Hard Assets Investor

Countries, Commodities And Correlations

The above link is to something I wrote for Hard Assets Investor.

Hopefully I will have a couple of posts there every month.
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A Substitute For Another Fund

With apologies to The Who.

I have been wondering whether this new BuyWrite ETN (BWV) could serve as substitute for a regular S&P 500 fund when combined with one or two other products.

The idea would be to capture most of the effect with less volatility. My first thought is some sort of combo of BWV and iShares DJ Dividend Select Fund (DVY), which a few clients own.

If SPY yields 1.5% a 50/50 mix of DVY, 3% yield, and BWV, no actual payout, obviously means no yield is given up.

The thing that is given up is growth. You may have a negative opinion about growth but no growth makes for an undiversified portfolio. If you want to add growth, how much should you add? It appears that growth accounts for 48% of the S&P 500. I get 48% by looking at the Total Market Cap numbers for the S&P 500 Growth and S&P 500 Value ETFs, IVW and IVE respectively.

Since this is just theoretical I could see where 25% to growth, 35% to DVY and 40% to BWV could create the effect but it would be very underweight growth. Because BWV is brand new there is no way (at least I'm not aware of away) to analyze this as portfolio. See the chart below though and you will see that during dips of varying magnitude in the last two and a half years the BXM index (the thing that BWV will try to mimic) has really held in very well which is why in other posts since this blog started I have wanted a product like BWV to come.

Lest anyone add one plus one and get eleven I still believe it makes sense to let BWV prove it can track the BXM index. While I don't know exactly how long it will take to prove itself I would think it would take at least several months.

This post belies the fact that I am favorably disposed but I have no position and I can't be certain at this point if I ever will have a position. Further, this post is simply an exploration, more specifically a fumbling around in attempt to learn more about this.

On an unrelated note, did anyone see the quick Ray Liotta interview during the second period of the Stanley Cup game last night? "Oh, snap" is all I can say.
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Table From Index Universe

This is great info, IMO, for top down portfolio management.

You can click here if you can't read it very well.
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China

Ok, so China had some sort of event overnight that seems to have knocked foreign stocks down for the day. The US market started lower and shrugged it off. I have touched on this before. I think a real meltdown in China would have an effect on other markets but it would be more about emotion than fundamental causality.

The thing behind the thing (and others have said this too) is that the internal modernization and ascendancy to middle class is going to continue regardless of the stock market and what GDP does. A 50% hit to their market may slow things down I am not saying it won't but progress will continue. If so then I would expect things that benefit from China would still benefit but they won't be immune from a correction to be sure.

Earlier today on the network I heard a segment with JJ Burns and Marc Pado about investing in China and China's impact on our markets. They both seemed to agree that retail investors should not own individual stocks.

That an investor should not own a stock from some country because they are an individual or retail investor strikes me as balderdash (Jim Rogers favorite word perhaps?). For a given investor a stock may or may not be appropriate but a blanket statement like this seems incomplete.

I have touched on this a fair bit in the last few days but the risk taken by owning some stock with a heavy weight in the ETF for that country is does not make you a risk junkie if you own the correct proportion. If you allocate 7% to emerging markets and split that 7% into three stocks from different countries that rely on different things that you have researched thoroughly you are not being crazy. The picks could turn out to be wrong but this is far from gambling as the chance of fraud is statistically insignificant and as long as you have some sort of exit strategy.

I disclosed selling Sinopec across the board about a week and a half ago in a video post. At some point I will be back but I am not sure when. Part of being involved with a big, popular, white hot theme is being prepared to sell when you have made a lot and being willing to sit out for a year or maybe even longer.

I am stepping into a meeting I will proofread this post when I get out, sorry.
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International Fixed Income

A reader left a comment asking about international fixed income that you can read here.

I am a big believer in foreign diversification for stocks, bonds and cash. Many clients have foreign bonds with a CEF that is mostly Australia and an individual issue from Norway. As time goes on I can see adding individual issues from other countries. These are difficult to access for individuals as the minimum at Schwab is $100,000 per trade. I can allocate to clients as small as I want however.

There are several reasons why I believe in doing this. While I think the dollar is generally headed lower, slowly over time there will be periods where it is strong (bonds from other countries is one way to benefit from a weak dollar). The strategy here needs to be one looking at the long term. Also the blending of fill in the blank from different countries tends to reduce volatility. This especially makes sense when you consider that the middle of the US curve is very low by historical standards. I think it makes sense to expect that the curve will normalize at some point and when it does I think intermediate and further out maturities will be higher in yield and shorter maturities will be a touch lower.

This normalization, if it happens, means bond prices would go down. As a rule of thumb a 1% increase in rates works out to about an 8% decline in price--of course shorter maturities work differently.

Another aspect to this is that I think other countries are better off economically which makes for a compelling investment destination for stocks, bonds and cash.

I am far from the gloomiest guy on the future prospects for US capital markets but I do think that better results will be had over the next decade or so by looking more to foreign. I have been about 35% in foreign and can envision increasing that to 50% (a point I have made quite a few times in the past). My foreign exposure to bonds is quite low currently but I could see that going to 25% in the future. Of course if things really come unglued in the US I could go heavier with foreign bonds but I don't think it will come to that.

Constructing a foreign bond portfolio is not dramatically different from constructing a foreign stock portfolio. I would have a mix of different countries some with surpluses and some with deficits, countries with different types of economies at different points in their respective economic cycles and varying interest rates.

The big point here is you probably need to learn about this if you have not already done so in order to make your own decision. There is no way, now, to know how important this will become. Having to learn about this on the fly during some sort of unraveling seems less than ideal.

I would expect that accessing this market will get easier as fund providers bring product to the market (at least I expect this to happen). MSCI has created a lot of indices for this space, someone just needs to license them and create the funds.

Now from the where are they now file; Kirk Gibson, yes that Kirk Gibson, is a coach for the Arizona Diamondbacks. Maybe I'm the last to know.
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Emerging Markets

There is a cautionary article in the WSJ about emerging markets that warns of a possible crisis in Hungary, Kazakhstan, Russia, Ukraine, and Estonia because of how they have borrowed money.

While it seems there are more people that call for a crisis than actual crises that occur this point could certainly pan out exactly as opined but I don't know.

It is much easier to know that certain countries face the same risk. For example Iceland, New Zealand and to a lesser extent Australia are all vulnerable to yen strength. It is easy to see whether a particular country is a deficit country or a surplus nation and chances are you want exposure to both, that is if you break it down to the country level.

Of the Eastern European markets mentioned above Russia is the easiest to access. Russia has a lot going for it; surpluses, strong currency, natural resources and so on. There is some sort of political risk (the amount and reality depends on whom you ask) and if the price of oil cut in half Russia would be hurt. Clearly anyone wanting to add Russia does so expecting to add outperformance versus their domestic benchmark. No one adds Russia as a defensive measure.

It almost makes the argument that with any Russian stock or fund you buy you should really go for a lot volatility. If the selection of Russia is correct a more volatile Russian stock, or whatever, will really do a lot of lifting withing the portfolio. The place for moderation is in the weighting not the stock selection (bottoms up research still needs to be done of course). Putting 2% into a stock that could go berserk in either direction is not the most reckless thing you could do, far from it.

Investors get in trouble when they get so enamoured with a stock like this that they put 10% in it.

All of this theory aside it is difficult for a lot of people to buy a stock from a place like Russia but the point about how to allocate risk within a portfolio should be relevant. Putting more than 2-3% into something you think is very volatile, regardless of whether it really is or not, will bite you at some point.
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Buy Write ETN

A few days ago I wrote about the buywrite ETN (BWV) for RealMoney. My initial reaction is positive but I do plan to give a couple of months before I make a final decision about buying it. If it can track the CBOE BuyWrite Index (^BXM), which I can't be certain of yet, I will probably buy it.

The chart compares the BuyWrite index with the market price and the NAV for the Madison Claymore Covered Call Fund (MCN & XMCNX) which is a fund I owned across the board and a name I still have for one or two clients.

The charts of MCN and XMCNX are distorted due to its large dividend but even factoring the distortion BXM looks to be less volatile on a short term basis.

If I end up buying BWX I can envision allocating 2% to it and pairing back the call writing CEF I use now to 2% for a total of 4% for some clients.

Relative to the way I allocate to these things 4% might seem a little high but for now my take is that the CEFs, being actively managed, are riskier than an indexed product. There is no attempt to chase yield, no matter what the at the money call is trading for that is what is sold, period.

One item about BWV to point out is that it will not pay a dividend. According to a phone call to Barclays last week, any income derived within the fund will accrue to the NAV.

To be clear BWV, IMO, needs to prove it can track the index.

An unrelated item; yesterday during the NCAA Lacrosse D-1 final commentator Quint Kessenich said that if lacrosse was a stock Cramer would say "buy."
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Holiday Rant

Why doesn't the US government contract out to have all of its land in Nevada turned into one giant solar panel farm (or whatever the right terminology is). Maybe this could be done for $10-20 billion. I would think all those square miles of panel collecting solar power could satisfy a lot of the country's electricity needs and change the entire dynamic of the problem. The nature of the location is such that no one's life would be disrupted. When its done the electricity would seamlessly originate from a different source.

Why doesn't the US government farm out things like department of health, education and just about everything else to the state level? They could provide the money but shut down their offices, give the employees two years salary as a severance and save quite a bit of money I suppose.

The department of defense would be an exception as would energy and treasury. There may be more that should be excluded from this big shut down but these are the first three that come to mind.

Why don't we have a flat tax? How about we pay nothing on the first $35,000 and 7% on everything above $35,000? No deductions, no exemptions, no capital gains, no AMT, no nothing.

The form might look like this;

What did you make_________
Subtract $35,000 _________
Multiply by .07 _________
Send it on in _________

That would be the entire form. Maybe it should be $40,000 and 8%? The billions spent on IRS that would be saved might help shrink the deficit.

Why don't they teach kids in high school how to balance a checkbook, fix a toilet, change the oil, mix concrete, use credit wisely, hammer a nail properly, gun safety (this can be done without any guns in the classroom), how to iron a shirt and the absolute basics of personal finance.

This post is more tongue in cheek than anything else, I certainly have knowledge gaps on these things but still, I'm just saying.
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Sunday Morning Coffee

Short and sweet today. Barron's had a write up on something I mentioned the other day that came from FT Alphaville about Sovereign Wealth Funds.

Some numbers from Barron's;

UAE $875 billion (I can't believe the number is so big)
Singapore (GIC) $330 billion
Norway $312 billion
China $300 billion
Saudi Arabia $300 billion
Singapore (Temasek Holding) $100 billion
Kuwait $70 billion
Australia $40 billion
Alaska (pictured here) $35 billion
Russia $32 billion

This represents a lot of capital, that is still growing, that has been deployed and will be deployed in the future. Keep in mind these numbers are not the treasuries of these countries but money set aside for investment.
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The Big Picture For The Week Of May 27, 2007

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Two News Items

FT Alphaville has an interesting post about Sovereign Wealth Funds, SWF. There are a lot of these, maybe as many as 25, and the dollars involved is in the trillions. This capital will flow somewhere, actually many different somewheres, and be very important to understand. Being able to follow this sort of thing, or somehow be in front of it even, will go a long way to putting the odds for success in your favor.

If an SWF is having success with an investment destination it is like to continue to direct new investment to that same place. You catch a tailwind by going along for the ride.

You may have heard that Nasdaq is buying the OMX Group which owns a lot of exchanges in Northern Europe including Iceland. I actually wrote about OMX being a target a year ago for RealMoney. I subsequently bought the stock and sold too early. Perhaps this deal creates visibility for access to Iceland and some of the other interesting markets OMX trades in.
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Friday Thoughts

Here is a link to an article by James Picerno about ETF proliferation and a look to the future about what direction the industry might take.

The visibility for future ETFs in one way seems clear in that there will be product that covers market segments that now can't be easily accessed. In another way it is not so clear because "not easily accessed" would not seem to imply a couple of thousand more ETFs to come as Robert Arnott theorizes in the article.

I do not think of myself as someone who uses particularly obscure ETFs but perhaps that self assessment is wrong. As a matter of philosophy I think simple is better and so an entire portfolio of strategies not easily understood would seem to be counter productive.

Using individual stocks to capture a desired effect can be simpler than using ETFs. Obviously picking a stock from Singapore takes on some more risk than a country fund for Singapore but the big phone company for a country is not the most difficult type of stock to analyze compared to say a bank.

A reader left a comment that noted his very reasonable discomfort with picking stocks from emerging markets (in this case China). So here you can go with a product obviously but it might be worthwhile to learn a little more about how to pick a stock from one of these places.

I plan to address this in more detail in this week's video but for now I would ask how much would you invest in one emerging market? Would you go as much as 5%? What about more? If you have been reading this site for a while you might recall that starting out with 3% is about as heavy I go and with an emerging market stock it would be more like 2%.

Is the risk profile of most big cap stocks from a country so much greater than a product that capture the entire market of that same country? The vast majority of the time it isn't.

More about this over the weekend.
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Everything Is Down

Sometimes everything goes down and today is one of those times obviously.

Gold, most other commodities, foreign stocks, foreign currency and fixed income are all down today. If one day can trade like this so can a week or a month.

The point is that a portfolio designed to capture some zig-zag may not be working very well unless some sort of inverse product is held.

Today is a great example of why focusing in the short term, which a lot of people do, makes the job of participating in market much more difficult.
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Revisiting DBV

I have written quite a few times about the DB Currency Harvest Fund (DBV) in the past and even traded it personally a few months ago. The fund goes long the three highest yielding currencies in the G-10 and short the three lowest yielding G-10 currencies; a carry trade of sorts.

On May 10 the Bank of England raised its Fed Fund equivalent rate to 5.5% which is higher than the Fed's 5.25% which means that the US dollar is no longer one of the longs.

Now that the fund is not long* the US dollar I am thinking about going back in and possibly buying for clients as well. The carry trade is not riskless but the fund is short more than just the yen, so while DBV would feel any yen dislocation it might not be as bad as pure yen.

I think the proper weight might be 2% of a portfolio which is small but again the strategy underlying the fund is risky to a point; not one-drug-biotech risky but still.

I enjoy, personally, exploring these types of strategies and adding them into a portfolio does add value, IMO, but it seems that do-it-yourselfers invest way too much in each of these alternative-ish investment products.

Please, moderation.

* The fund does have dollar exposure in that it owns mostly treasuries, that pay yield, and uses futures contracts to get long and short.
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Off The Record

My visit with WisdomTree was off the record so I can't say much about their new Tunisian Fund (JOKE JOKE JOKE, there is no Tunisian fund on the way).

What I can do is forward along the comments left this morning and print the reply but I do not have an expectation to set as far as when I will get a reply.

One thing that came from the meeting is that there is a new ETN benchmarked to the CBOE BuyWrite Index that trades with ticker BWV.

It is a debt instrument of Barclays (client holding) and not an ETF. Chances are this fact will never matter but it is a technicality that anyone buying needs to understand. I am going to do some work on this. I have wanted one of these for ages but we'll have to see whats what.
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A Sit Down

Later this morning I am having a sit-down at a Starbucks (the location was my idea) with a couple of folks from WisdomTree.

I have a few questions in mind but candidly I am not sure if this will be an on-the-record interview or an off-the-record chat.

If I can work out the logistics I will check the blog for comments...so if you were going to have a face to face what would you ask?

I am inclined to ask what they personally would like to see in the industry, maybe this can make more headway than asking what WisdomTree plans to do. I have some ideas for narrow-based products that I wonder if are even feasible and I would like their take.

As an unrelated unintentional comedy nugget; I think I heard the Stallion say "don't ask me to explain folks." Ok, Bob, you got it.

It seems like a lot of people are coming on the network with very bullish short term outlooks for the Chinese markets. I disclosed selling the last of the Sinopec (SNP) I held for clients over the weekend in the video (sold on Friday, disclosed on Saturday). The stock closed on Tuesday about where I sold it.

My sale could turn out to be a bad one but after tripling in 17 months I think I need to hear more from the bulls about why the obvious concerns that might arise when a market has gone up so much in such a short time are in fact not going to be problems. It might be a function of the questions these guys are asked but for a six month period or so the risk seems to be greater than the reward.

I expect to be back into China in an across the board fashion but I think it will be a while.

ISK is now way below 62, holy cow.

The Celtics got the fifth pick in the lottery which was the worst possible outcome given their record. Yikes.
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Going Mobile

I found this article on MarketWatch about investing in Central and Eastern Europe. In the article there was a mention of a company called Telefonica O2 Czech Republic. It trades in London with ticker TECZ.

The article talked about the big energy, bank and telephone companies as ways to invest in emerging markets (a point I have made a few times as well). About all I learned from the article about TECZ is where it trades and that it yields 8%.

The info in the article was enough for me to want to learn more about the company and maybe buy in at some point. Before I did any research I called Schwab to see if it could be traded or not--the answer was no. Since I can't buy it there didn't seem to be much point in doing any further research.

While markets are opening up it seems as though access for US based investors is not quite keeping up. TECZ trades on the London market for Pete's sake but because it is a GDR, no dice.

I expect things will have moved along much further five years from now but for now things seem to be moving slowly. Direct access to Iceland is not possible because of a lack of custody agreements needed to facilitate trading. In the last year the ICEX-15 is up almost 45% compared to 20% for the S&P 500 with no US buying. There are many markets offering diversification and high returns that are not available. Consider this post to be a rant about the issue.

To be clear I am not advocating loading up on frontier/emerging markets but I am saying it would be nice to have more choice for the small portion I allocate to the space.

I am not sure if TECZ is THE big phone company or not, although you can click here for the company website.
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Priced In Lag Bolts....

Eddy Elfenbein had a funny post up the other day that has gained some traction about how, when priced in other currencies, the US stock market hasn't done that much. Eddy counters, saying "Who cares? I don’t use euros anyway. Why not compare it to bandwidth? I use lots of that."

A couple of years ago Marc Faber said that measured in Polish zloty the US economy contracted 19% last year, referring to 2004.

Peter Schiff recently made one of these comparisons of the Dow against the price of eggs on CNBC.

So, does it make any sense to look at equity prices in this light? Some will say yes and some will say no. If you are a US based investor it won't matter most of the time but sometimes it will.

If you invest in gold you know that it is priced in dollars and usually moves inversely to the dollar. There is an equilibrium that exist between the two and many times movements in gold can be attributed to what the dollar is doing but I'll repeat not always. So if the dollar goes down gold will go up but that move up in gold becomes a nonevent for gold investors based in other countries.

So it can be for equities too. If US stocks rise 10% when the dollar declines 10% against, say, the Danish kroner, Danish investors would not benefit. In this example there is an equilibrium that exists, one goes up and one goes down with no real movement.

I would say that however often this effect matters between gold and the US dollar the frequency of this mattering between US equities and various foreign currencies is far less often. I do think it is important to understand relationship.

The consensus seems to be for more dollar weakness, I certainly fall into that line of thought too. If the dollar does fall it creates a drag on the return for foreign investors. This potentially becomes a problem to the extent that we need foreign capital invested in our market, which of course we do.

There will always be some demand for US assets so the potential effect is at the margin the vast majority of time but at times this issue will move markets and it wouldn't be a surprise if it was the tipping point for some sort of correction or worse at some point.

Eddy's comments notwithstanding it does make sense to understand the dynamic here even if it only matters occasionally.

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The S&P 500 Moves It, Moves It

To a new high (sort of) that is.

Who can say what the real significance is or isn't but it is nice to see prices going higher plus I like use this picture whenever possible.
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More Greenback Irrelevance

Kuwait is abandoning its peg to the US dollar according to FT Alphaville. There have been a couple of small countries in the middle east that have done likewise in the last year or so and there have been other countries that have re-weighted their reserve baskets to reduce dollar exposure.

None of the individual stories along these lines has significant impact but they do speak to the idea that slowly the dollar is becoming a little less important on the world stage, a point I have been writing about for a couple of years.

This puts upward pressure on interest rates. Obviously rates are now low but that does not mean the pressure from less demand is not there. I continue to believe that US rates will move to the higher end of what is historically normal. This has the potential to slow things down so that maybe our growth rates will look a little more like western Europe. This may not be great news but it is not an apocalyptic death blow by any means.

The investment implication is one I have been writing about for a long time which is lower than average investment returns in the US creating the need to learn about and invest in foreign markets.

Of course if this is wrong and "Goldilocks" lives in the US stock market, all the better.
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All Done Saving!

Whew, what a relief, my wife and I don't need to save anymore. How do I know this? Well I plugged our numbers into a retirement calculator on Yahoo Finance and according to the calculator if we wait until I am 70 to draw social security we will take in $97, 197 and our income need will only be $79, 181 (we live quite a ways below our means). This really is a load off my mind because we "spend" a lot of money funding our various retirement accounts and now with this news we can just spend the money on fun stuff. For that matter we can spend what we have already saved because our social security will always be more than our income need.

What could go wrong?

It seems like anytime I look at one of these calculators it tells me we will have a gajillion dollars leftover if I die at 110. I'm not one for relying on this sort of thing. I have written before about whether brokerage firms tell people to save too much, not that I have an answer to that but the idea of saving too much seems silly, the sellside's motivation notwithstanding.

Barry Ritholtz had a link to a post on a blog called The Float that warned about inflation, more specifically purchasing power risk, being the biggest risk to a successful retirement. Within that post was a link to a WSJ article on the subject that included a profile on what seemed like a financially normal retired couple that spend $11,640 per year on various medical coverages including long-term care insurance. They also set aside another $3000 for "uncovered costs."

My wife and I spend about $2400 on insurance and maybe another few hundred on checkups (high deductible HSA) so $11,000 seems high to me but obviously I don't have the right perspective. The point is that medical expenses are high now for retired people and should be expected to take up more of people's budgets in the future. As a 41 year old trying to save I have no clue what my medical expenses will be in 30 or 40 years. What is your time horizon for retiring? Do you have a clue as to what your medical expenses will be?

Given the variable nature of this, the need to save as much as possible seems fairly obvious. There are, reasonably speaking, several big unknowns but, recurring theme, you still need to map something out if you have not already done so.

What do your numbers look like with social security? How about without? Are you counting on an inheritance? What if it somehow falls through? Are you planning to work forever? What if you can't?

These are questions we all have to factor in and ask again every so often.
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Sunday Morning Coffee

A reader left a comment noting some stats about odd-lot trades being relatively low and taking that as an indicator that a lot of retail investors are sitting out this rally.

This could be the case but I had a thought about the utility of this as an indicator. The number of do-it-yourselfers that can put $10,000-$15,000 into one stock is much greater today than it was ten years ago.

Given that the vast majority of stocks trade below $100 I am theorizing that there is much less demand for odd lots than in the past and that demand can only decrease in the future.

If this holds any water it is an example of evolution for a stock market indicator. If one indicator can evolve than I suppose others can too.

A short while back I mentioned having heard from WisdomTree that five more ETFs were coming quickly, well make that three. I am on some sort of distribution list (nothing special, I think it comes with having registered at their site) and the latest one says to look for International Real Estate (DRW), Emerging Markets (DEH) and China (DCF). DRW and DCF are both dividend funds but I am not sure about DRW.

I shaved off a little bit of another stock on Friday in addition to selling Sinopec (SNP). Some clients own Marathon Oil (MRO). A few folks had owned it long enough that it become too large for their respective portfolios. It was a modest pairing back for only a few people. It seems like the stock has become more volatile since I first bought the stock a couple of years ago and this seemed like a good time to reduce the position.

Tom Lydon found this link to a WSJ article saying that we should expect a lot more fixed income ETFs was well as further product expansion in other areas too. If correct I think this is a positive but I do concede that some people will misuse them and hurt themselves.

A lot of products will come but I think that we are a year or two away from more funds closing due to a lack of interest by the investing public.

Things like the dividend capture I mentioned the other day along with buy-write index funds and single country bond ETFs are what I would like to see the most. It looks like we have dividend capture coming but I can't seem to make any headway on the other two just yet.

The picture is of the gas station in Kalaupapa on Molokai.

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The Big Picture For The Week Of May 20, 2007

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Sitting Out

There have been a couple of comments lately implying that a lot of people are sitting out this rally we are having, more than in past rallies. I'm not sure there is a great way to quantify this and it seems to me that ten years ago, or whenever, there were fewer people expressing themselves so freely due to where the Internet had evolved to at that point. Even in 2003 there were fewer people interacting on the web the way they do now.

The point is that there may not be more people sitting out, there could be fewer people sitting out.

The momentum of the market seems very good for now. It will stop at some point and the next bear market/correction will start and of course a couple of people will be exactly right about when.

If you buy into the idea that the bull market is long in the tooth but don't want jump out just yet it makes sense to increase the market cap of your portfolio. I did this in January when I added Altria for most clients. It is up a little since I bought, probably trailing the market but I think that if leadership continues to narrow and move up the cap scale, which is what happens when bull markets start to end, I think it will participate.

While I have been expecting the market to turn we have seen this run go on a long time and it may continue for a long time yet. The mega caps lead the market for several years at the end of the tech bubble. I have been unambiguously wrong about the market going down, a point I have made numerous times, but have not missed anything because I did not make any big bets, only small ones, anticipating a turn.

The reason to repeat this sort of thing is to show consistency in my thought process as the weeks pass. This sort of consistency helps me manage volatility and expectations. I was visiting with a client the other day and was asked about the market crashing. I explained why I assign a low probability to a crash but if it happened that we would sell the double short fund because it would be up a lot and mentioned a couple of other possible things we could do.

I have thought about a crash and have a plan if there is a crash and made the plan when the market was doing just fine. While I am quite certain I would not react emotionally to a crash all I would need to do is just stick to my plan. This is important for crashes, bear markets and bull markets too. Not enough people plan this way including professionals.
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More Fun With Currencies

This is a chart of the dollar's decline against the Brazilian real.

While the typical American is unlikely to be directly impacted the dollar has nonetheless cut in half in a short time period.

Chances are you know most of the story with Brazil and the surpluses created by the commodity boom.

The dollar has had big declines against a lot of currencies in the last few years without causing panic. My expectation is that this trend, which seems likely to continue albeit with less magnitude IMO, will create a drag, slightly higher rates and below average equity returns (a repeat from a recent post).
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New ETFs

If you read the IndexUniverse ETF Watch this week you probably noticed a couple of filings from Claymore that I think could be interesting.

One is a dividend capture ETF. There are several CEFs and OEFs that employ this strategy. In its simplest form instead of buying one stock and collecting four dividends you buy one stock that goes ex-dividend in, say, May and then sell it and replace it with a stock the goes ex-dividend in June and rotate back and forth between the two.

Most of the funds in this category do this with their holdings in such a way that they qualify for the 15% tax treatment but I don't know if every dividend capture fund is tax sensitive.

The Claymore ETF will tilt to large cap and can include ADRs (hey guys about a foreign-only while your at it). The prospectus reads like the screening process will generate two lists of stocks and then the fund will rotate between the two every two months-there is a little more to it though.

I will be curious to see how this compares to the CEFs. The obstacle, if there is one at all, seems to be adhering to an index as defined in the prospectus. In a truly actively managed product the managers can make decisions to buy or sell as they see fit. That might not matter for an ETF with 100 holding but this is my only question about whether dividend capture in an ETF can stand up to active management.

Regardless of whether the ETF is better, worse or the same I still will stand by my comments from the other day about moderation. Its a great concept but no one needs some sort of freaky unintended consequence taking down their entire portfolio.

The other fund that caught my attention was the Claymore Robb Report Global Luxury ETF. I would imagine the fund would own stocks like Nordstrom and Saks but the fund can own ADRs too so we'll have to see. What little I read of the prospectus didn't give me an idea as whether there is any qualitative screening or if it is just market cap within the subsector. for now it doesn't matter, they just filed on May 4.

While I am sure Morningstar will tell us to run like the wind from this fund I might offer a "not so fast my friend" on that. Assembling the consumer discretionary portion of a portfolio with stocks like Nordstrom, Best Buy, Lowes and Viacom is far from crazy. To be clear I picked these names at random, I do not own them.

So instead of those four stocks why not four different subsector ETFs? Well maybe Lowes and Best Buy would be in the same fund. Discretionary makes up about 10% of the S&P 500. If you would allocate 10% to four stocks you could just as easily allocate that same 10% to three or four subsector ETFs without anyone thinking you are a risk junkie.

I must say this seems rather UN-complex yet a lot of MSM can't quite grab on to the idea of using narrow-based products responsibly.
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Cartwright!!

All things China continue to go berserk.

The new listing in Shanghai for Bank of Communications surged 71% on its IPO.

The Chinese stocks I follow are mostly up a lot over the last few weeks, not as much as the Shanghai market but they do seem to be capturing a lot of the effect.

The Shanghai exchange has about tripled in the last year and a half. It has been a wild ride for a relatively new stock market.

If the market cracks, crashes or does anything else nasty it makes sense to expect other markets to react. I don't really get the wave of commentary that says otherwise, it seems that other markets would in fact feel a China meltdown.

However that does not have to mean that there is a fundamental reason for all other markets to go down with China. I would suspect that a reaction in sympathy could retrace rather quickly. Here though you need to think in terms of weeks not days.

It seems that most of the big, short term, "Vs" in the US market over the last ten years or so have needed six weeks or so to retrace.

You should be less afraid of a V shaped move than a U shaped move.
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Under Performers?

Robert Pavlik from Oaktree Asset Management was on CNBC and made a comment in passing about under performing stocks. He seemed to be generally bullish but made a comment, in context of giving generic advice, about investors perhaps selling some under performing stocks.

Be careful with that one.

If everything you own is going along for the great ride up we have had, what do you suppose will happen when the market turns?

One aspect of being truly diversified is that no matter what is going on you always have some stocks going up and some that are going down. Hopefully the mix of what is going up and what is going down is such that returns are reasonably close to whatever benchmark you use.

I am not saying Mr. Pavlik is wrong but his comment has the potential to be misconstrued leading people to take action that results in becoming overly exposed to whatever is perceived as being hot.

As I look at client portfolios in any given quarter there are always stocks that are white hot and some that seem to be wilting. This can happen to companies when the fundies change or when they do not change. Selling a stock that is "wilting" when there is no fundamental change is probably not a great idea.

Becoming impatient with an ETF or fund that seems to be lagging is probably an even worse idea, assuming the portfolio is intended to be diversified.

It is very easy to get caught up in the action of the stock market, feeling like you have to do a trade. For the vast majority of people this is not the way to go. What makes this complicated is that occasionally something does need to be sold either for good reasons or bad reasons.

I think the best way to go about this is to have some sort of game plan going in. Generally when I buy a stock I hope I can hold it forever. This does not always work out. I am a seller when something grows to big (this is a good), I am a seller if a stock does not capture the things (like sector or country) that I think it will and occasionally I am a seller when I want to reduce exposure to a sector for top down reasons that might have nothing to do with the stock.
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Kiwi and ISK

If you have read this site for a while you know I follow Iceland and New Zealand very closely. I believe both investment destinations have the potential to play larger roles in the world economic order in the coming years.

Both countries do have some serious issues with regard to their respective current accounts and a few other things and so many people view both currencies as being in real trouble.

Certainly the naysayers could turn out to be correct and both currencies could get pasted, both have had their moments in the last couple of years, but this chart shows the decline of the US dollar against both the kiwi and the krona.

The reason to bring this up is that both of these are considered a little shaky as I mentioned yet the US dollar is down a lot against both of them. Maybe this speaks to even bigger problems in US or it may not, that is for you to decide for yourself, but the important thing, assuming you don't want to invest in either New Zealand or Iceland, is that these currencies could be sending a signal about US markets.

I generally believe in the concept of message of the markets and I think there is a message in NZD and ISK. To be clear I don't think the message is one of doom but more along the lines of what I have been saying for quite a while; more currency weakness, slightly higher (but still normal) interest rates and below average stock market returns.

Lastly I realize that NZD is quoted the other way but this is the only format I know to make it work on BigCharts, Yahoo Finance can't chart USDISK and Google Finance can't even quote it so this was the only way I know to get them onto one chart.
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Get A Plan

A financial plan that is.

If your financial life is more complicated than "how much ya got and can you live on 4% of that?" you need a plan.

There are so many ruinous mistakes that can be made from spending too much, spending from the wrong spot first, investing too conservatively, investing too aggressively, somehow creating a tax problem, not understanding inflation, not knowing how to assemble a portfolio, make good decisions about social security, know whether you need some sort of insurance product, not having a back up plan if the first three years of your retirement looks like 2000-2002...any others?

This is not a pitch to hire anyone but for you to either empower yourself to do the job or if not to find someone who can help you.

I do think the work can be done on your own. It is not easy, I know I have a lot to learn about the topic. Portfolio management (what I do) is not financial planning. I know a lot of questions and few answers which would not cut it. The fewer moving parts in your financial life obviously the easier making your own plan will be.

The first building block of our plan is that we live below our means. This is something I have touched on many times here. We live in a modest cabin that we love and have no plans to "trade up."

I have faith in the 4% rule of thumb (5% is very reasonable too). Whatever we put away, we'll have to get buy with 4%. Planning for a certain number is fine but if you "need" $2 million but you end up with $1.5 million...4%. This is a personal belief of mine so I understand any disagreement with this notion.

Tying in is the idea of saving as much as you can. This probably means that some years you won't save enough and some years you will over save. You can only do what you can do but chances are we all need to stretch a little bit in this regard.

I'll repeat that this is not easy at all but it is not impossible. Maybe deciding whether you need help or not needs some uncomfortable introspection but one way or another you need to map it all out. The idea here is giving yourself the best chance for however you define success.
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From Everyday Life

The combination of my being a wildland firefighter and living in the woods means I am unlikely to go too long without having a tree encounter of some sort. On Saturday we discovered that an old oak tree on our property that has been dead for a long time was probably rotting from within.

A friend came over Sunday morning with his chainsaw. He cut it down for us (he made the cuts while Joellyn and I pushed it where we hoped it would go) and then I cut it into rounds that I will split into firewood at some point before it gets cold again (it wasn't that rotted so it will burn well).

The way the tree fell, not quite where we wanted, it landed right on the edge of our glory whole, well its not quite a glory hole but its close. The ground was not real solid under my feet, I had to make some cuts with the chain saw held a little higher than what's comfortable, at one point part of the tree rolled into the glory whole before I wanted it to and combine all that with the normal difficulty of cutting up a tree like the saw is heavy, sometimes a chain saw kicks up for no reason and no matter what, trees, fallen or otherwise, do not yield for you.

The nastiest medical call I have ever been on involved a round rolling down a hill into a guy.

And while whole thing took less than an hour I would have rather been watching the college lacrosse tournament on ESPNU but the work had to be done.

I think the entire episode translates into investing. Sometimes the ground under the market's feet is not solid, sometimes you need to allocate capital when prices are higher than what is comfortable, sometimes a stock takes a roll into the glory hole before you want it to, sometimes the market kicks up for no reason at all and no matter what the stock market does not yield for you.

But the work has to be done.

Logging without getting hurt, like investing without getting hurt, is a matter of assessing risks before they become a problem. If I had been standing in the wrong spot when the bottom portion started rolling into the hole I would have been in real trouble so I made sure I stood in the right spot. Limbs on trees in this situation can be very dangerous so before each cut I made sure that there were no limbs that could stab into me.

In your portfolio you are vulnerable to certain things, risk assessment means making sure you are not too vulnerable. The market is always vulnerable to certain things, risk assessment means studying what the market is vulnerable to.

This is simply work we must do.

On an unrelated note The Sopranos is starting to wind down and while I won't giveaway last night's episode in case you haven't seen it, the dominoes are starting to fall, wow.
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Sunday Morning Coffee

As I mentioned a while back I will be speaking at the ETF Summit in NYC on June 15th.

I spent some time on Saturday putting together some notes for a powerpoint for when I speak (I have a deadline coming up to get this submitted).

My topic is international investing. I think I am closing out my portion with a quick tidbit on frontier investing.

I have mentioned a couple times my preparing for below average returns for US stocks in the coming years.

If this turns out to be correct it will be even more important to study, understand and invest in foreign markets. For a lot of markets I prefer stocks but do use products for some markets. We know from the latest filings from iShares that there will be more markets accessible through funds.

As a top down manager I think it is more important to be right about the country than anything else. Being right about the best product for that country is usually, but not always, less important.

If you have read this site for a while you know I don't believe that broad based products like EFA or VEU offer great diversification because the attributes of the various countries get blended away.

In assembling the foreign portion of the equity portfolio I start with the countries I want to own; usually the reasons are a combination of cyclical and the type of economy the country is; Australia is commodity based and Ireland is wildly pro-growth as two examples.

The stocks I pick for these countries might be because a given country is known for a certain sector, like Switzerland and health care, or a certain sector might just make sense to me for that country like China and the oil majors.

I think that the way investing will evolve we will need to know about a lot more countries than we do now. There are a lot of little countries in Europe, in particular, that will open up to US investors and maybe a little further down the line the middle east and then Africa after that.

I realize it seems hard to imagine that investing in Slovakia will be something you will do but I am thinking a little further out than Q1 2008.
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The Big Picture For The Week Of May 13, 2007

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Friday Lift

Well nothing to worry about anymore, right? Short term moves rely on a lot of irrational things but closing out the week like this is better than the alternative.

I disclosed getting stopped out on Volvo yesterday; today the stock is up close to 10% on earnings news. I sold roughly 1/3 of the position. It had grown in to as much as 6% of some accounts (give or take) which is a lot more than I allocate to one stock. In a way the sale looks bad, which is how it goes sometimes, but I still own the stock and so the way I look at it I have a stock at 3-4% for most accounts up 10%-ish--not a bad day. However any criticism of the timing of getting stopped out is very valid.

I found this little diddy in the FT; there are going to be a lot more Chinese IPOs. The positive is more choices will mean less buying pressure on the names that already exist. The negative is this creates more supply and based on history supply will eventually overwhelm demand. That is what happened with the internet bubble.

I still believe mania is a better word than bubble to describe China--well where US investors are concerned. Everyone you know does not have 50%, or more, of their portfolio in Chinese stocks, I don't think I am hearing a lot of "this is different" and a lot of people seem to think a big hit in China is plausible.

If China cuts in half, or worse, I do believe other foreign markets, including the US, would be impacted but I do not think it would be the all-encompassing deathblow that 2000 was. If a normal correction or bear market gets triggered because of China, and to be clear I don't know what to expect, it would have been something at some point so why not China?

On a related note I shaved a little bit off of the one Chinese stock I own for clients this morning. The name in question is up a ton today after a nice move and so for some (not all) people, as a function of circumstance, it made sense to cut back a hair.

Update/correction; there is a second Chinese stock I own for two or three people but not across the board and I took no action on that one.
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Assumptions

A reader left a comment on a post from a few days back called Savings. The post itself was very short but whipped up some good comments about saving too much (or not) and what sort of return you need to average to make the money last.

The last comment had a link to a post by Scott Burns on this subject. The reader quoted Mr. Burns "A conservative 40 percent equity/60 percent fixed-income portfolio could be expected to produce a long-term annualized return of 7.34 percent." I made the numbers bold, not the reader or Burns.

This might be a flawed assumption. Burns cites research from Ibbotson but does not say how long the research was. This could matter if the study was only 30 years because for about 22 out of the 30, yields have been declining which means price going up which helps total return.

Another concern about the assumption is that yields are now low by historical norms. There is visibility for yields to head higher over the next few years. I do not think we will see 14% yields again but 8% or 9% is plausible even if it is not accurate. With yields so low, people are buying high which is why I have maturities very close for clients.

Anyone building a true bond barbell at 4-point-whatever today is likely to have problems.

One fun little fact to think about WRT to stocks is that with all we have been through in the last ten years the S&P 500 stood at 824.78 on May 11, 1997 (a Sunday). That is an 80% gain which ranks poorly compared to other ten year periods. There have been quite a few ten year periods where the S&P 500 has tripled.

If the market averages 6% per year over the next ten years, a number consistent with my expectation of below average returns, the S&P 500 would be at 2675 on May 11, 2017--a 79% increase. In that same time frame your expenses will likely be 40-50% higher.

The market might average 6% a year but it won't go up by that amount every year. There will be some sort of combination of up and down varying magnitudes which of course makes this much tougher but equities are very compelling when managed smartly, with the right mind set and time horizon.

These numbers should be of interest to anyone below the age of 70 and more and more to people older than 70 too.
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Stray Items

There was some chatter on the network, as Adam likes to say, about China being in a bubble or not and the consequence for global markets.

There was at least one expert on saying there would not be a spillover into other markets. Well that is not a bet I would want to make.

If China has a nasty V shaped decline I would expect other markets to feel it as well and I would expect it would scare a lot of people.

If the stock market is a bubble and a problem ensues, I don't think it would take away from the long term appeal even if staying away for a while turns out to be the right trade. Everything going on internally now will still be going on if the market cuts in half. The US will still need all of the low cost stuff it imports from China. The returns could be bad for a while but I don't think it permanently derails the China dynamic.

In my post this morning I was wrong about the S&P water index. It has 28% in US companies so it is more global but not totally global. You can get the skinny with this PDF.

The other day, in the car, Dr. Bob was on Kudlow saying how great the retail sales would be this week. Well the same store sales generally stunk and we will see about retail sales tomorrow. The point here is to urge caution about believing people that sound credible. Dr. Bob seems to always be bullish but not everyone will know that. The first time you ever heard fill in the name of any perma bull you did not know he was a perma bull. Likewise the perma bears.

I would not have correctly predicted lousy same store sales but there was no visibility for the to be a great as Dr. Bob was calling for either. Bottom line is this reiterates the need for a grain of salt.

iShares has currency ETNs out to compete with the Rydex Currency Shares. For now there are three ETNs; EURUSD (ERO), GBPUSD (GBB) and USDJPY (JYN). There could be some tax differences with these compared to the Rydex products that are not easy to digest. IndexUniverse has it covered here.

I had an across the board stop order on Volvo execute this morning. It was only on a portion of the position. The stock went parabolic over the last couple of months, paid out some monstrous dividends and split its stock. I can't know whether my stop price will be the bottom or not but the stock had grown into a huge position and trimming some seemed prudent.

I have no expectation that I can be exactly right on something like this but I do have the expectation that I can be prudent. My first stop order was around $80 and I moved it up a couple of time before getting stopped out at $90 which adjusts to $18 for the split.

Just as I was going to hit the publish button on this post a comment came in asking about the Nuveen Currency CEF (JGT). I mentioned it last week and said I would call Nuveen. I called the spokesperson at the bottom of the press release, she said someone would get back to me and no one did.
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A New Slew...

...of ETFs that is.

First Trust Consumer Discretionary AlphaDEX Fund	(FXD)
First Trust Consumer Staples AlphaDEX Fund	(FXG)
First Trust Energy AlphaDEX Fund	(FXN)
First Trust Financials AlphaDEX Fund	(FXO)
First Trust Health Care AlphaDEX Fund	(FXH)
First Trust Industrials AlphaDEX Fund	(FXR)
First Trust Materials AlphaDEX Fund	(FXZ)
First Trust Technology AlphaDEX Fund	(FXL)
First Trust Utilities AlphaDEX Fund	(FXU)
First Trust Large Cap Core AlphaDEX Fund	(FEX)
First Trust Mid Cap Core AlphaDEX Fund	(FNX)
First Trust Small Cap Core AlphaDEX Fund	(FYX)
First Trust Large Cap Growth Opportunities AlphaDEX Fund	(FTC)
First Trust Large Cap Value Opportunities AlphaDEX Fund	(FTA)
First Trust Multi Cap Growth AlphaDEX Fund	(FAD)
First Trust Multi Cap Value AlphaDEX Fund	(FAB)
First Trust S&P REIT Index Fund	FRI

These were supposed to list last week but are now scheduled for today. I will check out the sector funds and the small cap value.

While there are plenty of funds due to come and plenty have listed recently it seems like there have been a lot that are just mild tweaks to existing products which is tough to get excited about.

A couple of the StateStreet funds that just listed are interesting as is the Market Vectors Russia ETF (RSX). I tend to lean favorably to WisdomTree's funds and they have a bunch in the pipeline and five in particular that are supposed to list soon.

Claymore is supposed to list a new water ETF any day now (I will have more on this when it comes) that will be very different from PowerShares Water (PHO), which is a client and personal holding. The Claymore Water ETF will own foreign companies, I believe there will be no US stocks. If you know your water you won't surprised to know that France is the largest country in the fund. PHO is about 15% foreign.

First Trust also has a water ETF coming that is based on the ISE Water Index (might not be the exact name) but the overlap between this and PHO is extensive.
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Done Dirt Cheap

You probably remember the old AC/DC song Dendreon, done dirt cheap.

The stock is getting crushed from a speed bump (or worse?) for its Provenge drug.

This is constructive from a learning standpoint. The stock went up a ton when there was a recommendation from some sort of FDA panel. Similar to take over news (real or otherwise), that approval was going to be the vast majority of the move higher for an extended time period meaning there was way more risk than reward for the short term.

I tend to be a seller on a huge move higher driven by a news item.

Longer term their could have been more reward potential for DNDN but I don't think in the short run, this is consistent with a couple of posts here in the last few days.

If you own Dendreon; sympathies but if you don't be wary because this sort of thing repeats over and over with story stocks.
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Look To Currency First?

Donald Coxe from BMO Financial Group was on CNBC with Maria yesterday talking about foreign investing; specifically why a strong currency is a good top down reason to pick a country to invest in which leads him now to Canada and Australia. He is partial to the mining stocks.

The idea of being in touch with the strength or weakness of the currency for any country you invest is something I have stressed for a long time on this site. For purposes of this post the assumption is that you don't get all your foreign exposure from one or two broad-based funds.

I would add a little more to Mr. Coxe's idea. Obviously it is impossible for anyone to cover all the bases in a short sound bite.

While there is nothing wrong with seeking investment destinations with a strong currency it might not ideal to limit yourself to such places. This is sort of an odd period because it seems like the dollar is weak against every currency so to pursue this you might need to look at different cross rates.

What I would add is to own countries with differing characteristics. I tend to think of countries with surpluses or deficits, commodity based or not, in their own world, big and obvious growth engines and so on.

It is easy right now to find Canada and Australia compelling (I have exposure to both for clients and personally) for all the reasons you already know. But the things that make them compelling are very similar. If something goes wrong with the commodity idea both countries would seem poised to be adversely effected. In this scenario if your only foreign exposure is here you will take a hit, a bigger hit than if you had several different countries with differing attributes.

I invest in and write about all sorts of countries in an effort to explore them for myself and encourage exploration beyond the UK and Japan.
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Out In The Blogosphere

A couple of items.

Paul and Justin from Birinyi hung their own shingle at Bespoke Investment Group doing some blogging, investment management and a few other things. I imagine the content will be very good; best of luck with the new venture.

Andy Swan has a very interesting post about retirement. One idea is not retiring. I have touched on this from a slightly different angle in that retirement is evolving into something different than it has been in the past.

As far as investing for retirement, Andy says just buy the Dow, presumably he means the Dow Diamonds Trust (DIA). This is not that crazy of an idea. The Dow will always be a proxy of some sort for the US stock market, even if it is flawed. If you have a long time horizon, are not worried about the occasional bear market and can live with the occasional lag or beat of the S&P 500 or some other broader benchmark...well, why not?

I think there is an element of tongue in cheek to the idea but it does take you back to thinking about portfolio construction in simple terms which is not a bad thing.
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