May 08, 2008

Hello, this is Dan Wiener with the FFSA Vanguard Hotline update for Thursday, May 8.

There are some changes recommended for our Model Portfolios. Grab a pencil and some paper, and I'll give them to you in a minute.

The employment report last Friday was quite positive, with just 20,000 jobs lost and the unemployment rate actually improving from 5.1% to 5.0%. And today's new unemployment claims number came in at a lower-than-expected level, on top of a productivity report yesterday that shows unit labor costs are not going to be a catalyst for higher inflation.

The ISM Service Economy index came in much better than had been anticipated, showing expansion, not contraction, in the service side of the U.S. economy, which represents about two-thirds of our GDP. Certainly a good number. And April retail sales were stronger than expected. Add to that the fact that Disney said consumers continued to head to theme parks despite what many Chicken Littles have called a recession heading to Depression, and you can see that consumers are not to be counted out. And remember, most haven't gotten their economic stimulus checks yet.

As I've mentioned again and again, the earnings news and reports on the state of the economy are divided between the housing and finance industries, and everyone else. If you strip out financials, which are taking massive write-downs, earnings for S&P companies were up quite nicely in the first quarter, though final figures aren't in yet.

Speaking of financials, you may have seen a report that lending standards have gone way up, and hence, fewer loans are being made to individuals and businesses. Remember that there's a flip side to this: The loans that are being made are being made to businesses and individuals with real needs and real ability to pay them back. In other words, quantity may be down, but quality is up. There's nothing wrong with that.

Oil closed at $123.53 yesterday despite good inventory data. I can't tell you why oil is moving so much higher so fast, and neither can any of the supposed experts, though they all have theories and know that theirs is the right one—only one or two can possibly be correct. I would say, however, that though we keep our eyes on oil, and its impact at the pump, the U.S. economy is much less dependent on crude than it once was, and the fact that our service-based economy went back into expansion mode in April despite steadily rising oil prices is a good signal that all is not lost as we scale new heights. We'll be getting a look at April CPI next week. The numbers should prove interesting.

One last item that may interest you: Tax-exempt money fund yields are now higher than taxable yields and have been since the end of April. If you haven't taken a look at your money fund in a while, consider doing so—and think about moving assets from a taxable to a tax-free money fund. For an investor in the 35% income tax bracket, the difference is an astounding 1.7% on a tax-equivalent basis between Prime Money Market and Tax-Exempt Money Market.

Our Model Portfolios are showing losses ranging from 2.1% to 4.7% for the year through Wednesday compared with a loss of 4.4% for Total Stock Market, a loss of 3.4% for Total International, and a gain of 1.8% for Total Bond Market. This is the first calendar year in many that our Growth Model Portfolio has lagged the overall stock market (by a mere 0.3%, I should mention), which on the face of it doesn't make me happy, but on the other hand points out the strength of the approach you and I are taking. Despite several of our managers having an off year so far, including those running Health Care, International Explorer and Selected Value, we're still just a few basis points off the benchmark's return—and with less risk, to boot. I expect that the trades we'll make tomorrow, outlined below, and a return to more a normalized economic and market outlook later this year will once again put us ahead of our bogey. Stick with me.

Now, here are the changes to our Models. All trades will be made at Net Asset Value tomorrow, Friday, May 9.

In the Growth, Conservative Growth and Income Model Portfolios, I'm recommending that you cut your Health Care stake in half and use the proceeds from sales to purchase additional shares in Dividend Growth.

No doubt, some of you are going to be surprised to see me cutting Health Care at all. But there are plenty of good reasons to do so now. And, I'm not suggesting you cut the fund entirely. We're trimming. And I should mention that this is the first trade in the fund since we last trimmed holdings in December 2004, almost three-and-a-half years ago.

I'm particularly interested in making this trade since we are adding to holdings with a top Wellington Management portfolio manager who's put some life into his mega-cap stock fund, Dividend Growth. The fund has much going for it, including a small portfolio of just over 50 stocks chosen by a veteran stock-picker who clearly is not shadowing an index benchmark. In addition, with the transition that many health care service and pharmaceutical companies are going through now, the loss of patent protection on a slew of drugs, and market concerns leading up the November elections—which I believe are nonsense, but still impact our performance—this is a good time to take a bit off the table in our health-care-focused holding.

Again, in all but the Growth Index Model Portfolio, cut holdings in Health Care by half and use the proceeds to purchase additional shares in Dividend Growth.

On another note, April must have been a more taxing month for investors than anyone realized. Vanguard's money funds saw more than $4 billion flowing out during the month. Presumably, tax bills came due, and after years of low levels of capital gains, investors suddenly had to pay the piper. Plus, if you're like me, you used up most of your embedded losses some time ago. Of course, if you took a look at my story on tax efficiency in the current issue, you know that there are plenty of good funds with decent after-tax returns and fairly high efficiency. But, no doubt, many simply underestimated what they'd have to pay for their gains in 2007 after years of fairly minor taxable distributions.

I'm heading out to the Las Vegas Money Show next week and hope I'll get a chance to meet some of you at the InvestorPlace booth or possibly at one of my talks. But, I'll be back in the saddle here at the Hotline by next Thursday.

So, until next week, this is Dan Wiener wishing you a safe, sound and prosperous investing future.