In 2006, my pessimism didn't pay

By Tim Middleton

It's fess-up time. Looking back on a year's worth of these columns, I've had some ideas I'm proud of and some I'm not.

The one thread running through my mistakes is that I was too pessimistic about the outlook for stocks. That led me to write too often about defensive measures to avoid a downturn that never came. Fortunately, this year's market was so forgiving and the profits so widespread that my mistakes weren't too costly.

So without further ado, here's my report card for 2006:

In one of my first columns this year I took note of so-called focus funds, which have only a couple of dozen holdings and therefore are apt to be streakier than funds in general. I predicted their fortunes could reverse in the coming year, and they did.

Longleaf Partners (LLPFX), which had fallen to the bottom 80% of similar funds in 2005, ranked No. 1 in 2006 with a gain of 24%. Jensen Fund (JENSX), which last year finished in the 96^th percentile, near the bottom, this year soared to the sixth spot on a gain of 14%.

Clipper Fund (CFIMX) climbed to the 50^th percentile this year from the 98^th last year with a 13.1% advance. Oakmark Select I (OAKLX) rose to the 55^th percentile from the 76^th on a gain of 13.6%.

Just as gains followed losses, so did 2005's winners surrender their titles in 2006. Marsico Focus (MFOCX) tumbled into the 57^th percentile from the 13^th with a total return of 6.9%. TCW Galileo Select Equity I (TGCEX), usually in the top 20% of similar funds, plunged to the 98^th percentile with a return of minus 4%. CGM Focus (CGMFX), in the second percentile last year, slipped to the 23^rd ranking with a gain of 15.2%.

The lesson: Buying good managers when they're down is more likely to be successful than chasing them when they're hot. And selling them when they're down is a mistake.

Hedges good and bad

In another early column this year, I discussed strategies for hedging your portfolio against what I saw as a world of risk. In fact, securities markets did extremely well this year, meaning most of my hedges were busts.

Pimco Commodity Real Return Strategy D (PCRDX) sank 0.6%. Oppenheimer Real Asset A (QRAAX) tumbled 10.6%. And it got worse: The two leveraged Nasdaq bear funds, Rydex Inverse Dynamic OTC (RYVNX) and ProFunds UltraShort OTC (USPIX), were each down 11.1%.

Three other funds I recommended in the same "Build your own hedge fund" column did very well but for a quite different reason. CurrencyShares Euro Trust (FXE) has risen 14.3% this year, as of Dec. 12; iShares Comex Gold (IAU) is up 20.8%; and StreetTracks Gold (GLD) has spurted 21.1%. All three have benefited from a weaker U.S. dollar, not weaker domestic securities markets.

Having touted gold in that column, I panned it on fundamental grounds in another with the headline "Gold's big run is almost over." I said $570 an ounce was likely to be the metal's peak price. On Thursday, it was trading around $623.

That price is down, however, from a peak of more than $700, which gold reached three months after my column appeared. So far, more has been lost in gold than been made since my column appeared, and in that sense I may have done some good.

Real profits

One place where I profitably overcame my own skepticism was in recommending real estate. It had already been on what I called a "six-year rampage" in March, but it continued, and the average fund investing in that sector was this year's top performer, its 33.8% gain more than doubling the market's own strong advance of 15.1% at Vanguard 500 Index (VFINX).

Despite the group's momentum, I predicted it could continue to advance because demand was increasing from investors as well as tenants, and overseas as well as at home.

By the same token, my contrary nature was richly rewarded when I wrote a column in April disparaging U.S. Oil Fund (USO), an exchange-traded fund created to track the per-barrel price of oil.

I said, "Aside from the fact that now is probably a better time to be selling oil than buying it, I think U.S. Oil Fund represents the kind of overspecialization that does little other than create yet another revenue stream for the fund industry."

Since the column appeared, the price of U.S. Oil Fund has tumbled more than 20%, even as the market has advanced 10%.

In February, I warned that small and midsize foreign stocks had gotten awfully expensive and suggested you take profits there and deploy the money into large-cap foreign growth stock funds.

I was wrong, and one fund recommendation was awful. I had touted T. Rowe Price Japan Fund (PRJPX), and it fell 6.3% this year. My other recommendations at least weren't too costly. The average small and midcap foreign growth fund advanced 23.9% this year, while the average large-cap foreign growth fund gained 22%.

Re-emerging

Where my advice was more costly was a column in May called "Time to leave the emerging-markets party."

Noting that sudden, strong rallies in developing markets were historically followed by periods of underperformance, I predicted an 8.5% decline in the group. In fact, after a sharp correction just before the column appeared, emerging markets soared. The average diversified emerging-markets fund surged ahead 27.6% this year.

Chief contender for dumbest words I uttered all year are this opening paragraph of a column in August about investing defensively: "It's official: The economy is going into the tank, and the market is going down with it."

My premise was that the Federal Reserve had stopped raising interest rates specifically because it feared that might bring on recession. I went on to recommend a handful of funds I felt would be safe refuges from a tormented market.

Since that column appeared, the market has been anything but tormented, with Vanguard 500 Index spurting ahead 12.1%. Among the seven funds I recommended, however, six have done well anyway: T. Rowe Price New Era (PRNEX), up 9.2%; iShares Dow Jones Select Dividend (DVY), up 10.1%; Yacktman Fund (YACKX), up 10.6%; Icon Materials (ICBMX), up 11.8%; and Financial Select Spider (XLF), ahead 12.3%, the only market beater. Pimco Floating Income D (PFIDX) is up only 3.6%, but for an ultrashort bond fund, that's outstanding.

The big disappointment was Vanguard Consumer Staples (VDC), ahead only 6.5% in the last four buoyant months.

I once graded myself on this year-end review, and not surprisingly, I gave myself a pretty high score. This year I wouldn't be as kind to myself. I was way too cautious.

Right now I'm not feeling particularly pessimistic, and it's not just because of the holidays. Change lately has been for the better, and that's always cause for optimism. May my judgment be better in 2007.

At the time of publication, Tim Middleton owned the following securities mentioned in this article: CurrencyShares Euro Trust and T. Rowe Price New Era.