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Focus On: Technology Funds

(Published 09/01/06) The last time we upgraded technology-oriented mutual funds was in August 2002, when we raised the category from a (Weak) to a (Neutral). At the time, the Nasdaq was in the 1,300 to 1,400 range – close to the crash low and near the index levels of 1996.

Why didn’t we upgrade to a (Interesting) or even a (Most attractive) given the opportunity in tech at the lows of 2002? The main reason was, at the time, there were better opportunities in other fund categories and our rating system is relative to the market.

Recent subscribers may think of us as negative on most fund categories, but at the time of our 2002 tech upgrade we had top ratings on several fund categories: small-cap growth, telecom, natural resources, utilities, convertibles, balanced, international diversified, global, global balanced, Japan, Asia, Europe, and Latin America. Most funds in these categories have beaten tech stocks over the three years following August 2002. Today, with valuations and investor optimism where it is, we’d be more excited about tech only if the Nasdaq was at 1,300.

In 2002 our rationale for the tech upgrade was–-

“…largely because the valuations of many tech stocks today are not that far out of whack with the rest of the market, adjusting for potential future growth. We don’t see tech stocks as a class dramatically underperforming the market as we have the last couple of years. We’d be perfectly happy if it takes five years for the NASDAQ to reach 2000 because from these levels that would be a 10% return per year. “

As it turned out, the turnaround in tech came on pretty strong after it finally bottomed in late 2002. The Nasdaq broke 2,000 – almost a double from the crash low – at the beginning of 2004 but has been holding at that level ever since. We downgraded the category back to a (Weak) in June 2004 (at Nasdaq 2,000).

Such is the nature of the stock market – often it takes an advance on the future prosperity of corporate America, and then has to sit and wait for fundamentals to catch up.

The Nasdaq took a quick dip to below 1,800 in 2004 after our summer downgrade and we upgraded back to a (Neutral) in September 2004. Along the way we’ve picked up some tech funds (usually ETFs like iShares Semiconductor – IGW) in our higher-risk portfolios during moments of weakness. Some we’ve sold after the Nasdaq ran up a few hundred points to the outer reaches of reasonable valuations.

We don’t see technology stocks as a particularly great value now, just reasonable compared to everything else, hence the upgrade to a positive rating – our first for tech. We expect a 6 to 8% return annually in the coming years, with some swings that may make it possible to see 10% or more with the right entry point.

Fundamentally, technology stocks are risky and sensitive to an economic slowdown (computer budgets get slashed during hard times – at home and at work). More important to us, investors are not that interested in technology anymore – they see better upside abroad or in commodities. Mega-cap tech, the old 1990s growth favorites, like Dell (DELL), Intel (INTC), and Microsoft (MSFT), are particularly out of favor compared with just about any time in the last decade or so (the market crash bottom of 2002 being the only possible exception). Some of this is warranted as growth going forward is going to be slow and margins compressed. Without a major recession it’s unlikely these sorts of companies will fall on much harder times – or at least do no worse than most other companies. We’d have to see actual panic selling in tech and even better valuations – maybe Nasdaq 1700 or so – to upgrade to our highest rating, but funds investing in tech stocks should perform better than most going forward.

Tech ETFs are among the least favorite of the more mainstream ETFs around. Total assets in all no-load tech funds and ETFs are just under $20 billion today. For comparison, near the bubble peak just two tech funds collectively had over $20 billion in assets (T.Rowe Price Science and Technology - PRSCX and Janus Global Technology - JAGTX).

More stunning is the fact that fund investors have lost more money in tech funds in the 2000-2002 crash than currently is in tech funds. They even lost more money collectively than was made in all those hot, triple-digit return years of the late 1990s. Buy high, sell low.

It’s almost impossible to find a tech fund that isn’t sitting on tens of millions – sometimes billions – in loss carryforwards from the crash. Paper gains quickly became very real losses for millions of investors. Don’t expect any taxable dividend distributions anytime soon in this category.

It’s a good idea to invest in fund categories that other fund investors have lost gobs of money in. It’s proof you are doing the opposite of other fund investors – and doing what the other investor isn\'t is the cornerstone of the Powerfund strategy.

Category Rating: (Interesting - should outperform the market and 60% of stock fund categories over the next 1 to 3 years)

Previous Rating: (Neutral - should match the market\'s return and perform in the middle of other stock fund categories).

Expected 12-month return: 8% (raised from 6% in our last favorite fund report)

OUR FAVORITIE TECHNOLOGY FUNDS
RANK/FUND NAME/TICKER ADDED SINCE ADD vs. S&P 3 MONTH 1 YR.
1. SSgA Emerging Markets (SSEMX) 9/02 209.90% 145.86% -2.93% 45.08%
2. Excelsior Emerg Mkts (UMEMX) 9/02 217.43% 153.39% -5.09% 37.90%
3. Vanguard Emerging Markt Indx (VEIEX) 9/01 224.45% 194.02% -3.20% 37.89%
4. Bernstein Emerging Markets (SNEMX) 9/02 270.69% 206.65% -3.26% 36.36%

The Fed - Dr. Feelgood

08/23/06 -

Much of the volatility in the stock market in recent months relates to investors’ fears about the Federal Reserve’s decisions on short-term interest rates. Until very recently, the big questions were, ”When will The Fed stop raising rates? Will they overdo it and cause a recession? Will they fail in trying to stop the climbing inflation rate?”

On August 8th The Fed didn't raise rates, ending a campaign that started back in June 2004, yet some fear they are not done yet – while others worry that the damage was already done.

The Federal Reserve gets a lot of play in the financial press, but the reasons behind the fed raising and lowering interest rates are not clear to most people. We thought it was high time for a short primer on why the Fed does what it does.

July 2006 performance review

In July, safer investments performed better than more speculative ones. The Dow was up 0.45%, the S&P500 gained 0.62%, and the S&P100 – the largest stocks from the S&P500 - rose a solid 1.7%. The Russell 2000 small cap index was down 3.25%, while the Nasdaq fell 3.71%. Larger cap foreign stocks more or less stabilized and moved up with the U.S. market, but smaller cap foreign stocks had some trouble. Bonds gained as interest rates headed downward – so much for the big interest rate increase. The Vanguard Total Bond Index was up 1.35% for the month.

The 'Rent vs. Buy' Lie

08/11/06 -

After a multi-year plateau, rents are finally rising again. Rising rents can make buying a smart move, but with inflated home prices, renting and investing in mutual funds could be a better move.

Renters are watching closely, and asking themselves if now is a good time to buy a home. Rents are currently going up faster than home prices, reversing a multi-year trend of homes price increases far outpacing rents.

Unfortunately, many so-called “rent vs. buy” calculators on the Internet can lead you down the wrong path. For one thing, they should be called “rent & invest vs. buy”.

For the last few years, home prices have climbed, but falling interest rates (and creative mortgage products) have made homes almost as affordable (in terms of monthly payments) as they were before the big run-up. Recent increases in interest rates — notably shorter-term rates that are used to set many adjustable rate mortgages — have made the current home price levels unaffordable for many new buyers. This increases demand to rent, which, coupled with decreases in the supply of rental units from condo conversions, can raise rents. But do rising rents make buying a smart decision now?

Will the big bad Fed blow your house down?

Inflation is increasing and economic growth is slowing. The Federal Reserve knows they created inflation with their recent stint of economic stimulus, but is worried attempts to cool the economy could cause a major recession. If they take a wait and see stance, inflation could spiral out of control even with a slow economy – the dreaded stagflation of the 1970s and early 80s

Don’t Get Swept Away

07/21/06 -

The good news about the Fed bringing interest rates back up is that investors no longer have to make due with pitifully low yields on the cash they have lying around.

Trouble is, many poor souls with accounts at the nation’s premier brokers are STILL earning rock bottom rates of around 1% (and lower) a year. In today’s 5% world, this just shouldn't be. The culprit is the innocuous sounding “sweep” account. At the big four “discount” brokers – E*TRADE, TD Ameritrade, Schwab, and Fidelity – investors parking cash often get carjacked.

How are the brokers sticking it to customers, and what can customers do about it?

When you are not in stocks, bonds, or mutual funds, your cash is swept into the broker’s “interest bearing” account.

Many investors keep a good chunk of their account in cash at any given time – not just between trades but often for years at a time. Recently E*TRADE customers had total cash deposits of $10 billion in sweep deposit accounts – the largest single place customers park cash, more than money market, savings accounts, and CDs combined. E*TRADE paid out an average rate of 0.74% on this $10 billion last quarter.

June 2006 performance review

June started out a little rocky but recovered somewhat as the month progressed. The S&P500 was up just .14% while the Dow was essentially flat (down .05%). Tech was a touch weaker, with the Nasdaq off .31% in June.

Sell High

07/13/06 -

The top of the great emerging markets run will likely be very close to the levels hit on May 16, 2006. That’s the day Dreyfus filed with the Securities and Exchange Commission to launch another emerging market stock fund – to be named Dreyfus Emerging Markets Opportunity Fund.

With billions of new money flooding into emerging markets funds (after a massive three-year rally that has seen most funds in the category triple in value), Dreyfus is getting tired of sitting on the sidelines while competitors bring in all the loot.

Can you blame ‘em? Emerging market funds are about the last area where a fund company can make an honest buck. Management fees for your typical emerging market stock fund are double domestic stock funds – even the ETFs in this area have high expenses. iShares MSCI Emerging Markets Index (EEM) charges 0.75% a year. As this ETF recently peaked at around $14 billion in assets, Barclays Global Investors (the company behind the popular ETFs) rakes in more money from this fund than any other they run.

Ask MAX: Payoff Debt or Takeoff in Funds?

07/06/06 -

Ray and Margaret ask: 'We are a 26-year-old couple getting married and want to invest our wedding money in the best way possible. (We estimate receiving 25k.) My fiancé is still in grad school, and I am paying off student loans. Should we put the money toward paying off our educations? Or should we invest it in a mutual fund?'

As an investment advisor, I should tell you to pay off all debts before investing because it's unlikely you'll earn more investing than the rate on your debts — especially after taxes, commissions, and the like. Plus, it's a lower risk strategy — imagine your investments go sour, you lose your job (the two can be correlated with the economy) AND you still have your debts.

That said, I'd only pay off high interest rate debt like credit cards (and then only if you WON'T rack the debt right back up). Student loan interest is acceptable debt to carry. For one, unless you earn a lot of money ($65,000 per year single filers or $130,000 for joint filers) the interest is deductible on your taxes (thank you Bill Clinton). Credit card interest is not deductible (thank you Ronald Reagan).

Buying Opportunity?

Let’s check in with what fund investors are doing – and as usual, consider doing something else.