Don't Get Caught Up In Year-End Hype

12/9/2013


For those managing their own accounts, returns for the 12 months ended Dec. 31 are no more significant than any other 12-month period. But for those managing other people's money, calendar years can seem like the only periods that go down on their permanent record.

That may help explain why the S&P 500 Index's winning percentage of 63% in December is higher than any other month since 1928: Portfolio managers who've been too cautious during the year have an incentive to play catch-up by chasing market rallies, while those who've been bullish are probably still optimistic.

Or perhaps December has been atypically strong — with a 1.4% average monthly return for the S&P 500 since 1928, second only to July — because taxable investors can delay tax payments at least 12 months by deferring sales until after year-end.

Both of these year-end effects will tend to be stronger in up years, and there is nothing wrong with incorporating seasonal tendencies into your near-term market view. But history suggests that betting on near-term market zigs and zags is a tough way to make a living, even if you do it for a living.

As an individual investor, one of your biggest advantages over the professionals is that you don't need to worry about how the next month will impact your returns relative to a benchmark. You can execute according to your long-term game plan.

For our money, we plan to do the following:

Watch the averages. The Dow Industrials and Dow Transports reached all-time closing highs on Nov. 27, and the primary trend is unequivocally bullish. But at some point the market will suffer a significant correction, and it will be the action of the averages following such a setback that will determine if the Dow Theory remains in the bullish camp.

As a very general rule of thumb, significant corrections retrace one-third to two-thirds of the preceding rally over three weeks to three months. If that much of the rallies from the Oct. 8 closing lows were retraced, the Industrials would trade at 15,215 to 15,660 and the Transports at 6,715 to 6,990.

Look for reasonably valued growers. Our emphasis on shares of quality companies with attractive valuations does not outperform in all market environments. But history suggests it works more often than not, and our emphasis on not overpaying can also help us set our stock-market exposure.

Part of the reason we're comfortable holding 95% to 99% of our buy lists in stocks is that we're still finding attractively valued growers. When that is no longer as true, or when we can't find enough names in different sectors to diversify sufficiently, we will reduce our stock-market exposure. For now, we continue to see such growth-at-a-good-price standouts as Helmerich & Payne ($80; HP), Lear ($82; LEA), Qualcomm ($73; QCOM), and Skyworks Solutions ($28; SWKS) as attractive picks for both 12-month and 36-month returns.

BUY LISTS RETURNS
Year
Focus
List
(%)
Buy
List
(%)
LT Buy
List
(%)
S&P 500
Index
(%)
Since 2003 *
159.4
200.0
137.7
104.0
2013 *
31.6
36.9
36.2
25.9
2012
14.2
16.0
15.8
13.4
2011
(4.8)
(9.1)
(4.2)
0.0
2010
19.5
12.7
10.3
12.8
2009
40.0
37.6
30.6
23.5
2008
(48.8)
(46.3)
(36.5)
(38.5)
2007
22.8
19.2
10.8
3.5
2006
12.9
16.9
9.7
13.6
2005
8.1
13.2
4.1
3.0
2004
17.5
22.4
9.0
9.0
2003
20.2
29.2
24.6
26.4

Returns assume fully invested portfolios and exclude dividends, taxes, and transaction costs. * As of Dec. 3.

Watch for signs of irrational exuberance. Sentiment surveys and mutual-fund inflows suggest bullishness is already fairly rampant. If the averages melt higher through year-end and sentiment indicators hit extreme levels, a shift toward defense may be in order. That could mean rotating into other sectors or simply selling some of our recent winners.


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