Six things to know about the winners and losers in November’s market

A monthly review of financial market performance and trends, as told through mutual fund category performance (data supplied by Morningstar).

November was a great example of how the major stock averages do not always tell the story of what the “market” is doing. While the S&P 500 posted a total return of .01% (between friends, we’ll call it break-even), there was a fairly wide range of returns in different growth market segments.

• Equity Energy was the month’s best performer, with a 4.76% gain. This category reflected the gains in some of the larger oil and oil-related stocks during the month. Equity Precious Metals gained 3.99% to take third place for the month, as the market focused on some evidence that the global economy could be picking up. That would likely ignite demand for natural resources, and funds in that category gained 2.88%, among the month’s leaders.

• Smaller was better in November. Morningstar’s categories representing Small Growth, Small Blend and Small Value stocks all posted gains of near or above 3% for the period. Confirming the emphasis on smaller companies, Midcap categories outperformed Large Cap categories, by a modest but clear margin.

• Japan, the much-maligned fund category owing to that country’s 20+ year economic malaise, had a strong month, gaining 3.48%.

• Yes, Christmas came early. In U.S. primary sector fund categories, Consumer Discretionary was the clear winner, at 3.80% positive for the month.

• The widely-publicized problems in the Irish banking system, as well as the general fear of “contagion” across several weaker European economies, showed up in the stock markets of those countries. The Europe Stock category lost a whopping 5.53% for the month, and pulled down Europe-centric categories of all types with it. The World Bond fund category dropped 3.48% and the Emerging Markets Bond category did not fare much better (off 3.22%), showing that economic issues hit bond markets and stock markets without playing favorites.

• Funds that offer “inverse” exposure to different market segments, as represented by Morningstar’s Bear Market category, dropped by 1.02%. This continues a trend in which this category of mutual funds has underperformed the “inverse” of the broad market. For instance, over the 12 months ended November, the S&P 500 Index gained 9.94%. Bear Funds, which might be expected to closely match that number, but with a minus sign in front of it, are down 23.29% over that time! I suspect that there are “extenuating circumstances” that make this category a tough one to analyze. It includes several funds that not only short the market, but do so with a leverage factor of 2x or higher. Thus, moves are exaggerated. I plan to ask Morningstar, which is revisting some of their fund category classifications, if they are considering breaking this category into levered and unlevered (or low leverage) funds going forward. I think it would bring some clarity to the evaluation of the performance of such funds.

Can these funds maintain the pace?

We all know that it has been a tough time for growth-oriented investors for the past decade. In particular, even 2010’s fairly strong equity market performance has only brought the S&P 500’s 5-year annualized return up to 0.98%. Interestingly, of the 50 fund categories I track, 42 of them outperformed the S&P over that time! Nearly half (22 out of 50) posted annualized returns of at least 2% above the “market (S&P 500).” That may not sound like much, but when you consider that a 2% advantage, annualized over 5 years, is a cumulative excess return of over 10%, now you are talking about real money. On the flip side of this tale, certain categories now boast 5-year returns that make you wonder if they can maintain the pace. Equity Precious Metals (20.78% annualized the past 5 years), China Region (18.77%), Latin America Stock (16.09%), Pacific/Asia ex-Japan Stock (11.58%) and Diversified Emerging Markets funds (10.90%) should all be examined carefully by anyone looking to invest after missing that kind of outperformance.

Past performance: the double-edged sword

To follow on the 5-year performance trends covered above, here is a simple but extremely critical facet of fund analysis. Naturally, great past performance is not a reason to automatically shun an investment. But I do find it fascinating with all of the investment industry’s hyper-focus on past performance of mutual funds, that seeing such premium returns in a tough period might turn people off.

Bottom-line: past performance has only one guarantee – that you cannot have THAT performance…it already happened without you, in the past! You are better off looking from today forward in evaluating funds and looking beyond return figures through most of your investment process. In future columns, I will focus quite a bit on analyzing risk, and emphasize that in my opinion, one’s evaluation of risk in any mutual fund investment is far more important than a cursory review of trailing or annual returns. In the meantime, figure out what “market” you and your clients are really trying to attack, and direct your energies toward it.

If you have any questions on what you read here, or suggested topics for future columns, please reach out to me at rob@theflexibleinvestor.com.

Robert A. Isbitts, a 23-year industry veteran, is a newsletter writer, published author, and the Chief Investment Officer of Emerald Asset Advisors LLC, a South Florida RIA firm. He created and manages a series of separate accounts available to RIAs, and is the lead-manager of two asset allocation mutual funds. For more information on those mutual funds, visit www.easfunds.com. Rob can be reached directly at risbitts@emeraldasset.com. His second book, “The Flexible Investing Playbook – Asset Allocation Strategies for Long-Term Success” was published by John Wiley & Sons in August, 2010.

The information herein has been obtained from sources believed to be reliable, but Emerald Asset Advisors, LLC (“Emerald”) does not warrant its completeness or accuracy. Prices, opinions and estimates reflect Emerald’s judgment on the date hereof and are subject to change at any time without notice. Any statements nonfactual in nature constitute current opinions, which are subject to change. Projections are not guaranteed and may vary significantly. Further information about the firm may be obtained from the firm’s Form ADV Part II, which is available without charge upon request.