European Central Bank President Mario Draghi's pledge to do
"whatever it takes" to save the eurozone from collapse and dollar
weakness propelled European markets and stock funds above all
others in August.
That performance may prove to be a fluke, however, as the
region faces a flurry of uncertainties from the upcoming
political events in Europe, another Federal Reserve meeting
midmonth and seasonal market weakness in September.
Europe stock funds surged 4.31% in August vs. 2.75% for the
average U.S. stock fund, according to Lipper Inc.
The S&P 500 has rallied for three months straight to a
four-year high during the month. It gained 1.97% in August and
10.55% year to date. It would be normal for traders to book
profits after such a healthy run and especially in September, the
market's historically worst month of the year.
"Once tans begin to fade and the new school year begins, fund
managers tend to clean house as the end of the third quarter
approaches," said Jeffrey Hirsch, chief market strategist at
Magnet AE Fund in White Plains, N.Y. "Portfolios are restructured
and weeded out in preparation for the fourth quarter and to
improve performance numbers."
By some measures, the stock market is overvalued compared with
historical averages. On a trailing 12-month earnings basis, the
S&P trades at 16 times earnings vs. the long-term
price-earnings ratio average of 14 times, said Zach Liggett, a
portfolio manager at Kahului, Hawaii-based Financial &
Investment Management Group with $600 million in assets under
management. "Its dividend yield of 1.9% is well below the
long-term average of 4.4%."
Russell Investments' strategists also believe the market will
pull back from its August highs. In addition to high valuations,
they see corporate profits succumbing to sluggish U.S. economic
growth. Eventually profit growth has to align with nominal gross
domestic product growth and that adjustment might be more abrupt
than previously thought, they wrote in a "2012 Global Outlook."
They believe the market got overly optimistic following Draghi's
late-July comments that the ECB will do "whatever it takes" to
save the euro.
Europe Leads Globe
European funds returned 9.69% year to date. Investors can
expect a wild ride in September from the upcoming ECB policy
decision, Dutch election, German Constitutional Court ruling on
the eurozone bailout fund and myriad economic data releases.
Scotiabank projects Europe's economy will contract 0.7% in 2012.
Scotia lowered the European economic growth forecast to a mere
0.2% in 2013, down from 0.3% previously estimated. Contrarian
fund managers say it's time to follow Warren Buffett's words of
wisdom: Be greedy when others are fearful.
"I'm quite excited by the opportunities in Europe," said
Andrew Sleeman, manager of Franklin Templeton Mutual
International with $21 million in assets. "Global companies that
happen to be domiciled in Europe are trading at discounts to
their U.S. peers."
"Corporate balance sheets are a lot healthier than government
balance sheets," Sleeman said. "With challenges come very
interesting opportunities that will generate earnings through
His top holdings include Rexam, the largest beverage can maker
in Europe and Brazil; REXLot Holdings, a lottery machines
developer and producer; and Aozora Bank. His fund returned 7.20%
year to date vs. 6.92% for the MSCI EAFE index for developed
markets, according to Morningstar. It gained 1.94% in the past
year vs. -0.04% for the benchmark.
Japan funds ticked up 0.16% in August and 0.93% year to date.
A 0.38% loss in China for the month weighed on emerging markets,
up 0.76%, which have underperformed foreign developed markets
this year. Latin America added 0.60%.
Fund flow data indicate retail investors missed out of some of
the solid stock fund performance in August by favoring bond
funds. Investors pulled $15.5 billion out of U.S. stock mutual
funds, while funneling $16.3 billion into bond funds in August,
according to EPFR Global. Stock mutual funds globally disgorged
$17.5 billion, while bond funds globally took in $22.7
"We fear this potentially parabolic move in equity markets in
the short term may lure the retail investor back into the markets
just before the beginning of the next cyclical bear begins," said
Douglas Stewart, manager of the Sherwood Forest Alternative with
$12 million in assets. "We are nearing the end of this cyclical
bull rally (that began in early 2009) with a potential
parabolic-type of melt up before entering the next cyclical bear
market in the second quarter of 2013," Stewart said.
Stewart's top holdings includeProShares Short Russell 2000 (
),ProShares Short S&P 500 (
) andiShares FTSE China 25 Index (
Sector Fund Performance
One of the worst performing sectors of the past year outpaced
all sector funds. Precious metals funds rallied 10.18% amid
expectations of more quantitative easing, a weakening dollar and
seasonal demand. Jewelry makers tend to store supplies in late
summer/early fall for increased demand during the Diwali holiday
in India, India's wedding season and the year-end holidays in the
Technology funds climbed 4.42% asApple (
) rallied 8.92% to become the world's most valuable company in
history. Consumer services, 4.10%, were the third highest-gaining
Utilities, down 1.33%, were the only sector to end the month
in the red. Health care ticked up 2.13%.
Outperformance in sectors dependent on economic growth and
underperformance in defensive sectors shows investors have a
strong appetite for risk. Alec Young, global equity strategist at
S&P Capital IQ, recommends overweighting consumer staples,
energy and technology, while underweighting basic materials and
Consumer staples benefits from inelastic global demand and
strong dividend growth. Energy trades at low valuations, while
falling oil prices have prompted negative earnings revisions.
Technology trades at low price-to-earnings growth rates and
enjoys pent-up demand. Young is bearish on materials because
slowing global growth will limit commodity prices. Utilities
trade at high valuations with weak earnings prospects.