Can
it be that another year-end is in view? It just seems like the beginning
of the summer was yesterday, never mind the beginning of autumn.
It has been yet another interesting year in the financial markets (and
we still have two months to go). Despite having to deal with a lot of emotionally
wrenching volatility, as investors we ought to be pretty happy with this
year’s gains so far. If anyone had a crystal ball in January, and
could have seen all the news that would unfold this year, we would venture
they would have predicted a down market, rather than one on pace for above-average
returns.
As we approach a new year, what should investors do to their portfolios?
The short answer is that long-term investors shouldn’t do a darn
thing just because the calendar flips a page. There is no particular reason
why one’s investment outlook should change on December 31st.
However, the more complete answer is that the end of the year is a good
time to practice the discipline of re-balancing your portfolio. Re-balancing
your portfolio simply means bringing its asset allocation back in line
with your long-term strategic targets. In other words, if your game plan
is to have 60% in stocks and you currently have 65% in stocks, then you
should sell that extra 5% to get back to your strategic weight. This is
often difficult to do – why sell something because it is doing well
or conversely buy something that isn’t? However, several academic
studies have suggested that it can add real value over time. Discipline
is rewarded in portfolio management, just as it is at the kitchen table
or at the gym.
At Kobren Insight Management, while we will look at re-balancing throughout
year, we also employ the discipline of reviewing accounts for re-balancing
at year-end. Year-end is a nice time for a combination of reasons, but
a big reason is to get the portfolios in a clean, neutral position for
the year ahead. Like a New Year’s Resolution, it psychologically
feels good.
However, in the case of taxable accounts, we may choose not to actually
re-balance in the last month of the year, but rather early in the New Year.
By waiting only a week or so after we re-balance the non-taxable accounts,
we are able to postpone the payment of any taxes on realized gains for
a full year. From a tax perspective, that makes good sense.
Another tactic we employ to make re-balancing of taxable accounts more
tax-efficient has to do with how we handle mutual fund distributions during
the course of the entire year. For non-taxable accounts, the easiest thing
to do is to simply have distributions immediately re-invested in the fund.
It’s convenient and it allows compounding to do its magic. For taxable
money, however, it is desirable to have distributions paid in cash rather
than be immediately re-invested in the fund. This way, with some cash on
hand, it is easier to re-balance the portfolio without having to sell some
positions and take realized gains in appreciated securities. While a small
thing, this little maneuver should be able to enhance after-tax returns
over time.
Go Overseas Young Man?
We conducted a conference call on November 1st and nearly 500 of you called
in to get our latest update on our thinking for the markets and portfolios.
For those who would like to listen to a replay, go to: www.kobreninsightmanagement.com/conference_calls/index.html
(Or go to www.kobreninsightmanagement.com and click on the conference
calls button on the left side of the home page.)
One topic that came up a few times during the call’s Q&A
session was the U.S. dollar. Investor sentiment is overwhelmingly
negative on the greenback, and for good reason. We are still running
massive trade and budget deficits, never mind the fact that the
Fed is dropping our short-term interest rates below those of most
other major countries (and currencies). There is also the significant
threat that countries that hold large foreign exchange dollar reserves,
such as China, will move to diversify their dollar holdings by
for example, using those dollars to buy euros or euro-denominated
securities. All in all, the fundamental background for the dollar
does not look good.
It may not seem very reassuring to fight such apparent fundamental problems
with clichés, but then again, isn’t it interesting how many
times the cliché seems to win? (After all, that is how they became
clichés in the first place!)
So for those who think it’s a lay-up that the dollar will continue
to get pulverized and therefore want to put a lot more money in overseas
holdings, here come three investing clichés:
“When everybody is on the same side of the investing boat, it is
going to turn over.”
“It’s always darkest before dawn” (admittedly not just
an investing cliché).
And, one of our personal favorites:
“
The market always moves in the direction that causes the most pain.”
While fundamentals do indeed drive the markets in their proper and rightful
direction over the long haul, the markets are inherently mysterious, and
there are times when they seem to go in the opposite direction of the “facts.”
How can this be? Well, sometimes, the facts are already well-known and
thus in Wall Street parlance, “baked-in” to the current market
prices. In other words, more “confirming news” won’t
push prices much further in the direction they had been moving. In that
situation however, any “disconfirming news” is often a catalyst
for a sharp reversal in price. As an example, consider a stock market that
is declining over worries about poor job growth. If job reports have been
consistently weak for several months, the latest month’s weak report
won’t likely move the market much – it was expected. But if
suddenly jobs surged one month – that “contra” evidence
could well spark a rally in stocks.
In some cases, when everyone shares the same view, after a while everyone
who is going to act on that view has already done so. If “everybody” is
bearish, and has already sold, where is fresh selling going to come from?
Then, when prices aren’t going down as much anymore, the first seller
that covers their position (i.e. starts to buy) may trigger others to do
the same. In other words, it is a condition ripe for a reversal.
Besides such a sentiment reversal, what else might cause the dollar to “buck” the
trend (sorry for the bad pun, we couldn’t resist). While our budget
and trade deficits are still bad in an absolute sense, they are improving
off their worst levels. Markets tend to follow changes on the margin. “It’s
the trend, not the level” is yet another market cliché that
captures what generally happens in the marketplace.
Another area of potential support for the dollar is its traditional role
as a “safe haven” currency. In times of financial stress around
the world, many investors have preferred to be in the dollar as opposed
to other currencies. However, there does seem to be some debate over whether
the dollar is still viewed as a safe haven currency.
The question is fair. Nonetheless, during times of elevated market stress
this year, the dollar has actually held up pretty well, if not actually
strengthened. So, if for some reason (and there seem to be plenty of them
right now) we do witness a full market retreat to high quality assets,
whether it be in stocks, bonds, or currencies, the U.S. dollar should do
alright.
All that said we still have significant non-dollar exposure in client
portfolios. Not only do we have exposure to dedicated un-hedged international
equity funds, but we also have non-dollar securities in our multi-sector
bond funds as well as in our alternative funds. In addition, we have international
exposure through our domestic equity funds. We have an overweight in domestic
large cap stocks, and the average large cap growth stock gets nearly 30%
of its sales from overseas.
Add it all up and it should be clear that we still favor plenty of international
exposure in client portfolios. But given the overwhelming negative sentiment
on the dollar, we don’t like the risk/reward bet of adding to that
exposure at this juncture.
