The year in review

By Bob Wood

As I write this column on the last trading day of the year, I think the timing is perfect for reviewing the advice I’ve offered during 2006 and determining, quite honestly, its value. Advice givers should be held accountable for the service they provide, and I am no exception. With that in mind, let’s take a look.

If you have been following my advice closely, you are, no doubt, aware that I have done my best to discourage you from investing in the domestic stock markets. As luck would have it, this has been one of the best years in a decade for the Dow and S&P 500. So far, not so good!

But anyone suggesting what not to invest in should also offer alternatives. And I did, beginning with foreign stock markets. In general, international markets have done quite well and, in some cases, dramatically better than our home markets. For example, two markets that are almost impossible for investors here to get exposure to have shown “eye-popping” returns, to help my case.

Investors in Venezuela’s stock market enjoyed a whopping 150% return in 2006, while those in Peru’s market watched gleefully as that market rose 180%. But as good as that was for local investors, too few companies based there were offered for sale on our exchanges, and few, if any, of our mutual funds included exposure to those markets. I provide this information only to show that the best investment opportunities often lie where the crowd is least likely to look.

However, there were plenty of other great places to invest money freed from domestic allocations this year. Instead of tying up your savings in the S&P 500, which rose about 14% for the year, you could have put money into some shares of exchange traded funds focused on places like India, where the market climbed enough to power the Morgan Stanley India Investment Fund (IIF) to a gain of almost 30%.

Investors in Brazil’s stock market have enjoyed an annual gain of 34%, as shown in the performance of the IShares Brazil Index fund (EWZ). And investors in the IShares Mexico Index (EWW) did even better, with those shares going higher by 37% in 2006. Also, investors in the Hong Kong market, as shown in the IShares Hong Kong Index fund (EWH), gained 25% for their efforts.

Admittedly, I didn’t have one dollar invested in any of those shares, since I prefer shares of closed-end mutual funds, which, at the time of purchase, are priced at discounts to their Net Asset Value (NAV). This feature allows buying a basket of stocks in selected markets for less than they are worth if sold piece by piece.

For example, as quoted from Barrons Magazine, shares of The Greater China Fund rocketed higher, gaining 149% for the year and doing almost as well as Venezuela’s market! Those shares are now selling at a premium to the fund’s NAV, and I sold them from all client accounts this week. To replace them, I bought shares of the Asia Pacific Fund (APB) at a small discount, since I still want exposure to Asia’s faster-growing markets and healthier economies.

That fund has risen in price by 52% for the year, followed closely by another I hold in client accounts, the Asia Tigers Fund (GRR), which climbed 47% in 2006. And one of my favorite choices in that area of the world, as managed by the legendary Mark Mobius, is the Templeton Dragon Fund (TDF), recording a 44% gain for the year. And Lipper shows the China Region funds, as a group, up over 54% as 2006 ends.

The Latin American markets of Brazil and Mexico have been well represented in my client accounts this year, with shares in the Latin American Discovery Fund (LDF) rising by about 58%. Following closely are shares in the Latin American Equity Fund (LAQ), which rose by 55%. Lipper calculates that Latin American funds rose over 39%, on average, in 2006.

Surprising many during the year was how well European markets performed, as they were well ahead of our domestic markets. Lipper shows the group of funds focused on there up almost 33% for the year. And emerging markets funds climbed 29%, with one holding, the Morgan Stanley Emerging Markets Fund (MSF), gaining 44% in 2006.

Also performing quite nicely in 2006 were gold-oriented funds, which Lipper quotes as rising 27%, as a group. One disappointment, considering my strong optimism for their long-term outlook, involved energy shares, which did not meet expected returns. As a consolation prize, though, Lipper quotes average natural resources funds as having risen by almost 16% for the year.

So, how do these returns fare when compared to the S&P 500’s gain of 14%? Not bad, eh? Of course, you could have done a bit better by investing in the Dow, which leads the major domestic averages with its 16.7% gain, or the Russell 2000, with a gain of 18%. But I wonder how many investors left money in those sectors with so many promoters convinced again this year that large cap stocks would outperform small caps, since smaller stocks have led the pack in recent years.

And I wonder how many tied up money in the health care sector, one of the most universally loved by promoters and returning meager 4% gains for the year? In addition, those universally-loved Science and Technology funds rose by about 7%, thus displaying another case of “opportunity cost,” for investors, who tied up investment funds in shares of companies that, in my opinion, don’t even register as investment possibilities, with so many cases of phony accounting and egregious executive pay packages.

Of course, my recommendations included that not only were domestic markets a bad bet for investors, but that hedging their portfolios with allocations in bear market mutual funds (which rise in a falling market) was a good idea. The fact that those funds tend to fall in rising markets didn’t help me much, although my favorite bear market mutual fund, the Prudent Bear Fund (BEARX), which I use to hedge against what I believe will someday be the resumption of the secular bear market begun in early 2000, is actually up almost 9% for the year.

That fund’s manager, David Tice is alarmed, as I have been, by massive money printing, rapidly rising credit availability and the staggering debt and liability loads of consumers, not to mention the federal government’s horrific fiscal situation. And his heavy allocation into gold stocks, used as an insurance policy by hedgers like me to rise along with a rising stock market, helped that fund. It offered a wonderful case for holding insurance against a falling market that also paid its holders to sit patiently with their shares. Imagine: an insurance policy that pays you to hold it!

Two other mutual funds used as hedges in client accounts did not perform as well, but, then, they are supposed to lose money in a rising market. Sizable allocations in the Rydex Inverse OTC Fund (RYAIX) lost over 7% on the year, and shares of the Direxion U.S. Short Fund (PSPSX) lost about as much as the S&P 500 gained, as expected.

So in general, what I have advocated in these 2006 columns went as well as could be expected, considering my bad call on domestic markets, which have risen far more than I would have ever imagined as the year began. But the strong returns in foreign markets, especially the closed-end funds, as well as allocations in gold and energy stocks, saved the day.

As for my “Outlook 2007,” which is so much in fashion at this time of year, I don’t have one! I never plot a strategy for one year. My long-term strategy remains well in place. I still favor the foreign over domestic markets, and allocations in gold and energy remain in place as they have been in recent years. I see little reason to make substantial changes from one year to the next and prefer to stay with what I see as the best long-term trends.

Being wrong in one year or another, at least to some degree, is part of the investment game, But being right in the long-term helps ease any damage done by being on the wrong side of short-term market moves. And what went right this year was enough to offset what went wrong. Overall, I’ll take the gains gladly and head into next year with much the same allocations.

Have a great week,
Bob

Bob Wood ChFC, CLU Yusuf Kadiwala. Registered Investment Advisors, KMA, Inc., invest@muslimobserver.com.

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