A little over two years ago, I first shared my list of "Recommended Funds" for my online readers. Prior to that time, I presented a quarterly Model Portfolio showing quite a few stock and bond funds (and ETFs) and suggested percentage allocations to each fund. However, over recent years, my Model Portfolios, while doing quite well, were typically slightly underperforming merely investing in two or three of the most popular index funds. I therefore decided instead to merely list those funds that I had been most successful with down through the years.
Periodically since then, I have published how these Recommended Funds were doing, most recently this past December. Over the subsequent two year period since I first published my Recommended Funds list, these funds continued to deliver excellent returns.
Since the start of 2021, these recommended stock funds have, for the most part, continued to perform well. However, there has been some rotation away from Growth funds into Value funds. Additionally, most bond funds, regardless of whether they were included my recommendations, have started to tail off disappointingly as compared to their prior performances. Later in this article, I will show how my recommended stock and bond funds have performed in the nearly four months since that above cited December data was published. I will also include two new bonds funds within that Recommended Funds list.
This is but another example that things in the investing world don't always remain "as is" for too long, even with relatively less volatile fund investments as opposed to individual stocks. So, while my Recommended Funds may be highly suitable for the needs of long-term investors who rarely change their portfolios, for those who occasionally shuffle them based on their perceptions of newly developing market conditions, there now may be some changed things to take into consideration.
While not necessarily implying that investors who hold some of my December Recommended Funds (or similar types of funds within the same categories) completely reconsider these holdings, a lot has happened over the last few months that may alter the investment picture as will be summarized below. As a result, some types of funds may do better or worse than was previously thought to be the case.
Of course, it is not certain that we have moved into a different investing environment in 2021 and project forward to the months and even years ahead. But it is beginning to look more likely that this is indeed the case. Consider that as more individuals are receiving their Covid shots, it is anticipated that the economy will start to return to some semblance of "normal." In fact, we may see the release of pent-up economic activity that was stifled for so long. Add to that a new Democratic administration that seems eager to spread money to most corners of the country in order to, hopefully, ensure a full recovery, such an economic expansion is now more likely than not.
Aggressive investors have already begun to anticipate these changes, likely causing certain types of stock fund investments to jump while others now seem to be lagging quite a bit behind, in spite of a continuing overall bull market.
Bond funds, on the other hand, have begun to see some selling, perhaps suggesting that some adjustments might be made to what was previously working so well.
With these possibilities in mind, let's take a look within both stock and bond fund/ETF categories for now what appear to be the best opportunities to respond to and profit from these trends.
As you likely are aware, so-called Growth funds have trounced so-called Value funds for at least a decade. Many forecasters have previously predicted that the pendulum would shift the other way for many years already, but it hasn't really happened on a sustained basis, until perhaps now.
During the latter half of 2020, I offered to evaluate my Newsletter readers' portfolios. Dozens took me up on the offer and sent me the details of their fund investments. From that, I could see that most investors were still assuming that Growth funds were the place to be as opposed to Value funds. I advised most of them to strive for a more balanced portfolio, with a minimum, at least an equal emphasis on Value funds.
While the average Growth fund was still outperforming the average Value fund during the third quarter, by the fourth quarter, things had turned around. Here are the fourth-quarter performance figures, not annualized, from the Wall Street Journal:
Since these returns for just a single quarter were hefty enough for most investors in Growth funds, it was unlikely many felt the need to jump ship into a heavier emphasis on Value funds. After all, Growth funds had been such stalwart investments for so long. But guess what? So far, year to date through Mar. 18, the trend reversal has gained even more momentum as shown in the list below:
My above-mentioned Recommended Funds included two domestic Value-oriented funds and one Foreign one, namely Vanguard Windsor II (VWNFX), Vanguard Equity Income Admiral (VEIRX) or Vanguard Equity Income Investor (VEIPX), and Tweedy, Browne Global Value (TBGVX). Each of these funds has come to life lately, especially since late 2020; see recent results below. As Covid vaccines were shown to have a high degree of effectiveness starting this period, investors began to assume the world economy, especially in the U.S., would start to bounce back. It further became clear that with Democrats now in control of all three branches of government, along with the Republican-appointed Fed chairman, more economic fuel would be thrown on the fire even after the second round of stimulus payments passed in late Dec. and with Fed-controlled interest rates promised to remain near zero. The third stimulus round, just passed, was much more massive, even though the economy was already showing signs of recovering.
Historically, Value stocks have done best when the economy is in recovery mode, that is, when a recession is ending and interest rates are starting to rise, descriptive of the current situation.
Growth is expected to rise in a stellar fashion in 2021, as a result of all the above, with Gross Domestic Product (GDP) predicted to advance 6.5% this year according to a Bank of America estimate. Since growth typically produces higher prices, investors as a result are now beginning to sense a possible strong whiff of inflation in spite of what might appear to be a somewhat "what-me-worry" attitude from the Fed, our supposed guardians against too much inflation.
According to an article on Marketwatch.com, rising rates and anticipated inflation causes investors to flee from bonds into assets that can serve as hedges against these, including stocks, commodities, and inflation-protected bonds. Stock market sectors that tend to do well during inflation are energy, financials, industrials, and materials, which are considered cyclical stocks, that is, those that follow the cyclical tendency of the economy to either expand or contract. Generally speaking, Value funds have a higher commitment to these major market sectors than do Growth funds. Thus, we may see Value funds continuing to excel versus Growth funds ahead.
Additionally, when coming out of a recession as we have suffered through due to Covid, small-cap stocks "have outperformed large caps in nine out of the last 10 economic downturns," according to an article at cnbc.com.
Among the likely reasons:
- Small caps are considered riskier than large caps so when a recession is entered, small caps tend to be avoided as investors focus on perceived safer large caps. But coming out of a recession, investors once again take on riskier stocks causing small caps to outperform.
- Small companies reflect the U.S. economy to a larger extent than large companies, the latter which often derive a bigger percentage of their sales abroad compared to small companies. Thus, when the U.S. economy is expected to accelerate, it will be reflected to a greater extent in small caps.
These assumptions mirror actually happened when initially, starting in late February 2020, stocks began to fall with the pandemic subsequently declared. Stocks then entered a bear market, with small caps dropping more than large caps through mid to late November. However, since that latter date, small caps have widely outperformed large caps as shown in the category performance listings above.
Furthermore, especially within the Value sphere, Small Cap Value funds have considerably larger positions in sectors that are sensitive to the economy than large caps. For example, the Vanguard Small Cap Value ETF (VBR) has twice as many investments in financials, industrials, materials, and energy than the large cap Vanguard S&P 500 ETF (VOO). Thus, the Small Cap Value category would seem to be well suited to do well if the post-pandemic projections of many investors and economists turn out to be correct.
While interest rates have been rising lately, most of the rise has been confined to longer-term bonds as opposed to shorter-term ones. Thus, while 10-year Treasuries rates have gone from 0.92 to 1.62% since 2021 began, two-year Treasuries have only risen from 0.13 to 0.16%, as of Mar. 18
Short-term rates are mainly determined by Federal Reserve policy. Since the Fed has promised not to raise its near zero Fed Funds rate through 2023, short-term rates have stayed stable. Long-term rates, on the other hand, are determined by market forces such as anticipated inflation and economic growth. Since investors are projecting both inflation, and especially growth, will rise as a result of the end of pandemic lockdowns, long-term rates are much more at risk of rising. Therefore, I advise investors not to currently have investments in long-term bonds, and instead, focus on short- and intermediate-term funds. (Disclosure: I still retain some of my muni bond funds in long-term investments).
The trade-off, of course, is that while long-term bonds pay somewhat higher dividends, they can lose principal and cause losses if you decide to sell. If you are seeking income from your bond investments and you are sure you won't need to sell some or all of these investments anytime soon, you will probably do better in the long run with some intermediate- and longer-term bonds. (The widely owned Vanguard Total Bond Market Index Fund or ETF (VBTLX or BND)), and other so-called core or core-plus funds, usually contain a mixture of bonds but mainly intermediate term bonds).
If, however, you want to avoid seeing the price of your bond fund drop, you should probably stick to short-term bonds. Data on how susceptible a bond fund is to rising interest rates is available by checking the "Fixed Income Style" box for the fund at Morningstar.com. The graphic displayed upon selecting the Portfolio tab shows one of three possibilities: Extensive ("Ext") interest sensitivity, meaning the fund will likely suffer considerably if interest rates continue to rise; the two other boxes, Limited ("Ltd") and Moderate ("Mod") are currently the less vulnerable choices.
My Recommended Funds, that is those that I have currently have the most invested in, are shown below along with how they have done since the end of November when I last published the list. Results are not annualized. Two bond funds that are newly added are shown in bold text.
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Disclosure: I am/we are long ALL OF THE FUNDS/ETFS MENTIONED. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.