2009 Presents Challenges and Opportunities for Investors
In this months Viewpoint, Michael J. Chasnoff answers four frequently asked client questions:
What do you expect from the markets this year?
As most of our clients know, we do not believe in market timing nor do we place any value on market forecasts. This being said, it is fair to say 2009 presents an unusual challenge for investors. While economists believe the recession will get more serious, many do not expect the economy to spiral further into a depression. Many indicators suggest that the current downturn is deeper than most recessions and its duration may be longer than the average economic pullback.
Recently, the stock market was down 50% from its high. Like many investors, the market tends to overshoot fair valuations and the probability is high that the stock market has over-discounted our economic difficulties. In many respects, the market is at a much more attractive value than a year ago. The dividend yield is up to 3.5% and is higher than Treasury yields for the first time since 1957!
The value of the S&P 500 Index is ultimately derived from the balance sheets and book values of the 500 corporations that comprise the index. Back in 2000, investors were paying $6 for every dollar of invested capital (i.e., book value) in the index. Now that number is down to $1.80 for each dollar of capital. Given the market downturn and current valuations, we would expect equities to return close to their historical average of 10% annually over the next decade.
What is your greatest concern which could hurt the market?
While it has been said the market will climb a wall of worries, from our perspective, the greatest concern is the condition of the credit markets. The Troubled Asset Relief Program (TARP) could be called the Toxic Asset Relief Program. While the treasury has injected hundreds of billions of dollars into the banking system, little relief has been transferred to the consumer through tax relief and mortgage assistance programs designed to ease the pressure on foreclosures.
Why should I maintain my present asset allocation?
Many investors are questioning their commitment to stocks and bonds. While we believe stocks represent good long-term values, we also believe high quality bonds are offering the best yields in 50 years. Ten year Treasury bonds are yielding 2.1% and 30-year Treasury yields are 2.5%. Yet high-quality rated corporate bonds and AAA municipal bonds are yielding 7% or more. This would suggest that the anticipated default rate of bonds is higher than normal. And while part of the spread (perhaps as much as 1.5% of this yield) may be lost to failures, the difference will handily reward investors. To minimize security risk (due to defaults), we recommend broadly-diversified, institutionally-priced bond mutual funds.
Can I expect index and passive investment strategies to outperform actively managed funds?
The secret to the success of indexing and passive investment strategies is their inherently low-cost structure. Almost all the activity in the market consists of fund managers trading with one another. By sidestepping these additional costs, you should improve your return.
Lower cost includes lower expense ratios, lower transaction costs, and no sales loads. The typical mutual fund is held for five years, and, if you pay a 5% sales charge, you are adding 1% per year to your costs. With a 1% expense ratio, 1% sales charge, and at least another 50 basis points from 100% turnover in the portfolio, investors are paying 2.5% annually in costs. The chance that a fund manager can successfully overcome that annual drag and outperform the market over the long run is very low. A fourth source of costs is the tax liability generated by the inefficient way most mutual funds trade. Studies have shown the government makes more than investors across the fund industry – tax liabilities exceed fund returns.
Investors should maintain balanced portfolios with very broad, global diversification no concentration in investment style or capitalization.
Online Investment Journal Coming Soon
Additionally, I am pleased to announce that we will be introducing a new avenue of communication for our clients in 2009 with the launching of an online journal dedicated to providing insightful and educational investment commentary for the clients and friends of Truepoint. You will receive a brief email notifying you of the launch of this journal in the near future. We hope you will find this additional source of periodic information and guidance helpful.