July Performance Reports

Investors have or are receiving second quarter Performance Reports.  Since the market is generally up, I suspect most investors are likely pleased with what they see on their report.  As I have said many times before, returns on Performance Reports are pretty much irrelevant as they tell investors what happened over a specific time period.  They do not predict the future.  

There are many examples of the irrelevancy of Performance Reports as a predictive tool.  An easy one is from 1995-1999 performance reports generally looked good with nice gains.  The stock market, as measured by the S&P Index, had double-digit gains beginning in 1995 through 1999 with the lowest gain being 21% in 1999 and the highest being 38% in 1995.  Beginning in 2000 and ending in 2002 the stock market, again measured by the S&P Index, declined each year and declined a total of about 40% for the three year time period.  

I remember 1999 well because it was one of my least favorite years as an Advisor.  What many investors have forgotten is the gain in the S&P Index from 1995-1999 was driven in a large part by technology stocks.  During 1999 investors, investors reviewing a performance report often wanted to increase their allocation in technology stocks/funds or growth funds heavily weighted towards technology stocks and reduce their holdings or allocation in other areas.  

The investment world looked much different at the end of 2002.  The stock market, as measured by the S&P Index declined by about 40%.  Technology stocks or funds had substantial declines, some as much as 80%.  At the same, other sectors in stock market value, many value funds, for example, increased over this time period.  Low-risk holdings, again such as short-term and intermediate returns had very modest, but positive returns.  

So what should investors do today when Performance Reports are looking good.  I would suggest the following:

• Review your current asset allocation.  As part of this, do a risk/reward analysis and expected return analysis. 
• Review holdings to determine if some are trading at all-time highs or if the current market values are lower than previous highs.  If holdings are trading at an all-time high, it is important to ask the question, are the valuations reasonable and if not, what will drive these holdings higher short-term?
• Understand the importance weighting means in an Index and the effect it may have on a portfolio.  For example, the S&P Index is a weighted index.   Currently, 49 stocks in the S&P Index account for 50% of the Index.  The remaining 451 stocks in the Index account for the other 50%.  Some investors, in funds or ETF's which track the S&P Index, believed they have a diversified investment when actually, I would describe it as narrow in its holdings.  It was similar in 1999 and did not end well for investors who gave in to the temptation of increasing their holdings in the best performing sectors.  
• Finally, take some time to think about both the Global economic and political environment.  As part of this, consider long term trends which may affect valuations going forward.  

If you would like to discuss any or all of the above and do not have anyone to talk to, contact me.  I will be happy to visit with you, for a modest fee.