Wednesday, August 31, 2005
This ties into what I have been talking about for a while as negative sentiment has been building. There is clear visibility for bad things to happen to the market. Visibility does not mean inevitability which is why I have taken no defensive action ahead of what might happen.
I am not that bright, just ask any of my family members and they will tell you. Trying to out maneuver a big turn in the market is not something that is likely to go well. If you invest in the stock market you have to be prepared for down a little. You should be able to tolerate down a little. I have written too many times about utilizing a very simple exit strategy where stocks are concerned and that I do not try to be too nimble.
The market strength today is a surprise. Fortunately for my clients there is no financial consequence to my being surprised. There have been many comments in the last few days from people describing why they are bearish and the action they have taken. The whys center around a laundry list of very scary things. But none of the commenters left an objective market related catalyst for why they took their action. The yield curve is going to invert but it hasn't yet and may not. The economy is going to have a recession but GDP came in today at 3.3%. There is a housing bubble but what if it is just a mania?
If you study market history you will see that the market gives you plenty of time to get out at down a little when truly bad things happen. Zero stock exposure right now seems like a hugely risky bet.
I may be wrong but I don't think of the action today in the two year and the three year as being a true inversion. The problem created by an inverted yield curve is that lending becomes un profitable. Most banks are not looking to borrow for two years so they can lend for three. I do think there is more chance of an inversion now than there was a week ago, but it has not happened yet.
As a matter of philosophy I do not want to take defensive action against something that might happen. It usually takes months for an inverted curve to be felt in equities. I feel so sense of urgency on this topic. I mentioned the other day, long term money can handle down a little. The SPX is 20 or 25 points away from its 200 DMA. A drop from here down to there is only down a little. I am not worried about down a little.
The fact that there may be a touch of panic out there is probably a call to NOT get very defensive.
Another thing with all of this is that capital markets have had some sort of knee jerk reaction to Katrina and the waves (obscure music reference from my youth). Some of that reaction will be unwound as things get back to normal. I do not know how long that takes but its a good bet.
There is not a lot of content out there that addresses this but here is one article that creates awareness from Marketwatch. The author asserts his belief that things like falling dollar funds and inverse bond funds will likely be winners in the coming months.
I don't know anything about the author. I don't really care if he ends up being correct or not. What makes the article so useful is that it creates awareness of what I think is a very important topic.
Tuesday, August 30, 2005
We have been hearing about this point for many months now. I am not fond of this line of thought or, depending on how its used, justification.
I don't want the worst period in our country's history for energy prices to be the benchmark. If the inflation adjusted number is $100, how relieved will you be if it only goes to $92? Does it ease your mind to know if it costs you $52 to fill your SUV now, you only have $13 to go before your 1980 station wagon equivalent?
I find the whole thing to be silly. If a year ago is cost you $32 to fill your car and now it costs you $44, you either have a hardship or you don't regardless of what was going on 25 years ago.
The latest article is about single country funds. You can read the article here. The conclusion of the article is
"We're concerned about all the interest in single-country funds, though. For starters, it's always dangerous to chase after hot performers. Moreover, these funds come with all sorts of geographic, sector, and other risks, and they're difficult to use effectively."
The author later says this about China funds
"All told, China funds are way too explosive for conservative to moderate investors and those with shorter time horizons. They're also far too daring and focused for individuals who want only a supplemental international offering with lots of upside potential."
To be clear, single country funds are more volatile than broad foreign funds. For some folks single country funds are clearly not appropriate. But I disagree with the way in which the author so broadly advised two out three types of investors ( I am making an assumption, when he says conservative and moderate that the only other one is aggressive) to avoid them.
Single country funds are a tool to be used or mis-used by investors. Some investors will be more informed than others and some will have more success than others. As a first step, it does not take much work to figure out that there are some interesting things going on in China, as an example. Perhaps a little more work may lead to an investment in one of the China funds. What the article ignores is how much should go into a China fund. If you have read this blog for any length of time you know I would probably say 2% of the portfolio makes sense, once you have assessed what you may be in for.
Now lets say this fund was bought at the top of the Shanghai market, in spring 2004, with no exit strategy, and was still owned today. The fund might be down 35%, close to what the drop in the Shanghai composite has been in that time. In this scenario the drag on the portfolio would be 0.7% over a year and a half, again this assumes no exit strategy. Are you conservative? If so could have withstood this type of hit to a portfolio? Of course if you are conservative you might have had some sort of exit strategy when you bought the fund.
Whatever might be the reality of the fundamental things going on in China, there are a couple of market related things going on too. The Shanghai market is down 30% from a recent high ( I think of two years as recent), it has a low correlation to the S+P 500 and the S+P 500 might be rolling over.
This post is not meant to serve as a recommendation to buy China. But hopefully it is a catalyst for you to hone your process. There is way to use these types of funds (single country). The article makes no effort to explore how. This post isolates one way, there are others.
Single country funds are very volatile, they way in which they are used can either enhance or mitigate that volatility.
He says it is not a gut feeling on his part. He notes the yield curve is almost inverted, energy is a problem, there is a housing issue, military conflict and so on. If I read his comment correctly he has zero equity exposure.
I do not disagree that any of these things create visibility for problems. The curve is NOT inverted. It might invert, and if it does for more than a day or two it will not be different this time. But almost does not count. An inverted curve means lending money becomes a money loser. Not being able to access capital is what hurts the economy.
I think Mike is applying rational thought to an emotional market. It is possible that Mike's comment has erected a wall of worry that the market might climb for a few months. I do not know, but if the next three months are straight up for no logical reason at all, which has happened repeatedly throughout out market history, a zero equity exposed account will lag badly.
The bottom line is that Mike has taken a very extreme position (again, if I read him correctly) and has not built in any counter strategy in case he is wrong.
One other thing from this, Mike asks if I am bullish about the next few years. I have to admit I don't try to look out that far in terms of labeling myself as bullish or bearish. So many people get one year wrong that I think trying to get the next decade right is futile. It easier for me to see that maybe oil demand will increase more rapidly over the next few years than it has over the last few, as an example.
At the beginning of 2005 I wrote that I thought we would be lucky to see mid single digit growth for the year. Now that we have better visibility for 2006 I see some real problems looming on the horizon. At this point the SPX is close to its 200 DMA, close but not under. The curve is almost, but not yet, inverted. I think long term money can risk down a little. If the curve inverts or if the S+P goes below its 200 DMA I will take some action. No matter what, defensive action will never mean selling every stock. I view that as very aggressive, which is 180 degrees from what I try to do.
Monday, August 29, 2005
55% equities seems low to me too, for most folks. If everyone in your family makes it past 90 and you are 60, you need a heavy weighting in equities. Not everyone in that situation can emotionally handle a lot of equities but that doesn't change the reality. Generally speaking the cost of most items goes up about 50% in price every ten years. The postage stamp captures this idea very well. 60% bonds does not give you much of a chance to keep up.
As for my wife hating CNBC, she really used to hate CNBC Asia. Now that I am a regular on the channel she tells people to watch.
One comment believes that we have a recession and bear market in the making and he has cash built up and thinking about shorting the market. He also sold stocks in his 401k. I would ask what is the catalyst to get that bearish? I would rather rely on a simple message from the market to take that type of action. Gut feeling alone makes the play quite risky.
The Japan story is a little lost on me for several reasons but I may be wrong.
I was pleased and impressed with the market on Monday. I would not be shocked if the market went down a little more for the week but it seems like a Katrina induced panic is off the table.
Here is a fun little nugget that I may be the last to know about; OPEC member Indonesia is a net importer of oil. Oops.
If the market really cracks because of this external shock (Katrina) I may hold off on taking action in the portfolio. A 5% move in oil seems like panic buying. If that is right, it would make sense to see it back at $66 soon. If the move in oil caused by Katrina can be unwound, it is logical (to me) that any damage in the stock market can also be unwound.
It looks like some insurance stocks will get hit as a result of this. Yet another reason why I don't own this sector for clients, along with Spitzer risk.
I hope Marty, the reader that sold 6000 XLE because Schwab told him oil looked toppy, has some exposure to the sector. Marty's plight made quite an impression on me, if you hadn't guessed.
If you are a do-it-yourselfer I would encourage you to seek out articles like this one. This one article is by no means a panacea but there is some process there, and I can't write enough times that every investor should continue to try to learn. When I write take a little from here and a little from there to create your own process, this type of article is one of the theres I am talking about.
The author cites a study from Ibbotson's about the following asset allocation;
According to the article, this portfolio had an average annual return of 7% compared to 3.6% for a stock only portfolio. Over a ten year period the all equity portfolio won 12.1% to 11% and over 15 years equities won 10.9% to 10%.
The returns are not radically different for the longer time periods but slightly so. I don't know if the returns of either portfolio include dividends or not but keep in mind if the SPX is yielding 1.8% these days it would not take too much work to add an extra 50 basis points or so in dividend yield. For an investor willing to apply themselves maybe 100 basis points in yield can be added.
If those that say we will have flat-ish returns in the equity market for several years to come are right it will be very important to have access to other asset classes and to have some extra yield in the equity portion of your portfolio.
I may not get a chance to post again today. My sister in law teaches 2nd grade down in Phoenix and my wife and I are doing a thing for her students about wildland fire fighting. I need to find some time to get some work done at the office too. It could be a long day because my wife hates listening to CNBC on Sirius. Oh well.
Saturday, August 27, 2005
The yield on the ten year treasury just went below its 200 DMA. Over the years the 200 DMA has been relevant many times so it may be a little while before the curve gets a little steeper, if at all.
If things really hit the fan here I plan to take some domestic off the table, add a little foreign and increase cash. I have not decided, yet, which domestic names I would come out of but I might be able to effect big changes by selling three domestic names and buying one foreign. I am not expecting to have to do this but I will have a plan in place in case I am wrong.
Changing subjects; there has been a lot of attention devoted to Greenspan's legacy at the Fed shindig up in Jackson. I don't care about this stuff at all. Dwelling on how good or bad he has been does nothing to help me manage money.
When his term actually ends we may see real news take a holiday.
This is not a comment but more of a question in regards to ETF's. I understand that ETF's can be bought or sold anytime during the day, but aside from day traders, why should that be important? It is impossible to know when a potential seller will receive the best price. I have looked at the costs of the ETF's at Vanguard and by in large the mutual funds are less expensive.
It seems to me ETF's are another way to encourage us to trade more. Something I view with concern! Investors who use sophiscated methods for trading may take advantage of rapidly changing prices, but I think the average investor should be wary of trading too much.
I have never liked the mechanics of only being able to exit a position in an OEF once a day. Rightly or wrongly, I think the potential twitchiness the comment refers to is more about where the money is than what product it is in. Most people are less inclined to actively trade their 401k than their taxable account at a discount firm regardless of what the investment product is. I also tend to think of twitchiness as more of a personality thing.
I could be 100% wrong about this stuff. I do think that successful investing requires a little introspection and understanding your weaknesses.
In general terms ETFs are cheaper than OEFs. Vanguard's funds are very cheap as OEFs go. I have never looked whether Vanguard's funds are cheaper than most ETFs. I have no interest in owning OEFs personally or for clients which is why I have never looked at this.
Friday, August 26, 2005
The folks at Macquarie have IPO'd another infrastructure product on the NYSE, the Macquarie Global Infrastructure Total Return Fund (MGU). Despite the Total Return part of the name, as I read the prospectus, there will be no option selling in this fund. Macquarie has two other products, that I am aware that trade in the US; Macquarie/First Trust Global Infrastructure/Utilities Dividend & Income Fund (MFD) and Macquarie Infrastructure Co Trust (MIC). Like MGU, MFD is a CEF. MIC is a trust. I'll spare you trying to explain the difference.
I first wrote about MIC, skeptically, on May 12. I was skeptical because they had not yet paid their first dividend and there was no explanation on the company web site. Since then time has gone on, the price has stayed stable (what I perceive it should do), the fund has caught up on the dividend and given Macquarie's expertise I bought some personally a few weeks ago and also for a few volatility adverse clients. My expectation is similar as that for the call writing CEF. Very low volatility and a high yield.
On July 31 I expressed some concern about how much optimism there was about the equity markets. I wrote that I thought 1190-1200 might be a logical bottom, short term. Aside from being shocked that I have a shot of being right about that, what matters now is what is next. Sentiment has deteriorated, that is a positive. The catalysts that have made me optimistic going into year end are still in tact. I will either be right or wrong about this and act accordingly if the market cracks. I have said before that being right about a prediction is a lot less important than what I do with client money.
Lastly, Hugh Hendry from Eclectica (whom I have quoted on this blog before) said on CNBC Europe that he sees the Nikkei going to 40,000 by 2015. How's that for timing on my post from this morning?
I think equity strategists have predicted 14 out of the last one stock market recoveries, if you know what I mean.
Perhaps this is finally when it happens. There are a couple of things about this current wave of optimism that leave me uncertain. The US imports about 60% of its oil. Japan imports all of its oil. Alan Greenspan was quoted as saying that higher oil will take about 75 basis points out of our GDP, he said this when oil was a little cheaper. Feel free to comment with the actual specifics of Greenspan's comments if you know them.
The only way, as I see it, that Japan can avoid a worse fate, due to oil, would be if the yen gets stronger against the dollar. Since oil is denominated in dollars a stronger yen makes oil cheaper in Japan.
But then a stronger yen hurts Japan's exporting of all sorts of things to the US. A strong yen makes Japanese products more expensive in the US, a big customer of Japan.
I may have this wrong but I haven't yet heard any of the current Japan bulls address this point.
Thursday, August 25, 2005
Ms. Dimitroff manages $200 million. It would be very difficult for her to add 4% weight in a thinly traded ETF like the BLDRs Europe 100 (ADRU) that was mentioned in the article. According to the article ADRU trades 8000 shares per day. 4% of $200 million is $8 million which would work out to 114,000 shares. So is the article is right about this, where large IMs are concerned? Actually not quite. According to the prospectus for ADRU shares can be created or redeemed in 50,000 share blocks through the fund sponsor. It is perfectly valid to not want ADRU but I don't think liquidity by itself is a reason for IMs to automatically dismiss a given ETF.
But even if an IM can not overcome the liquidity issue, you can. Lets say an investor with a $1 million portfolio wants to own only one ETF for non emerging foreign, wants that ETF to have a 20% weight in the portfolio and has decided (for whatever reason) that ADRU is the best way to go. $200,000 works out to 2850 shares. More often than not a limit order and a little patience will get the order done. Although you may not even need that. According to David at Schwab the size showing on either side of the quote at many points throughout the day was 10,000-20,000 shares, making 2850 shares seem easy to execute. In general terms the fund sponsors want their funds to be easy to trade. Even so, I would still use a limit order for any orders of size.
To be clear this is not a recommendation for ADRU or to put $200,000 into one ETF but some folks may want to have this type of position.
The state of Hawaii has set caps on the wholesale price of gas. Uh oh.
This is such a bad idea I can't imagine caps will be adopted anywhere else but if there are price caps instituted elsewhere it would cause me to change my near term, positive outlook and take a little defensive action right away.
To be clear I am saying take a little defensive action not go 60% cash.
Tinkering with market forces like this is a scary thing and I hope Hawaii reverses this quickly.
In the mean time, this is a picture from Hanalei Bay from our last trip to Kauai in 2003.
Squawk host Bob Doll had some comments about favoring tech and energy and being underweight financials and consumer staples. What is interesting is that in the last five years there is not much precedent for tech and energy to have any correlation. We'll see what happens.
For what its worth I have increased tech exposure this summer but I am still underweight.
Most of my financial exposure is in foreign stocks.
Wednesday, August 24, 2005
Here is a list of what I think matters right now;
- Clearly, equity markets are struggling. But I think there was good visibility for this after a great couple months coming into August. From the start of the month I have mentioned that I thought 1200 on the S+P 500 might be a worst case for the month assuming no external shocks. So to see the market headed that way with concern abounding actually makes me think I have a shot of being correct.
- Durable goods came in on Wednesday and they were a disappointment. So this week the chatter is we are going to have an economic slowdown. A couple of weeks ago it was full stream ahead. This sort of manic thought about the economy has been going on for months, if not years. I am quite certain we will get a number or two that makes consensus swing back to full steam ahead. This not what most people should be trying to game with their trading.
- After a blip down last week, oil has gone back up. Too many people bailed out based on one day's trading. While oil could go down at anytime, I continue to believe that it can not make a home below $50 anytime soon and maybe that number should be $55.
- The curve has flattened some over the last two weeks. I still don't think it can invert because we are now six months from the 30 year treasury coming back. I am convinced that no new issuance for the last four years has pushed rates down and now that the 30 year is coming back rates will go back up.
- I don't put too much into to "holiday volume" because what person in the business doesn't have a phone and a lap top along for the trip? If something needs to get done, it will get done.
- All of the M&A activity from this summer still bodes as a positive for the next couple of months.
- I also think another positive is that with the market almost exactly flat for the year, there are a lot of hedge fund managers that stand to not get paid unless something happens from here.
- I think the biggest factor moving stocks lower this month is the move up in the spring and summer.
This link is a column by Jonathan Hoenig from a couple of weeks ago from Smartmoney.com. It focuses primarily on interest rates and what he thinks might be going on with floating rate funds and mortgage REITs.
Jonathan has talked about these on Cashin' In favorably in the past but I am not sure where he has stood on these recently. I have written about these funds before, I have never liked them. I was surprised to see that they have not been doing very well, as this from the article chart shows.
He also has some interesting comments on the mortgage REITs as being a leading indicator for all interest sensitive products. I have never been a fan of these either.
Tuesday, August 23, 2005
I have 14 hours of flight time, each way, in front of me and I have been trying to figure out what to do to pass the time. I can't watch DVDs that long and I can't read that long either.
I have been holding out on reading Freakonomics because I figure I will have to read it twice, and a 14 hour plane ride might be a good time to do that, but thanks to CNBC's segment with Yale Endowment Fund CIO Dave Swenson I am going to read Unconventional Success : A Fundamental Approach to Personal Investment by Mr Swenson.
In the interview he laid out the current asset allocation for the Yale fund as follows;
- Absolute Return 25%
- Real Assets 25%
- Private Equity 17%
- Foreign Equity 14%
- Domestic Equity 14%
- Domestic Bonds 5%
- Don't try to outsmart the market
- Buy index funds but shop carefully
This is the top ten. There are only ETFs for Hong Kong, Singapore, UK and Australia. According to the article, Mr. Marotta also owns ETFs for Austria, Sweden, Canada, Germany, EFA, Netherlands and Switzerland to round out the freedom portfolio.
The article states that Mr. Marotta does not own countries that don't have ETFs; Luxembourg, Estonia, Ireland, New Zealand and Denmark.
I am not that concerned with the portfolio itself but to tie in with what I have been talking about a lot this week; explore other products to see if it is possible to get closer to the intended effect. For example, a single stock adverse investor might be able to capture Ireland with the Irish Investment Fund (IRL), click here and decide for yourself.
For Denmark there is no CEF or ETF but there are two NYSE listed ADRs. Would owning either of them allow an investor to capture Denmark? Click here and, again, draw your own conclusion. Click here for New Zealand.
This chart show the Luxembourg Exchange compared to the two NYSE listed ADRs. Does either seem to correlate to the market? Maybe.
There is still no easy way to for US investors to own Iceland or Estonia.
The point of this is not that you should buy ESF or TLD to round out Mr. Marotta's portfolio but that when you read unique idea's like this you should explore different alternatives. The Middleton article shares some process and this post tries to expand the concept a little.
For disclosure, clients and I own EWA and EWO.
The process behind the call had to do with a big drop in the price of oil that day.
The tone of my piece was that I had already reduced beta in the sector but that I was still overweight and that I had no plans to cut back now. For the week since Cramer's call it probably made more sense for longer term investors to have made no changes.
Cramer could turn out to be correct about oil topping out at $67.10, I don't know. Neither do you and neither does he. Everyone has an opinion but no one knows.
I have been writing about oil as a major theme in my client accounts throughout the life of this blog. The theme has been working for a couple of years now and I will either be right or wrong about it working for the next few years. The point here is that I don't think it makes sense to give up on a theme because of price action on one day.
Individual stocks may be another story.
Monday, August 22, 2005
ETFInvestor reran my post about Marty, who was told to sell a bunch of XLE by someone at Schwab. A little later in the post I commented that all ETF portfolios may not be ideal and that I believe in using individual stocks where applicable.
Herb left this comment on ETFInvestor;
I have been following the post and need to respectfully disagree with the statment ÂIf you have a lot of money and you are paying for advice I think you should be getting more than just ETFs.
I agree that anyone paying for advice should be getting other services in addition to investment management. This could include advice on real estate transactions, insurance, financial and estate planning, and other areas.
However, if the author is suggesting that ETFs alone cannot make a complete and total portfolio solution, then he/she is off base. Further, a statment such as the one made did not quantify the amount being paid for the advice so it would be difficult to judge the value. I believe the author is suggesting that individual stocks should be included in a portfolio to justify an unnamed fee structure.
It is my opinion that individual stocks should be included if they are in an area where the manager has an extremely high level of conviction, and the client has a tolerance for the risk associated with individual stock ownership.
Regardless of the need, or the level of fees or the size of a portfolio; indexing can present a total solution and ETFs are now of sufficient quantity to cover every core asset class. Academic work in the area of portfolio returns has concluded that it is asset allocation rather than security selection which determines portfolio results.
All the best, thank you for allowing my post.
Then I left this in response;
Thanks for the comment on the post. You obviously have some detailed thoughts on this matter. I am not quite sure what you mean when you say It is my opinion that individual stocks should be included if they are in an area where the manager has an extremely high level of conviction. I don't know why a person would pay money to an IM who is not comfortable picking stocks. Where small subsectors are concerned I can see where an IM may stay away but if you are talking about one of the big 10 sectors of the SPX I have to think that picking stocks should be part of the service, hence my confusion over the comment.
As for indexing as a TOTAL solution I disagree. As a tool that is PART of the solution, yes. There are individual stocks, ETFs, CEFs, OEFs and maybe one or two other things available for professionals and do-it-yourselfers alike to utilize. Using just this or just that seems counterintuitive. I give my clients the best chance for success by making use of everything that is available.
As an example last fall I decided I wanted to own Norway because it seemed reasonable that Norway in general and Norwegian oil stocks specifically could do well given what seemed like good visibility for oil prices. There is no easy way for a US investor to capture Norway in an index. I felt that in this case owning one of the common stocks made the most sense. The stock has been a good performer with a very high yield.
About two years ago I decided I wanted to try to benefit from what I thought would be good things in the Indian stock market. There is no index that can be easily accessed by US investors. You either buy an actively managed fund of some sort or an ADR. I chose one of the CEFs.
There are areas where an indexed product does make the most sense and so that is the tool used.
I was quite clear in the post that I made some assumptions about MartyÂs situation and that even if they are all wrong I would urge ANYONE reading this to make use of all tools available to manage your portfolio.
One last point that I agree with you on, is that a clients tolerance for volatility plays a key role in portfolio construction.
This whole thing is a perfect example of what I mean when I write take a little from me and little from other people and create your own process. Herb and I do things differently, much differently. Is one better than the other? You decide for yourself.
Herb has some performance numbers on his site that are a little difficult to read. The all ETF portfolios on Herb site were started some time in 2004. Most of the returns published are hypothetical. I don't know if his portfolios have a year in existance yet. Looking at the twenty year portfolio, Herb's YTD return, as of 6/30, for the conservative portfolio was +1.9%, for the moderate portfolio his one year return was +2.0% and the aggressive portfolio was up +1.3%. During that time the S+P 500 went from 1211 down up to 1191 which is a 1.65% loss. Herb does not disclose whether his numbers are net of fees. Clearly Herb is adding some value.
Again the SPX started the year at 1211 and closed on 8/22 at 1221, a gain of 0.8%. Maybe I am adding some value too. I have a couple of common stocks sprinkled in but this account does not capture much of a dividend the way larger accounts do. For larger accounts I own more individual stocks and so in certain sectors I can capture a much higher yield. The yield issue is the biggest flaw, in my opinion, to an all ETF portfolio.
To repeat; take a little from me, take a little from other people and come up with your own process.
Financials make up 19% of the SPX and 14% of the S+P 600 (IJR), a small cap index. Technology is 15% of SPX and 14% of IJR. Healthcare makes up 13% of SPX and 13% in IJR. So in the S+P 500 the three add up to 47% of the index and in the S+P 600 they add up to 41%.
It would be tough for the market to do well without these three.
Financials may have a tough time as lending is less profitable with a flatter curve. Tech seems struggling for both fundamental and sentiment reasons at different times and health is dominated by big US pharma which seems like it will struggle for a long time to come.
All this post is intended to do is to point out potential headwinds. Three big market sectors have problems these days. There is nothing that says that despite these problems financials, tech and health can't go up taking the broad market with it.
This has happened repeatedly throughout market history.
I have been more optimistic about the US market for the rest of 2005 and more concerned about 2006. That has not changed. Clients will not be ruined if I am wrong. Predictions are far far less important than action. No matter what I think, if the SPX goes below its 200 DMA I will stick to my exit strategy.
I have written a lot about emerging markets. The role I think these countries can play is that they tend to have a low correlation to US markets and just a couple of holdings can add a lot of return to a diversified portfolio.
I am benchmarked to the S+P 500 which has no foreign stocks but long time readers know I have a heavy foreign exposure. Since there are no emerging markets in my benchmark it is tough to say how much would be equal weight, overweight or whatever. That being said I think for someone with reasonably normal tolerance for volatility 4% or so might make sense as an equal weight number. These days most clients have 7% or so in emerging markets.
I think picking one of the emerging market ETFs is a great way for some with a low tolerance for volatility to capture exposure. Most clients own one of the ETFs and anywhere from 1-3 individual stocks or perhaps one of the CEFs that invests in India. All of the stocks I own for clients in this area have dividends ranging from healthy to huge.
One catalyst to reduce, not eliminate, exposure to emerging markets would probably be if there was a clear and obvious path for very good things for the US market. As time goes on this analysis evolves.
A big focus here is the low correlation. Although these markets can be volatile, when blended with domestic stocks, the volatility of the overall portfolio can be reduced.
One goal that just about every manager says they have is market beating returns with less volatility. To my way of thinking, doing this successfully means there will always be stocks that are up and there will always be stocks that are down. If I think IBM is the best tech stock out there (just an example, I don't own IBM) and the tech sector is doing poorly I would expect IBM to be down. That does not make the name a sell. Hopefully value is added with the decision to be over, under or equal weight the sector, technology in this example.
So while the next 10% for emerging markets could be in either direction, the role that the asset class plays will not change.
The idea of focusing on the portfolio and not the individual holdings is not easy to do. A common mistake is to focus on the holdings which can lead to selling low, buying high and having a lopsided portfolio.
Saturday, August 20, 2005
Top down portfolio construction (or at least the way I do it) starts with the decision to own stocks or not. Since the market has an up year 72% of the time you probably want to own stock a lot more often than not.
Once that is resolved I then decide how I want to weight foreign, style, cap size, sectors, volatility, yield and so on. I make these decisions by looking at things like, commodities, currencies, slope of the yield curve, where we are in the stock market, where we are in the economic cycle, what has worked well during other similar periods in history, various economic indicators and so on.
Usually doing all that boils down to just paying attention.
Over the last couple of years energy, foreign, materials, utilities, small cap and value have been the area that have worked well and I have written a lot about these areas probably because I have been overweight these areas and they have been more interesting to write about. It would be reasonable to think that I tend to have smaller value bias which is not really the case.
If over the last couple of years I had been overweight large, growth, tech etc, and that had been the place to be overweight, I probably would have written more about those areas. In hindsight I would have to say my writing has not been fair and balanced, I will try to improve on this.
I tend to believe the market works a certain way and rewards certain asset classes at different times. I will favor any area that gives my clients the best opportunity to succeed in the capital markets. Thinking small cap value is right for all seasons makes no sense to me. Small cap anything was absolutely the wrong place to overweight at the end of the 1990s. Mega cap companies have lagged badly over the last few years so I have not been very heavy there. There is no question whatsoever that mega caps will provide leadership again. I may or may not figure out when that will happen but it will and I'll either be early or I'll be late. I do have a few mega caps right now as a counter strategy in case their resurgence has already started.
Hopefully this makes sense. You can pigeonhole me as one thing or another, I don't really care, but don't pigeonhole your portfolio.
Friday, August 19, 2005
As to your comments on oil, I agree with you but I must admit I sold 6000 shares xle as Schwab feels its time for a temporary breather on that oil etf. I'm no day traider but I put in a limit but at 5% below my sell and hopefully get back in. Actually I felt bad about my sell as I really think xle will gain over 10% a year over the coming years. Hope my greed didn't screw me up. Xle is up today.
I'm not sure of the totality of the situation here but I have to wonder about the advice Marty got. I don't know if 6000 XLE was his entire position in the energy sector. If it was then I have to say I can not fathom a suggestion that would tell a client to go to zero in one of the S+P groups. Also assuming Marty has a diversified portfolio (and maybe he doesn't) the size position that Schwab put him into is baffling. If 6000 shares at $48 is 10% or 15% of the portfolio, he obviously has a large portfolio, large enough that there should be some individual stocks mixed in. Let me be clear, as I read the comment, Marty is paying for advice from Schwab.
If you have a lot of money and you are paying for advice I think you should be getting more than just ETFs.
I have made quite a few assumptions about Marty's situation and they could all be wrong. Assuming I do have all the facts upside down, this last sentence is still the important thing here. Professionally managed all ETF portfolios are not necessarily appropriate for large portfolios. As a tool ETFs have a place in every situation I can think of but if you are going to hire a firm I hope you really examine what you are paying for and do some comparison shopping.
I can't imagine this will be different than the myriad of these funds that already exist. Now Merrill has thrown its hat in the ring, unless this is a second fund from Merrill? There are so many of these now I just don't remember.
I will say I have been very pleased with the CEF from that category that I own for clients and personally, MCN. The original thesis, which I have had to defend several times in the comments of this site, was that these funds will move less that equities in both directions and be less interest sensitive than bond funds. That is exactly how it has worked out since I bought it. It is up about a $1 and I have taken in three, I believe, dividends since I bought last fall.
A lot of the negative comments about these funds have been along the lines that they will lag in an up market and get killed in a down market.
I can't see where this does worse than the market in a nasty correction. Obviously on a given day anything can happen. 8% annually seems like a legitimate cushion against a decline.
As for lagging an up market? Yes I know, I write this everytime I mention it.
As a look to build a portfolio I want to own some things that will move more than the market and some that move less than the market, these types of funds move less than the market and that is exactly what I want from this one, out of many, holding.
The balance between expected out performers and expected laggards would speak to my expectations for the market.
By the way this is not a call for anyone to buy MCN. It now has close to a 7% premium to NAV. As I said earlier this week, a CEF I own growing to have a big (ish) premium is not an automatic sell.
I mentioned I took some beta out of the sector during the spring and that I was not planning to sell any more in the group.
Yesterday I saw a package on Boone Pickens and he said oil will go to $75 over the next year (I believe that was his time frame).
So what should you do?
I think this can be resolved reasonably simply. Forget about stocks and markets for a moment. Do you buy into the goings on in China and India? If you do, how long to you think the growth, expansion and modernization will last? If you think it will last for a long time then you have to think that daily demand will grow faster than supply can grow.
I have written many times that I think Pakistan and Viet Nam will be the next big emerging markets. Do you think there is a shot of that happening? If there is a shot, this would mean yet more demand in a few years.
You probably know Japan imports 100% of its oil. I don't think there will be a big ramp up in demand from Japan but what about Korea? Korea imports 100% of its oil. I don't know the Korean story very well but I would not be shocked if demand increased there either.
For all the chatter about Petrobras (PBR), Brazil does not export that much oil and over time I think there is visibility for less exports from Brazil in the coming years.
I could be wrong about this whole thing but I have been writing about a long term change in the supply and demand equation for oil ever since I started this blog. I have trouble believing the whole theme has unraveled because oil dropped 4%, or whatever, on Wednesday.
That does not mean the commodity and the stocks won't go down in price for months at a time and to be clear I did cut back some earlier this year.
What do you think will happen?
Thursday, August 18, 2005
I have to admit before last week I had never heard of Investment U but crikey they got a long interview with Jim Rogers. They have to be doing something right.
I am also pleasantly surprised anyone there knows about my site. I am amazed by some of the people that have emailed me about my site. I think this speaks to how small this slice of the blogosphere still is. This is encouraging for some of my theories about how individual investors will access investment information in the coming years.
Good work Slash.
I have to say that after ten and a half months of blogging I am surprised that this hasn't happened before, egg on my face the day of or day after I stick my neck out on something.
My average price from August 1 is $288.48. The lowest price I think I saw this morning was around $272, but it has come back a little since. The largest weighting I have for any client in the name is 1.5%. The impact for clients with a 1.5% weight, at $272, is 5.7 basis points for their entire account.
Hey, I wish it weren't down but I think I measured the risk before I entered the position and I am not sweating the stock in the $270s. If something unique to Google takes the stock down to $250 I would probably have to reassess.
This little episode will not discourage me from sharing my process in the least. I have written countless times that I try to be right more often than I am wrong. I'm not sure I am actually wrong on Google at this point. I think what this will mean is that I will have wound up with a bad entry point.
Wednesday, August 17, 2005
One was the First Israel Fund (ISL). I wrote about this fund on August 7. I bought it thinking it would be an intermediate term hold but I was lucky enough to catch a big move (relative to the time I held it). Despite what I what wrote about the trade I was really buying Benjamin Netanyahu, the recently departed finance minister and one time prime minister. Now that he is gone I am not sure how the situation has changed, if at all.
One point he pounded on was that ISL is trading at a discount to NAV. He warned not to buy it at a premium. I have written about this a few times. If a fund has traded at a premium of 5% or less for an extended period I don't think I would be turned off from buying it. A big change in the discount/premium picture might make me hold off however. A premium of more than 5% and I would wait but if a fund I already owned grew to large premium it would not be an automatic sell. ETFconnect has a chart that shows the historical relationship between the NAV and the market price. I was really surprised that Cramer picked this fund. I heard him on why and it makes sense but I am glad I'm out of the position now.
The other nugget was about energy stocks. If I heard him right he is suggesting lightening up on the group ( not zero exposure, I think). He thinks a top as been put in on oil. Maybe but I think earnings could go up dramatically for a couple of quarters as the oil companies sell more and more oil above $50. He said the sector's weight has doubled in the SPX and that is his exit strategy. He said energy has gone from 5% to 10%. I thought it started at 6% but that is splitting hairs on my part.
I have taken some defensive action in the sector a while back. I sold one of the tanker stocks and a more volatile E&P name. At this point most clients own two big foreign integrated oil companies, one oil company with a little refining exposure and one of the Chinese oils. The total weight is in the neighborhood of 11%.
The anniversary in question belongs to Google (GOOG). I have come up with a wild theory about the stock that is littered with ifs but could work out nicely.
As its one year mark since listing comes the stock can be considered for inclusion into certain indices like the S+P 500, the Nasdaq 100 and so on.
The market cap for GOOG is around $80 billion, pretty big for a stock not in the S+P 500. I think there is a chance that it will get added to the S+P 500. This is hardly a shocking revelation and of course it MAY NOT happen. If it does get added it will have about a 0.7% weight in the index and be in the top 30 in terms of cap size.
I would not be surprised if the stock, in a given twelve month period doubled in price. This is not a prediction ( because I have no idea what the stock will do) I am just saying I would not be surprised.
If it were added to the SPX and it went up a lot I think it could potentially have a dramatic impact. If, at a 0.7% weight, it doubled, it would add 70 basis points of return to the entire index. This would make beating the SPX much more difficult, for managers that are benchmarked to it,that don't own the stock.
The theory is that IF it gets included, active managers that don't buy it right away may be forced, in a manner of speaking, to buy it later. This could cause a very large move up in the stock as a secondary effect a quarter or two after, if, it gets added.
There are two obvious obstacles that I can see. First is it does not get added. The second one is Genentech (DNA). DNA's market cap is above $90 billion and it is not in the SPX. I doubt that the keepers of the index would add both at the same time, because of the beta that would add to the index. I also have to think that they would have added DNA by now if they were going to at all, but of course I could be wrong about that. After reading this paragraph I guess the two obstacles are really the same. I am sure you could come up with others.
On Aug 1 I bought GOOG at a 1%-1.5% weight for most, not all, clients. Usually 2% into a name is as small as I go. I can't imagine GOOG would disappear but if it does I won't have hurt anyone's future.
Keep in mind this is just a theory, it either works or it doesn't. If it gets added to the SPX I would expect some sort of positive initial reaction but the concept of the idea is for a longer term and bigger reaction in the price.
I heard in passing last night that MSCI may drop Taiwan from its global indices. The issue involves some sort of dispute over how Taiwan futures are settled in Singapore. I don't get it either.
If Taiwan is dropped it would mean a lot of global money benchmarked to Taiwan would sell out because they would no longer be benchmarked to the country.
I think there is very little chance of this happening but if you have exposure to Taiwan you should pay attention to this.
If ETFs are new to you, this is a good get you started article.
Tuesday, August 16, 2005
Here is a list the points I think are relevant to the market right now.
- Both Dell and Cisco hurt the market psyche, which has no doubt been fragile, last week. Deere and Walmart did further damage on Tuesday. While I think it is clear that these four hurt the market it is interesting that none of the four have provided a lot of leadership to their respective sectors.
- This may speak to that fact that only a perfect (positive) storm was going to lift stocks in August after a very strong three month rally.
- The ten year treasury yield has come down a little but is still equity friendly. Unfortunately the outlook for 2006 is starting to deteriorate.
- The inflation data and industrial numbers were fairly neutral on the equity market and I expect that to be the case for the rest of the week. This is because there seems to be almost nothing that can derail the Fed off of its current path.
- Crude oil above $65 looks to be a problem for equities for now. I don't know if we can go back down to $60 but that kind of move would be a big positive for equities
- Hewlett Packard's news might be able to help the market tomorrow.
- Looking out to September; for as bad as August and September are to the market there have only been six time in the last 20 years that the market was down both months. So if this trend continues for August, selling pressure might exhaust for September.
- Having exposure to dividend paying stocks through this choppy market will help offset some of this down draft.
- I am am still optimistic for the next few months.
For now those efforts have stalled out. CNBC Asia had the most coverage of the Macquarie story and the reports they had seemed to indicate that Macquarie would utilize its ownership of the LSE, if it goes through, in any number of its various infrastructure funds.
Macquarie has created a niche for itself by creating funds that invest in things like toll roads and parking lots and making the funds available to the public. This article in the Wall Street Journal (subscription required) quotes J.P. Morgan analyst Brian Johnson as saying intuitively, the idea of buying a stock exchange to my way of thinking isn't too much different to actually buying a toll road. I can see the similarity in that market participants have to pay a toll of sorts to do business through the exchange but I also think an exchange has more moving parts that a parking lot.
Also it is likely that the same folks that manage the LSE now would still manage it if Macquarie took it over.
I find this type of news to be very interesting.
NLY and IMH in particular are down quite a bit in the last two months. I have written negatively about mortgage REITs a few times over the life of this blog, you can read here and here if you'd like.
The basic idea, and I think this is very simple (which I look for), is that the next big move in interest rates will be up. This has been the case for a while regardless of when it happens. This will hurt the businesses of the companies, some worse than others. The other thing I have touched on before about these is that often the financial structures are very complex. This all seems like a big ongoing headwind and reason to stay away.
I can not get every stock pick right but avoiding very visible area like this makes my job much easier.
Monday, August 15, 2005
XOM, in blue, looks like it is below its April high. The Energy SPDR (XLE) is up 13% from its April high close, Total (TOT) is up 12% from its highest April close and BP is up 11% from its highest April close.
In that time the SPX is 8.5% from its lowest April close and up 3.6% from its highest April close.
This is obviously backward looking and guarantees nothing about the future but would Ned have a different take with the correct facts? Nah.
BP is a client holding.
Maybe but I think the yuan revaluation might end up being more important, at least for US investors, than any other theme.
The US dollar is going to get weaker against the yuan. I don't know by how much or how quickly but this is an easy thing to see as far as high likelihood. All clients have exposure through one of the oils and or a broad based emerging market ETF. I personally added FXI recently trying to capture what I think will be a big move. The Chinese stock market does not have to do well for this work, although that would help. The dollar getting weaker against the yuan, everything else being equal, will benefit any Chinese holdings. That the Chinese markets have done s poorly for so long might also be a catalyst.
This chart shows that FXI has outperformed the S+P 500 by a wide margin over the last month. I have to say I think this could last for a while, at least I hope it does.
As an administrative note I am using ADVFN for streaming quotes and charts. I just started using it a few days ago and so I'm still learning how to use it.
Some accounts I manage have a double short OEF and all accounts have a gold stock and a defense sector name in case something hits the fan in a bad way. Obviously the portfolio would still drop with a terror event worse than what we have seen but it would be nice to have a couple of things that might go up in the face of that.
Usually these types of calls have very little practical use for the retail and institutional sales force at the giant firms. If an extreme call turns out to be right it can be used as a sales tool in the future.
I don't doubt that there is plenty of work behind the call but for most people an equities exposure in the 40s is quite extreme. I would want to have more behind the call than the action in the one year treasury as cited on CNBC.
Saturday, August 13, 2005
The Fox Business shows featured both John Rutledge and Gregg Hymowitz suggesting ETFs during certain segments. I think this is a good thing. As surprising as it to me, there are a lot of people that still don't know about ETFs. The Fox shows reach a very wide audience and hopefully more attention given to ETFs will speed up what I think will be the rolling out of more innovative products as demanded by the investing public.
A regular reader/emailer sent me this link to the Wharton site about the Chilean retirement program. This is something I have written about several times before. I have exposure to Chile personally and for some clients.
Someone named ArbTrader left a link on a very old post to a site called Low Risk Strategies. I'm not sure if I was spammed or not with this one but the site is interesting. It is devoted to educating readers about structured products that trade on exchanges. I have touched on these products before. For the most part they offer less risk and less reward in a combo that can be attractive. The product itself can be very flawed but the site has a lot of content about how to mitigate the flaws.
Businessweek came out with a double issue about China and India. If you feel like you need to learn more that you already know it is probably a good read, unfortunately there was very little on investing in these two countries. I first bought India for clients in the fall of 2003 with the Morgan Stanley India Investment fund (IIF). I was concerned that paying $23, at the time, might be too high. I just bought some for a new client recently in the mid $30s. To be clear I have no feel for which direction the next five points will be, but I have to think that India will continue to outperform the US stock market for the next several years. I don't think it matters a whole lot how an investor accesses the country, but if emerging markets are suitable for your portfolio you should probably learn the story.
Likewise China. I have had China exposure for clients since spring 2003 by maintaining a position in one of the oil companies.
Friday, August 12, 2005
It seems to me that if less oil can be refined, the product becomes more scarce for end use. The price goes up.
You can blame oil or the calendar or Dell but part of coping with days like this is to train yourself to realize that this is how the market works. It goes down sometimes.
Clients own Dell.
The important thing about this is I was happy with the price I got yesterday, so I took it. Whether the stock was up or down after isn't really the thing. This stock worked out well for me, luckily.
Whether a stock works or not, once you sell, that should be the end of it, emotionally.
I took a quick peak at the cap size of the largest components of five different mid cap ETFs, including the three that Morningstar has, because the $8.5 billion makes no sense to me.
iShares Russell Mid Cap Index (IWR) has nine of its top ten bigger than the $8.5 billion number. The iShares S+P Mid Cap Index (IJH) has five of its top ten larger than $8.5 billion. The iShares Morningstar Mid Cap Core (JKG) has nine of its top ten larger than its own $8.5 billion threshold. The iShares Morningstar Mid Cap Growth (JKH) has nine of its top ten larger than $8.5 billion. Lastly the iShares Morningstar Mid Cap Value (JKI) has all ten of its top ten larger than the figure.
"Uh Mr. left hand, Mr. right hand calling for you again on line two."
The information on the site is great. The analysis continually underwhelms me. The make up of its own mid cap ETFs contradicts the analysts work. I think this could leave people with an incorrect impression of their portfolio composition, in the tools section, and perhaps cause people to take action based on what looks to me like flawed information.
Where there is one there must be others. If you have some web site or brokerage firm offering commentary on your portfolio make sure you double check the work the lead to the conclusion.
Thursday, August 11, 2005
The finance/economic blogosphere got a nice write up in the WSJ. Kudos to The Big Picture.
The name of the stock does not matter, I will generically refer to it Acme Brands. I bought Acme last fall for what turned out to be 2/3rds of the accounts I manage, I should have bought it for everyone. I expected Acme to be a slow and steady grower perhaps capturing slightly better returns than the consumer sector.
The stock turned into a monster home run, for such a short time period. I have had a stop order in since May or June and I think I raised the stop order four times since that first one. Today the company gave bad guidance for the next couple of quarters. My stop order was about 8% below last night's close. This morning during the first 20 minutes or so of trading the stock got with in $0.40 of my stop order and started to go back up. I decided to change my stop order to a market order and sold it about $1.20 above the stop price. As I write this now, the stock is about $0.50 higher than where I sold it.
Was this a good idea? I don't really know. What I do know is I was hoping to get 15%-20% out of the name in a year and I got about 60% in nine months. The stock has a tendency to gap up or down several points when there is news. If the next big news story turns out to be bad the stock could easily open a buck or two below what had been my stop price.
I would say the tactic used here was a combination of objective trading strategy and gut feeling. The stop order part of the story is disciplined strategy and tweaking it a little to sell the stock was my gut. Discipline and gut feeling are two tools that any investor can employ, why not use both?
|US Dollar Exchange Rates|
I have been a dollar bear for a long time, even through the spike up in the dollar in May and June. It was interesting to me to hear so many strategists make very bullish dollar calls during that time. I'm sure there were people that tried to make short moves for long term portfolios based on this commentary.
As I look at the big picture and at what I think is happening I think it is clear that the general trend for the dollar will be lower. Clients portfolios will not blow up if I am wrong, however. What do you think will happen longer term? Which currencies have increasing demand and which currencies have decreasing demand? To me, the answer is clear but I could be wrong.