with demand for transportation and modern luxury.

 

 

 

and Tesla (TSLA)  - the coolest electric car on the planet – of course you want one.

 

Happy Fall

Sam Jones