Fagan Associates Archive for September, 2009

Periodically, the Open Market Committee of the Federal Reserve meets to determine, amongst other things, the direction of interest rates.  One such meeting concluded this past Wednesday and from it, according to their press release, came some very interesting observations.

The release notes that “conditions in financial markets have improved further” since they last met during August and “activity in the housing sector has increased.  Household spending seems to be stabilizing, but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth and tight credit.”  The key word within this portion of the policy statement and the main reason for the recent run-up in the stock market is “stabilizing.”  Think back to one year ago when first Lehman Brothers fell to be followed shortly thereafter by the collapse of American International Group (AIG), investors of all kind were in a state of panic as there was apparently no safe haven.  Even the most conservative investors, those that invested in banks, were worried.  The belief was that the United States was headed into a depression.  Fast forward ahead to early March 2009 when, in hindsight the stock market bottomed.  It did so amidst a sea of discouraging economic news as well as a preponderance of consumer and investor pessimism.  Therefore, stabilization, although perhaps not adequate enough now to move the stock market higher, is a step in the right direction.

The press release observes that although “businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales.”  In other words, the supply out there is somewhat in proportion to current demand.  Furthermore, “the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability.”  There is that word again, “stabilize.”  What we gather from this paragraph is that the Fed sees a stabilization of economic growth with little inflationary pressures, at least in the foreseeable future.  In fact, the Fed goes on to state that “with substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.”

Concerns of economists are now beginning to center around the question of “how do we exit this period of easy monetary policy and quantitative easing?”  The Fed begins to address this issue.  “In these circumstances, the Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability.  The Committee will maintain the target range for the federal funds rate at 0 to ¼ percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”  However, “the committee will gradually slow the pace of these purchases (agency mortgage-backed securities and agency debt) in order to promote a smooth transition in markets and anticipates that they will be executed by the end of the first quarter of 2010.”  The phrase “gradually slow the pace” is the equivalent of the Fed taking away the punch bowl, and to mix metaphors, eventually passing the lending baton to the private sector.

THE BOTTOM LINE comes with the assurance that “the Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets.”  With this in mind, we believe that this accommodate policy by the Fed along with the Obama Administration makes for an attractive investing environment, one in where, we believe, that the risk is being out rather than in.

Given the fact that the stock market has run-up more than fifty percent from its closing low set just this past March 9^th and almost everybody is telling you to buy, we thought it would be a good idea to identify at least some of the reasons why one might sell.  Although there are many more reasons than those listed below, we thought limiting the number to ten might be a good idea.

The first reason for selling is that your situation has changed which may require a change in your asset allocation.  Perhaps you have an upcoming college tuition bill, a wedding or your retirement looms in the near future.

The second reason for selling pertains to a change in the objective of the fund or perhaps an inadvertent drifting away from its objective.  This can be as a result of the fund growing too large.

Reason number three, the fund is underperforming relative to other similar funds over an extended.  Remember to always try to improve your portfolio.

Reason number four, the mutual fund has changed managers or its management.  Many times the individual responsible for all of those gains is no longer at the helm.  This is a yellow light.

Reason number five, the fund has high expenses relative to other similar funds.  These days, gains are hard enough to come by without being encumbered by high fees and expenses.  Your job is to weigh the fees relative to the returns generated by the fund given the level of risk you are assuming.  Keep in mind that these fees can change over time and also these fees can be more onerous than other investment alternatives such as Exchange Traded Funds (ETFs).

Reason number six, after this fifty percent run-up off the bottom, perhaps you should rebalance your portfolio.  This would entail selling some of one fund and buying into another.

As we enter the final quarter of 2009, for non-qualified, taxable accounts investors should investigate selling one of their funds to claim a loss on their tax return.  For example, high yield funds may be solid performers, but given the fact that you pay tax on the interest/dividends every year, there may be an accumulated capital loss.

Reason number eight, you may own too many funds.  Consider selling one to improve the quality of your portfolio and to reduce the number of holdings.  Many investors are like kids in candy stores and accumulate way too many funds.  This generally results in mediocre performance, something we wish to avoid.

Reason number nine.  As many of you may have found late last year and early this year, you over-estimated your tolerance to risk.  Now with stocks in an uptrend you are able to look objectively at your portfolio without the emotional turmoil you might have experienced near the lows six months ago.  Determine your objectives and allocate your assets according to your risk tolerance, keeping in mind how you felt a while back.

Finally, the tenth reason you should sell a mutual fund is if you have some overlap of objectives within your portfolio.  Perhaps you have two or three “large-cap, growth” funds.  It may be time to trim one position keeping in mind reasons one thru nine prior to doing so.