The Big Picture For The Week Of July 1, 2007

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From The Top

This is from the head of the fire well after it was under control.

The chance for good pictures was when we first got there but I didn't have a camera. I need to get a disposable and put it my pack.
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Wacky In Walker!

I don't know what it is about late June/early July up here but we had a real fire about a half mile from my house. I was on my way back from town on an errand that was in itself wacky, I smelled smoke, slowed down, saw a lot of fire that appeared to be two acres in size so I hauled the last little bit to my house.

Joellyn was already getting ready, I got my fire gear and had a crew pick me up down just below the fire. I was initial attack and the first incident commander. I titled the fire the Snap fire because we anchored on Midnight Snap Road. I called for Forest Service support and air support and made a couple of other decisions that turned out to matter before ceding command to the Forest Service who changed the name (damn!) to the Midnight Fire.

After ceding command I then tied in up top with a bunch of different agencies to mop up. I was there from about 3:30pm until about 8:30pm. I may have more pictures coming from a neighbor.

On a personal note, I can't believe Joellyn and I do this. Despite the intensity, it is very rewarding and fun.

Onto some ETF stuff.

Index Universe reports that ProShares has filed for inverse bond ETFs and inverse foreign ETFs. This has been a theme here of late that there will be more products to allow for some sophisticated risk reduction strategies or maybe just hog wild speculation.

The filing includes short and double short EAFE, Emerging Markets, Japan and China. For the bond ETFs they are short and double short 7-10 year, 20 year plus, liquid investment grade and high yield.

Assuming the fixed income funds are like the equity funds, you could get a T-bill rate and own an appreciating product if rates go up. That could be very important over the next five years.

Also included in this filing is double long, short and double short biotech and telecom.

Other ETF news is that Claymore almost granted my wish of a product of global exchanges with a fund whose name is too long but the ticker is EXB. It is 1/3 exchanges, 1/3 asset managers and 1/3 investment banks per what I was told in a phone call about the fund. It is 66% US. The largest exchange weighting is NYSE Euronext at 4.57% but there are four other stocks with greater weightings. The foreign exchanges each have very small weights and may not be able to move the needle.
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$406 Billion?

According to this article from MarketWatch Russia's foreign reserves are $406 billion.

Obviously the country has been helped by strong prices and demand for resources. Russia has also benefited from a strong currency and generally positive economic trends.

There are a slew of political issues that some view as very risky and still others view the various antics as more noise than anything else. I maintain a little exposure for just a few clients (and personally) with Lukoil.

I believe the economy is a juggernaut that is becoming more globally relevant but anyone that adds it to their portfolio needs to realize they are adding volatility, even relative to emerging markets.
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Inflation

I first read about inflation generally following the price of a postage stamp in a book called The New Financial Adviser by Nick Murray. I don't remember who Nick Murray is but he knows his stuff and the book is a great read.

To understand what inflation can do to your financial plan, just look at this chart and think of all of your expenses as being the cost of a stamp.

Over long periods this is what your expenses have done and this can serve as a template, with limits, to what the future might look like. It looks like a stamp cost $0.22 twenty years ago. Recently stamps just went to $0.42 (it was 42 cents right?), a gain of 90%. It is not crazy to think that twenty years from now that stamps could go up another 90% along with your expenses.

Your portfolio will need to go up by at least that much just to run in place. Is this reasonable? On June 27th, 1987 (a Saturday) the S&P 500 stood at 307.16, it closed yesterday at 1506.34 which is almost a five-bagger. The last 20 years have included a crash, a bubble and a couple of wars and the stock market completely dusted inflation. If you bought a bond 20 years ago you are getting your principal back.

From a numbers standpoint I think it makes no sense to own bonds. From an emotional wellbeing standpoint of course you need fixed income exposure but it is important to understand the numbers behind asset allocation so you can think properly about the long term. This is important for everyone including folks that have already retired.

A healthy 70 year old is likely to live a long time which means he needs to worry about inflation eroding purchasing power just like a 50 year old.

If this is new to you learn about it sooner than later.
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Wednesday Morning Twofer

I have never been in the housing market is going to crash camp and still am not. I do think this business with Bear Stearns and any other stories like it has the potential to be disruptive and further impact capital markets.

To the extent that markets are interconnected, something unusual in some big segment, like the mortgage market, can cause problems for asset prices without causing people to lose their houses or causing home values to cut in half as some fear.

However the the bond market is very complex, the equilibrium between various bond market segments is complex, disruptions to that equilibrium will cause visible reactions. I am not calling for Armageddon, the the thought that this increased stock market volatility will persist seems very plausible.

Something at sometime will cause the next real correction, I suppose this could be it but I am not sure yet. For now the increased volatility for stocks looks more like a stalling out than anything else, if it deteriorates more so be it but whatever happens I can't imagine it will be unprecedented.

The following quote is from the Chinese Restaurant episode of Seinfeld;

GEORGE: Excuse me, I'm expecting a call. Costanza?

BRUCE: Yeah, I just got a call. I yell 'Cartwright! Cartwright!' Put Write! Put Write!, just like that. Nobody came up, I hang up.

GEORGE: Well, was it for Costanza or...

BRUCE: Yes, yes, that's it. Nobody answere

The CBOE has created a new product called the CBOE Put Write Index and can be quoted on Yahoo Finance with ticker ^PUT.

The idea behind the index is to sell cash secured at-the-money SPX puts that expire in one month.

This chart comes from the CBOE PDF that explains the index. Cash secured put selling is a fairly conservative strategy for people who know what they are doing and understand leverage.

I will say that I am amazed that it had periods of outperformance when the market was declining.

Also interesting is that according to page four of the PDF PUT has a lower standard deviation than the Buy Write Index (BXM) and a version of the S&P 500 they refer to as S&P 500 Total Return.

Another article you can read on this is from Index Universe, which is where I first found ^PUT. I doubt CBOE brought this out as merely an academic exercise. I suspect we will see an exchange traded something that mimics it soon.

A common theme to my writing has been that investment products will evolve in such a way that do-it-yourselfers who are able to spend the time will be able build very sophisticated portfolios for themselves.

The idea of having 1/3 of your equity portfolio in eight or nine products that take different routes to reliable 7-8% returns with a lot less volatility that the stock market makes sense for investors who have saved properly and really understand the concept of risk adjusted returns.

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MMM, Meat

I found this little item at FT Alphaville yesterday about what could simply be described as an Australian meat fund.

Its kind of a quirky idea and not surprisingly Macquarie Bank is involved.

I have no opinion for now on investing in cattle in Australia in this or any other manner but it opens a door to a different way to invest. According to the FT piece the market in Australia for beef has been healthy for quite a while. This fund would be a way to invest in the real economy, presumably (I just read about this so bear with me if I don't have every aspect of this dissected).

This is intriguing to me. It might pave the way to palm oil in Malaysia, timber in New Zealand or fish in Iceland, as three examples.

A reasonable first reaction might be to laugh at these but capturing the economic goings on in a country without direct stock market exposure is probably a good way to reduce volatility and dip a toe into some countries that you might not want exposure to because of volatility tolerance.

If this concept goes anywhere I am sure Macquarie will be in there somewhere. I would further add that this idea strikes me as having more merit that several of the equity ETFs that have come out or are in the pipeline.
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Keep On Raising

That is the take from the Bank For International Settlements in Basel, Switzerland meaning that central banks should keep raising rates.

Concern for higher inflation stems from the length of the current economic cycle and how long global growth has been above 4%.

You can get a summary here.
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Fads, Leading To?

There is a great article up at Index Universe written by William Bernstein about whether the ETF market place is on its way to being a bubble. As I read the article we are not there now but there is visibility for a bubble.

In the post Bernstein shares part of an email from Jim Wiandt in which the two enjoyed a chuckle over some of the funds that were then in the pipeline;

"a 'Dynamic Brand-Name Products Portfolio,' an Inverse Materials ETF, a Healthy Lifestyle fund, an Ellioit Wave ETF, a Georgia (the state) ETF and, my favorite, an 'Ultra-Short S&P 400 MidCap 400 Citigroup Growth' ETF."

I believe there is a typo in the word Ellioit above but I pasted the quote in and chose to leave it as I pasted it.

No doubt there have been a lot of ETFs listed that on the surface seem questionable. Some of those however do offer some tangible benefit as a secondary effect or maybe something else. I would also add that I think the short and double short ETFs are targeted more for professionals than individuals; the focus of the Bernstein article, as I read it, is the effect of these funds on individuals.

The article mentions the incredibly narrow HealthShares fund. I wrote about these for the Street.com a while back and did spell out a possible use for them in a small proportion but I don't use any personally or for clients. Bernstein wonders whether in the future the market for these funds could be pushed around in such a manner that the ETF structure effectively breaks down. If he is right then yes, holders of these funds would be hurt.

He gets a laugh from the Georgia Fund that is in the works; there are funds from a lot of states that could list like the California Fund and the Colorado Fund as other examples. I am unlikely to try to take anyone to the hole in defending this concept but the Georgia Fund, what do you think that will be? Anyone else besides me think it will have 15-20% each in Coca Cola (KO) and Home Depot (HD)? If correct the fund may still be useless but hardly a concoction of evil intended to separate unsuspecting mom and pops from their money either.

I think a more realistic take is that a lot of funds that have listed or will list soon will close up shop after three or four years with only $30 million invested regardless of performance. This is a point I have made several times in the past.
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Sunday Morning Coffee

There was an article in Barron's about bond insurer MBIA Corp (MBI) this weekend.

The article was complicated as it dissected the company. The whole topic makes a good point about stock picking.

The insurance business is a complicated business. Anything to do with bonds is complicated so any company involved with both is going to be very complex and have a lot of moving parts under its hood.

Regardless of your stock picking prowess would you really be shocked if something that MBI insured blew up or if something dominoed to hurt MBI? I am not saying there is something specific around the bend, I don't know just that it would not be a shock.

In assembling a portfolio that includes stocks it makes sense to consider what sort of chance a stock has of turning into something nasty. Obviously any stock can blow up but when a blow up seems very easy to construct in a portion of the portfolio, financials, where you don't usually take something like that on. This trait makes more sense with biotech, tech or small cap miners. Stocks in those groups have the potential to go up a lot, MBI...not so much.

New topic; a reader asked about how to get started managing money. I guess there are two paths; work for someone else or hang your own shingle. I learned quite a bit working for someone else before my current gig.

At some point you will probably need to ask friends or family to give you a shot. My first few clients were Walkerites (or are we Walkeronians? obscure Taxi reference). I knew that writing would be integral to whatever progress I might make. I never expected anyone to ever read my stuff but I thought I would be able to point back to things I had written, in the hope that I'd turn out to be correct every so often which might do some talking for me.

I lucked out latching on where I did, which came about after getting something published in Barron's a few years ago. So this was my path and obviously I think highly of it.

If you know a lot of really rich people, that would certainly be a way to get started on your own. Getting real heavy in networking might work but I would be so bad at it that I have nothing to offer on that approach.

Ultimately luck will have to play a role and whatever you think is the best way to break in you need to work very hard, be ready to not make any money (to speak of) for a while and love what you do.

The picture is obviously from the College World Series game we went to last Sunday. On another sports related note; the Padres lost to the Red Sox on Friday wearing some vintage, old school uniforms. Diehard sports fans can check them out here. What a hoot.
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The Big Picture For The Week Of June 24, 2007

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Stellar Performance

If you missed it Mark Haines was in rare form this morning making fun of all the Blackstone hype. Adam Warner pointed out to me that they missed the open of the stock while they were interviewing a couple of people about the IPO.

At one point I thought Mark was going to call Michelle an idiot during his next show but refrained. They had a tiff because Mark felt that the NYSE floor personnel were essential to price discovery, noting that pre-market trades in the $40 had to be canceled to support his idea. I think he overlooked that premarket trading is far less efficient than trading during regular hours regardless of where a stock trades. Thinking that NASDAQ trading would have been different probably isn't supportable.

Last night I heard Larry Kudlow say that this is not the top because there is no top in profits and that this cycle still has a couple more years to run.

I don't know if this is a top or not but this is certainly a hot fad and they are covering the hell out of it.

I also don't know whether this stock has investment merit or not but clearly there will be a lot heat chasing the name for a bit and the fundies, whatever they are, won't matter for a while.

All in all a great performance.
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A BIK House

State Street is launching its version of a BRIC ETF today (well scheduled for today) under ticker BIK.

As I understand it, the fund should be mighty mighty. Ahem.

The break down should be as follows; China 37.59%, Russia 32.33%, Brazil, 22.80% and India 7.28%.

It is heaviest in energy, no shock, at 36.6%, financials 28.5%, telecom 14% and then a few others in single digits.

China Mobile (a holding for a couple of clients) is the largest holding in the fund at 8.97% followed by Gazprom 7.09%, Lukoil (client and personal holding) 6.59%, CVRD (yet another client holding) 4.96% and Petrobras rounds out the top five at 4.60%. Infosys weighs in for India at number 10 with a 3.41% weight.

You may know that Claymore has a BRIC ETF (EEB) of its own and if I recall correctly iShares has one in the hopper.

BIK is noticeably different than EEB. EEB only has 4.77% in Russia and has 45% in Brazil. Hard to say which one is "better." Obviously if Brazil is the best market in the world EEB will do better and if Russia turns out to be the best BIK will be the better choice. But there is no way to know ahead of time.

The benefit to this type of fund is obviously getting the exposure to what have been and could continue to be very hot markets without single stock risk--by any reasonable definition. The downside is that it would not makes sense to hold the fund if you were bearish on one of the countries.

In taking the riskier path of picking a stock you potentially get a more precise impact on your account which is something I believe in doing. For example with Brazil every product I have looked at includes Banco Bradesco and Banco Itau. When I think of Brazil I think or resources so a materials stock just makes more sense; it strikes me as being simpler.

Regardless of what you think of that I think it is a good think that investors have some choice for BRIC exposure.
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That Left A Mark

Yesterday's decline was swift and unpleasant. The talking heads blamed it on the Bear Stearns fund that appears to be going down for the count.

This may be true or it may be that this fund business was just an excuse for a down day coming in the middle of multi month run with more up days than could be reasonably hoped for.

I've been saying that I think the dip from February was the start of a period of increased volatility. For months we heard how low the VIX was and while it is not real high now it is higher than it was.

If it is correct that volatility is and will stay higher for a while, some longer term folks might be tempted to try to game the market more than they normally do.

Changing your stripes like that in reaction to something happening in the market is going to be a bad idea more often than not. Over time people evolve, the market evolves and people's strategies evolve, this makes sense, but not over the course of a week or three.

As I hear from people in the course of doing my job or as a function of the writing there seems to be a common thread of making investment process complex. While I suppose there is some complexity to portfolio construction it doesn't need to be absolute alchemy. Some blend of good companies, products that do what they are supposed to or, even better, a mix of the two can be an effective and manageable way to invest.

This is not to imply shortcuts but maybe time does not need to spent looking for instances of the 10 day crossing over the 20 day and back again. Plenty of people have success with that or other similar ideas but if that's not you, you probably don't need to switch this week.
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A Couple Of Items

An article in the WSJ Online yesterday said that by the end of 2007 trading in ETFs will shift from the NYSE floor to the NYSE ARCA platform.

Assuming this happens it is one more step to stations looking like this one during the day and not just after hours.

I buy any argument that says human intervention can help get trades done at critical times but the truth is that more exchanges around the world are electronic and the NYSE seems to be headed down the same path.

And not from the department of redundancy department; PowerShares is listing four new foreign ETFs. They just listed a batch under their Dynamic brand but these newer four will be from FTSE/RAFI crew which is a different methodology.


The four funds are;

• PowerShares Europe (PEF)
• PowerShares Japan (PJO)
• PowerShares Asia Ex-Japan (PAF)
• PowerShares Developed Market Ex-US (PXF)

They are scheduled to come on June 25 but the nature of these things is that they could come on another day.

I was not able to find any composition information on the PowerShares site so we might have to wait a few days for that info.

PowerShares overlaps sector funds from the FTSE/RAFI and Dynamic brands. I looked at a few (not all) of the sectors, comparing the Dynamic versus the corresponding FTSE/RAFI and the sectors where there was a difference the nod went to the Dynamic brand often enough for me wonder. I have taken similar looks in the past and found the same thing.

I know the flagship FTSE/RAFI fund, PRF, has done very well against the S&P 500, not quite as good as S&P 500 Value ETF (IVE), but I have not studied the risk adjusted numbers.

This is a good reminder that there are a lot of variations on the same theme which can make things confusing. Further I would expect that different methodologies would take turns providing leadership the Dynamic/FTSE-RAFI results notwithstanding.

I should note I don't use too many domestic sector ETFs. Generally I think the foreign or the global sector funds are more interesting.
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Lumbering and Oafish

That's what I look like throughout this video.

You can click on the picture to go to the video.

Well I have tried to change it and can't get it to work, sorry for the hassle.

Go to the TSCM home page. Click the drop down for Video and click on the Mutual Fund ETF selection and then look for Analyze This dated June 14.
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ETF Stuff

According to an article on the Resource Investor website, Van Eck has a nuclear energy ETF in the works under their Market Vectors brand.

It looks as though the fund will have uranium miners, nuclear energy producers and everything in between.

I tend to think these very narrow ideas can be a good thing. When it comes to very narrow themes (like uranium, exchanges or oil sands) it seems that non stockpickers are left out.

No one bats an eye if a do-it-yourselfer buys shares of Cameco (CCJ) with 2% of their portfolio but if someone buys the HealthShares Metabolic Endocrine Disorders ETF (HHM) with 2% Jack Bogle writes an op-ed in the Journal.

That someone can learn a lot about one small-ish industry but still not want to take single stock risk seems more than plausible. I'm not sure that an investment product with ten global exchanges or seven Australian banks can be an ETF but the name of the product means a lot less than what the product owns.

I will concede that it seems unlikely that too many investment companies will take the risk that goes with something like this but maybe there will be another company that does take these risks like HealthShares does.

There are probably one or two very narrow themes that interest you for whatever reason. That you might not think of yourself of a stockpicker doesn't mean you can't add one or two stocks to your portfolio.
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It's True, I'm A Ten Year Old

Joellyn and I went to the Rice/North Carolina game at the College World Series last night and Steve Garvey was four rows ahead of us; I gotta give a big thanks to my buddy V for helping us get great seats.

I saw over on ETF Trends that iShares has a new dividend ETF, ticker IDV, that owns forgein stocks; well that is always worth a gander.

The underlying index is something called the EPAC Dividend Index. The way Tom referred to it I feel like it something I should have heard of but I haven't.

It kind of looks like a WisdomTree fund in that it is heaviest in Australia at 36%, then UK 31% followed by several countries with single digit weightings. It is heaviest, sector-wise in financials at 42% with a lot of the big foreign banks in the top ten. Even New Zealand Telecom (NZT), a former client holding is in the top ten with a 2.03% weight, the entire NZ exposure for the fund BTW.

Kind of unique is that Greece has a 3.09% weight.

The backtest blew away the S&P 500 and the EAFE at every turn but I was not able to find a Sharpe ratio or any charts to get a feel for how volatile it might be. I suspect its not that volatile but don't know for sure.
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Checking In

We flew from LaGuardia to Chicago to Omaha and then drove to Des Moines for a family function that starts in a couple of hours. Tomorrow its back to Omaha for game six of the College World Series.

Our luggage didn't quite make it to Omaha when we did so we are going to my nephew's wedding reception in a t-shirt and convertible pants for me and a t-shirt and jeans for Joellyn, what a hoot.

To a market related topic; I noticed that several stocks I own for clients have lifted their dividends substantially. The impact on the portfolio will just be a couple of basis points or so but it can add up over time.

I am reminded of the fact that people who bought Philip Morris (now Altria and a client holding) in the mid 1980s are getting 100% a year of their original cost. That to me is a very compelling argument to go heavy, but not exclusively, with dividend payers.

One item from the conference from the other day; during the panel I sat on (the only one I attended, shhh don't tell anyone!) I was asked a question about country selection and my answer included a mention of Sweden. One of my co-panelist who runs a lot more money than me but who I believe does not own any individual stocks (sorry if that it not correct) asked why I own Volvo instead of iShares Sweden (EWD) which he owns.

I have written favorably about EWD once or twice for TheStreet.com and while it has generally done well I view Volvo as a better way to capture the country. I pointed out that EWD is heaviest in Ericsson (turns out its 15%) and that telecom equipment stocks like that one, and Nokia for too, tend to rotate in and out of favor very quickly. Telecom is a sector (I think of Ericsson as a telecom stock) where I want less octane and more yield for now. Further Volvo is a way to add a lot of yield, more so when I first bought it four years ago.

I am guessing, based on the look on my counterpart's face, that they don't think about ETFs in that manner (to be clear this is supposition on my part). If you integrate any type of fund product into your portfolio I think it is crucial to make these sorts of assessments about the funds. It may be that adding volatility in telecom is the better trade but that is not the point, even with "passive" portfolios there will be some places where it will make sense to you to add volatility and some places where it will not.

I think viewing it in these terms will allow for better management of the overall result--maybe not better returns but maybe better risk adjusted returns.
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Mid-Morning

FT Alphaville � Blog Archive � Currencies and P/E ratios, according to Morgan Stanley

Well my presentation is done and while it probably went just OK I didn't make a total ass of myself.

I found this interesting nugget about currencies (Aussie, kiwi and the loonie) on FT Alphaville
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What The?

Click on the picture to go to the video.

This was a real hoot.
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Interesting Picture

Well, despite my looking 25 pounds heavier than I actually am this is a pretty good picture.

The hottie to the far right is my wife Joellyn.

I got an invite to the WisdomTree one year anniversary party on the floor of the NYSE last night. We were able to cruise around and take a lot of pictures, which you can't do when the market is open, I'll post more later.

Later this morning I will speaking at the conference (the reason for the trip) about using ETFs for foreign investing.

At the reception last night I chatted with Luciano Siracusano, the numbers guy at WisdomTree, for a minute and he said something interesting. He thinks that I am the only one who has really jumped on the sector funds--not just theirs but in general.

While this is just a matter of his perception and not true literally it does say that people don't yet buy into the idea of using narrow products which is probably too bad. I am convinced that with a little bit of study a portfolio can be constructed using some narrow-based, along with other things, to really fine tune volatility and yield which goes a long way toward smoothing out the ride.

I think that as time goes on there will be more interest in sector and sub-sector products, at least I hope so or fund companies won't be able to justify narrower products in the future.

Although its tough to see, the second picture is of the "Squawk Nest" where Mark and Erin do their show.
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The Street

I just got back from TheStreet.com office where I did an interview with Gregg Greenberg that should be up shortly.

I think the interview went well but the chair was so small that I think I am going to look stuffed into my suit; doh.

It seems like any time I am away from home the market does well. Trying to manage money becomes a whole lot easier if the market is up everyday.

Speaking of the market it still seems like it is trying to figure this ten year bond out. I doubt Tuesday was last of the ten year-induced one-day market pukes.

Lastly, I am scheduled to appear on Squawk Australia tonight at 6:30PM eastern, 3:30pm pacific or 12:30 pm in Hawaii.
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NYC

Here I am in front of our hotel in New York; it was a long flight.

There are a couple of CEFs in my universe of things I watch that I can't quite figure out. I find I am favorably disposed but don't own them for anyone or personally.

On such fund is Global Income and Currency Fund (GCF). This fund owns mostly short dated paper from other countries . According to ETFconnect it yields 7.58% and trades at a 3.58% discount.

This fund is managed by the same folks that manage BEP, BEO and a few others.

There isn't much in the way of very current info to try to piece together what the fund has been doing. As of year end 2006 the fund was long USD (50%), long Mexican peso, kiwi and Hungarian forint 11% each. It is long Brazilian real 10%, Turkish lira 10% and South African Rand 6.2%. It was short the loonie, yen, euro, Sing dollar and Czech koruna all in the neighborhood of 10%.

The share price has had a solid move up in the last year while the NAV went nowhere but has perked up in the last month or so.

That it yields 7% without moving around is appealing but there are other currency products out there with yields that are close-ish but might offer a chance for better price appreciation.

I have been watching this fund for a long time, relative to its existence and still am not sure what to make of it. That I don't know what to make is one reason why I have not bought it. No one can fully grasp every thing out there and this is one I don't fully grasp.
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What? Did Something Happen?

5.31%? Bring it!

That seems to be what is happening today despite what seemed like a genuine sense of "uh-oh" yesterday and in today's European session.

So I guess 5.31% was a head fake as I see the ten year at 5.21% now. I would not be too quick to think that this episode is over. The almost vertical slope of the ten year cried out for some sort of move like today, a move that could last a little longer.

My hunch is that a couple of months from now the curve will be flat but we could be in for a wild ride in between here and there.
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On The Road Again

PowerShares is scheduled to launch what are being billed as its first foreign ETFs (what about PID?) today as follows;

Global Water (PIO)
Global Clean Energy (PBD)
Developed International Opportunities (PFA)
Asia Pacific (PUA)
Europe (PEH)

I had a chance to look under the hood, the PowerShares website should have this information once trading commences, and it seems like PFA, PUA and PEH have a lot of holdings.

The back test on all of them is of course very good and my first impression is that they have a chance to add value for people who use broad-based products.

I will be curious to see how the Global Water (PIO) stacks against the Claymore fund with the similar name that trades under CGW. PIO does have more of an industrial tilt to it as opposed to CGW being more utilities centric so we'll see how that pans out in performance.

As is almost always the case I don't see much need to buy in on the first day. I tend to think it is best to let new products trade for a while to prove that they capture the intended effect.

On a separate note Joellyn and I are headed to NYC later today. I am speaking at a conference on Friday and doing a couple of other things too. On the way back we are going to a family function in Des Moines on Saturday and going to game six of the College World Series in Omaha on Sunday if we don't get rained out. The CWS is on my list so I am pretty excited.

As always I'll be posting as I go and if things work out the way I hope I should have some great pictures.
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Re-Pricification

The stock market is repricing itself to account for this increase in rates occurring in the bond market. The trade underway is what I have been referring to as yield curve normalization. Obviously with the ten year at 5.21% the curve is not yet normal; in the process of normalizing, yes, but not yet normal.

I was accused of whistling past the graveyard in a comment on Seeking Alpha on this issue. I don't think the reader had the full context of how I view these things.

The current downward action is smaller (for now) than the dip in February and the dip last June. If you have not thought about the fact the yields have been very low and the possibility that they might go up you might be as worried as my heckler appears to be.

The benefit of having a very simplistic trigger point to take defensive action is that you don't have to correctly interpret the current event or correctly predict what will happen next. It certainly helps to have your finger on the pulse of what is happening to be sure but it becomes less important.

This slight, and it is slight, dip may or may not be the beginning of the end (queue the ominous, foreboding music) but I don't know. I seriously doubt it but no matter, the market will either trigger my exit strategy, or yours (hopefully you have one), or it won't.

Hopefully this post conveys the dispassionate way I view these things. Down a little and down a lot are NORMAL market events. They are guaranteed to occur again. If you can get your arms around this certainty then there no need to assign emotion to this. You won't get out at the top, be disciplined and make the necessary changes as conditions dictate.
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Closed End Funds

TheStreet.com had a generic article about closed end funds that noted they have become more popular in the last few years because of their yields. The article then talks about how popular ETFs have become, which hurt demand for CEFs for a while but now CEFs are hot again according to the article and intuitively this seems correct but I would say that the resurgence of interest popped up a couple of years ago and is not that new.

I think this underscores a point I have been trying to make here for a couple years which is there is room for all sorts of products within a diversified portfolio. In a lot of articles I read I will see someone quoted who manages money using all-ETF or all-CEF portfolios for clients. While I don't doubt the success that these folks have I can't fathom what the appeal would be for someone to be a client of a firm that only uses one product.

As you manage your own portfolio you have the luxury drawing in the best product you can find for each segment you want to own. Generally speaking closed end funds are great for actively managed, yield enhancing strategies. ETFs are great for passive holdings, especially where sectors are concerned and inverse products. Stocks are great for adding very specific ideas to a portfolio like oil sands for example. While I am not a fan of OEFs they too can fill some gaps here and there as well.

Chances are you invest for a very important purpose so casting your lot on just one type of product seems unnecessary, it stands to reason that you should make use of everything available to find what is ideal. I recently wrote an article for TheStreet.com about an all-ETF portfolio I assembled as an academic exercise and even then I had to toss in one CEF to round it out.

As someone who manages money the idea of just using one product strikes me as way to make my job more difficult. I want portfolio management to be as simple as possible, how about you?

A reader asked what foreign bank site I read for research; Jyske Bank from Denmark.

For the BusinessWeek take on the Sopranos finale; click here.
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Whither Research?

You probably have heard that Prudential has closed its equity research department. It would be easy to make joke about lousy research, and I have done so in the past but I don't think this is a good thing.

I read research from a foreign bank about currencies and emerging markets on a regular basis. The benefit of the research is that it is a great source for facts. The reports spell out some facts, talk about why those facts lead them to a certain conclusion and what that conclusion is. Quite frankly this bank is wrong a lot but I find the access to the facts (data points really) and how they use them to be useful even if I expect the conclusion to be wrong.

This also stands up for individual stock research too. Relying on the conclusion may be a mistake but facts and little bits of process are very useful. There can be factual items in these reports that you might not find through other normal channels.
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What The?

Without giving anything away; what the? The final shot of Paulie reminded me of something from an international film class I took in college.

The last scene was brilliantly done, in a way, despite both of us being left scratching our heads.

I'll have something market related up shortly.
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Sunday Morning Coffee

I had several good questions come in on this week's video looking for a little clarification on some points. I'll try to accommodate here.

The first question was from Ulli asking, essentially, why I believe in taking a gradual approach to defensive positioning.

Well, a few things. I don't really want to sell a lot of stocks that have not changed, IMO, fundamentally. This creates more commissions, tax issues (depending) and then uncertainty about when or how to get back in. As a matter of philosophy I don't care about one stock going down (assuming the fundamental story has not changed) I care about the entire portfolio.

If the market is up 5% in six months and your portfolio is up 4-6% in the same time period does it matter if one stock in that mix is down 12%?

From the no one can get them all right file, a portfolio is a mix of holdings that are going up and down. This also makes for better diversification. It seems to me that individual stocks go down for short periods all the time with no change in the business. This sort of normal movement is not something I try to trade around.

Steve.scoot asked about gold going down with stocks and whether cash is the only true hedge. First things first, I view gold as a way own something that has a chance of going up when the market suffers some sort of external shock like a terror event. I am far less confident that gold will zig to the stock market's zag when there is a market event that hits stocks. The thing in February and the thing this week were both market events.

I know the fundamental story about why gold should go up but my take is that the reality will not be as good as the story. If I am wrong, fine, I own gold across the board.

Put options, used correctly make good hedges but of course like all products they have some drawbacks. Inverse funds make good hedges but of course like all products they have some drawbacks.

Tomk doubts that market timing can improve returns, he says it is better for managing volatility. I don't think of what I am talking about as market timing. I am not saying it isn't market timing I am saying that is not my mindset.

The big idea is that when there is a problem with demand for equities, regardless of the reason, I want to reduce exposure. Problems with demand are what lead to down a lot, in a very simplistic way of thinking.

The picture is from Friday night. My brother Larry and I went to see the Red Sox play the Diamondbacks down in Phoenix. Larry went down to the stadium a couple of days before and got insanely good seats. There seemed to be more Sox fans than D-back fans. It was a great time. You can read a little more about it here if you are so inclined.
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The Big Picture For The Week Of June 10, 2007

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Taking A Breather

It shouldn't be a huge shock that the market, along with our dog Tater, is taking a bit of a breather today, well so far anyway.

By now you know that ten year yields panicked up to 5.25% which seems like a short term high, but we'll have to see.

Ginormous moves like we have had this week happen occasionally but it is rare that they stick without a little backing and filling.

A long time reader just left a comment saying the Bill Gross was just on the network (I had CNBC Europe on at the time) to qualify his statement a bit. According to the comment the call from Gross was more about the yield curve normalizing. The reader asked for my take.

I have been saying this for many months. To be clear this was nothing clever on my part. Every so often the yield curve inverts, on average about nine months, and then it normalizes. It seems that most of the discussion about normalization asks will the front end go down or will the long end go up. I have felt that both would happen. The long end will go up to something within range or normal and the next move by the Fed will be to cut. I don't think I have tried to guess when the cut will happen but if I have I was probably too early.

On a more important note my hunch for the closeout of the Sopranos is that they whack his family and Tony is left to think about it for the rest of his life.
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Bill Gross

Bill Gross is being blamed for dropping an enormous boulder on the road to an up 30% year for the US stock market.

Apparently Mr. Gross envisions 6.5% on the ten year coming sooner than most people would like. This potentially hurts stocks and slows the economy as, quite obviously, accessing capital becomes more expensive.

While this is true I think it calls for a little perspective. A $300,000 mortgage at 6% for 30 years will have a monthly payment of $1798.65.

At 7.5% the payment goes up to $2097.64. For a couple, each making $3000-$4000 per month I am not sure this is a deathblow to the dream of owning a home. It probably is an inconvenience and it probably squeezes out the marginal buyer or more likely forces the marginal buyer to find a house that is a little cheaper. Here the context is people buying a home to serve as a primary residence.

For real estate that is intended to be an investment, speculative or otherwise, might not prices come down a little bit resulting in an balancing out or at least a partial balancing out? It seems plausible in some markets.

WRT to the portion of this rally that is attributable to private equity and whatever the expectation might be about the future contribution to any further lift would probably have to be repriced if rates do start moving up that much.

I think the real thing here and now is that the ten year and Bill Gross create an excuse for a sell off of some sort. The move this week has been very fast, and while the move may keep going for another day or two it is very unlikely that the market can maintain the type of velocity we have seen this week.

If this is the tipping point of the financial apocalypse (intentional hyperbole) you will have plenty of time to get out without succumbing to emotion today. This is why I have preached in the past about making a simple plan for yourself as to when you would take defensive action and what that action would look like long before you need to. This removes some of the emotion for folks who are prone to emotion.
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Banana In A Tailpipe

It appears as though Eddie Murphy might have shoved a banana in the stock market's tail pipe as lots of things are going down a noticeable amount this week.

The other day I opined that a 5% ten year treasury would not have a lasting impact on equity prices. With just a few days of the move behind it is too soon to know whether that opinion will turn out to be wrong or not. Also the move in yield has been so swift that a correction to lower yield seems likely to me, even if just for a few days.

The only green I see is Australian and my Norwegian stock is holding on to a whopping $.01 gain.

Every so often there are short spurts where everything goes down; various ideas about correlation appear to not hold up. A few day period is not really the best test for the concept blending assets with low correlations, especially when that few days is being driven by market events as opposed to external shocks.

The utility sector has been pounded this week. I am a big fan of the space and have been overweight, but that overweight has been very slight by design (yes more moderation preaching).

In yesterday's decline I lagged by a slight hair, today it looks like I am making that hair back. If my weight in utilities corresponded with my sentiment I would be heavier and really getting pasted with this decline.

The international real estate space, I have written about this lately too, is also getting pasted. This is a very interesting part of the market, very interesting, but I have no exposure and if I did it would be, as mentioned the other day 2%. Despite the potential it seems like a space with a lot of unintended consequences. Getting it wrong with 2-3% may not even be a speedbump though.
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Tenzing Norgay

You gotta love a country that puts Tenzing Norgay on its $5 bill.

Early today (or late yesterday if you prefer) the Reserve Bank of New Zealand raised its fed funds equivalent to 8% from 7.75% in a move that was sort of a surprise; not a total shock but not really expected either.

The day before, Australian GDP came in at 3.8% which was way above the expected 3.1%. These news items have sent both the Kiwi and the Aussie higher against the greenback as things seem to be cooking down under. Some of the other high yielding deficit countries (like Turkey and Iceland) have also had favorable data which has helped those currencies too.

Its a risk taker's paradise!

It seems like the currency market has a different take on the world than equities and bonds. So who's right? Unfortunately whichever market is correct now might be incorrect in a month so devoting too much this may not be too productive.

What we know (this is really just my opinion despite the declarative nature of the statement) is that many other countries are at different points of their economic cycles and so are still expanding; most of these places are commodity beneficiaries or in their own worlds. These countries' markets will likely go down in sympathy with the US market on a short term basis, as has been the case in the recent past.

However I don't feel these sympathetic declines are fundamentally justified. If this is true then being invested in these countries, where sympathetic declines are not justified, can put the odds in your favor for better risk adjusted returns. To be clear not fundamentally justified doesn't have to mean anything, investment in these countries guarantees nothing but I do think they give a better chance.

For anyone new, the countries I have in mind here are Australia, Norway, Sweden and Canada among others.
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More Currency and Bond Stuff

Up and Down Wall Street Daily - Barron's Online

Great post from Randall Forsyth that should be read. If you don't subscribe take the free trial (I'm assuming there is one?) to get this article.

One point he makes which is one I have made several times in the past is that other countries are not likely to be big sellers of dollar denominated assets but more likely is that they will simply buy fewer dollar denominated assets in the future.

Of course the US will draw some capital from the deployment of all of these sovereign funds we are now hearing more about.

I think the big macro is generally less demand for US assets, with sovereign funds slowing it down a tad, which is what I have thought for a long time and is the focus of Randall's article.
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Sell Europe?

You have probably heard about this call out of Morgan Stanley to sell European equities. I read about on FT Alphaville.

This model has worked the other times it flashed sell which according to Alphaville was April 1981, Sept 1987, Feb 1990, May 1992 and April 2002. Well with the reasonable exception of May 1992 these were all periods that were bad for the US market too. In May 1992 the result was a decline of 7% in Europe over the ensuing months, still within the realm of down a little.

So four out five times this model also meant bad times for the US might be one way to look at it?

If something bad happens to US equities it only makes sense to think Europe will react in sympathy in some magnitude.

I don't view this as any reason for long term investors to make changes. If they are right and whatever your exit/reduction strategy is gets triggered you should stick to your discipline. For now I don't think this is actionable for investors; traders maybe, not sure about that one.
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Bond Yields Rising

The yield on the ten year treasury is drifting up to 5% which is prompting discussion as to whether this spells trouble for equities and if 5% is not a problem what yield would be.

The bigger idea is that there is some yield that would entice an investor to sell stocks in favor of bonds. For example if 15% for long dated treasuries were ever available again a lot of people would dump their stocks and take that yield.

I heard part of a discussion on Kudlow that the Fed model called for stocks to be at equilibrium to bonds at a 5.13% ten year yield (I heard this in the car so if it was some other model please leave a comment). The show said that currently stocks are undervalued using this model. The big watch out with relying on this too much is that stocks can remain undervalued or over valued for years. In my opinion this offers no predictive value whatsoever.

While I have been expecting a correction in stocks for months I don't think 5% or even 5.1% will be the tipping point for a lasting decline. The S&P 500 is up better than 8% YTD including the dividend. Given the tendency to project past return forward I don't think allure of an extra 20 basis points is really much of a hook. But of course I could be wrong.

Perhaps this could cause a rotation within the bond market to lengthen maturity as a more likely first step. I would think that yields will normalize and that the middle of the curve will work its way back into the sixes but I am not sure how long this should take. Getting 6.25%, for example, would be much more competitive for me versus stocks. At some point above 6% I could see moving 5% from equities to bonds, above 7% a little more and 8% or above even more.
Of course the details would depend on whats happening all over but the thought process is very simple, at some point (different for everyone) bonds become cheap and the weight should be increased. If yields never go up then I will stick with short maturities and the current weightings.

It makes sense for you to think about this now before it happens so you are prepared to make changes if need be.
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Foreign Real Estate Funds

Last September I wrote an article for TheStreet.com pooh-poohing the RMR Asian Pacific Real Estate Fund (RAP).

This was a bad call.

Lately I have been learning about and warming up to the idea of adding a little bit of of international real estate, probably not RAP however, to client portfolios.

I am trying to learn about the various products out there. Alpine has a CEF (AWP) and an OEF (EGLRX). StateStreet has the SPDR DJ Wilshire Intl Real Estate ETF (RWX). There is the ING Clarion Global Real Estate Fund (IGR), Cohen & Steers Worldwide Realty Income (RWF) and WisdomTree has an ETF coming today with ticker DRW that could yield in the mid-threes or higher.

I have also looked at several individual stocks too. I'm sure I am missing several exchange traded products and other than EGLRX I didn't look for OEFs.

I am ever on a quest for asset classes that have a low correlation to US equities and maybe have a little yield too. RWX does not really have much yield but as I mentioned the WisdomTree product looks like it will.

My inclination at this point, which is still early in the learning process, would be to allocate 2% to a combo of a fund and an individual stock from a country I liked from a top down perspective and if there was a stock that I would want to own from the bottom up. Obviously this sort of mix will not fit in all accounts so in those cases I would just go with the fund.

The picture is one I found on the net of T's favorite real estate spot, Croatia. While I can't find an exchanged traded anything that isolates Croatia (open to suggestion) every picture that involves water from there looks spectacular. This of course may not mean anything in terms of investment merit.

If you know of any funds that I missed, please leave the ticker in the comments.
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China Es Muy Caliente!

Last night while all of America toggled back and forth between the Sox/Yanks and Fresno State/Cal State Fullerton baseball games (what, my wife was right, I was the only one?) China took it in the gut with a 8.26% decline.

I have been out of China (I sold my across the board holding a couple of weeks ago but a couple of clients still own another stock) for a short time with the goal having been to reduce volatility in something that was white hot.

Since that sale China has had two big down days, although it should be noted the stock I sold is now higher than where I sold it. I forget who made the quote about give me the 60% in the middle but having that sort of mind set for some of these more volatile themes is going to be the right thing for most folks.
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Not Just Europe

There was an article in the New York Times yesterday about the need to invest in foreign markets beyond just Western Europe in order to have a chance at diversification. This is something I have been writing about fro a couple of years, maybe someone at the Times has been reading this blog? Actually I am fairly certain no one there does.

The article points out that the MSCI EAFE has a 0.85 correlation to the S&P 500, another point I have been making all along. The suggestion in the article was to add a little Japan to your EAFE because Japan only has a 0.29 correlation to the SPX (according to the article).

I don't allocate anything to Japan, haven't in the time I've been managing money and have no plans to either. The reason I don't like Japan is pretty simple; years and years of wildly stimulative policy have not wildly stimulated the economy. Something ain't right so I leave it alone.

The Times introduces, but does not quite follow through with, the idea of using individual countries for foreign access instead of using a broad-based product that, in my opinion, blends away many of the attributes that individual countries offer.

Chances are in using individual countries you will have some exposure to Western Europe (here I mean UK, France and Germany) but you don't have to have all of your foreign in these countries and I would say that you shouldn't.

An investor wanting 30% in foreign equity could easily allocate 3% each to Australia, Ireland, Norway, Canada, Sweden and Switzerland which collectively should reduce correlation to the S&P 500 better than an EAFE product. From there adding in some emerging market exposure like maybe 6% which leaves the last 6% or so for Western Europe which would be a whole lot less than the 12% you'd end up with putting all 30% into an EAFE fund.
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Sunday Morning Coffee

Barron's Asian Trader column this week focused on the possibility that valuations in the Australian market, but not the big miners, are too high and ripe for a correction of some sort.

Australia has been very hot, there has been a lot of M&A activity, the Aussie dollar has been strong, there has been no recession in 16 years and the benchmark ASX 200 index has been making new highs for months.

Over the years that I have followed this market there have been a few dips but no panics that I can recall. There certainly could be some sort correction coming but the analysis in the article did not seem to spell it out very well.

If there is a correction the reason may not matter a whole lot. The more visible catalyst to me would be a spectacular decline in China. Australia dropping in sympathy with China would probably not be fundamentally justified but would probably happen anyway.

The reason I say not fundamentally justified is the that no matter where the Chinese market is, the country of China is still going to need a lot of the stuff Australia sells.

I write often about Australia as an important investment destination. It is a commodity based economy which offers developed market diversification to the US' service based economy. Further, stocks there tend to be a little cheaper and have much higher yields.

As much as I like Australia and put it in every account, clients only own one stock (or ETF depending on the circumstance of the client) that started as a 3% weight and has grown a little larger depending on how long they've been a client. A few clients also have very small positions in the Australian Dollar CurrencyShares (FXA) too.

Yes another post about moderation. At some point Australia's stock market will have some sort of problem for some reason. Having a small position means being right about why or when is far less crucial than if I had 20% in Australia. This applies to any theme you think is important.

Exposure to other foreign countries having little to do with Australia or the US also creates diversification, here Ireland comes to mind as an example.

I did not take the picture posted above. I did fight a fire one time where a lighting strike cause the roots of a tree to burn under ground (a common thing). The ground was smoking like crazy in a downpour and we had no real way to put it out.
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The Big Picture For The Week Of June 3, 2007

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SPX BXM Ratio For Timing

OK hopefully I can get the attribution right on this. Bill Luby at Vix and More has a post up that studies a possible timing tool using a ratio of the S&P 500 and the BuyWrite Index (BXM). Basically when it gets to 1.80 the S&P 500 turns down.

You can read Bill's post here (and by the way the chart is Bill's too). I found out about this from the Daily Options Report and Adam weighs in with a little more on the subject too.

The utility to something like this helps to create better understanding of market dynamics. There are relationships between different markets that have varying levels of importance but to the extent that we learn from them; all the better.
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Has The Dollar Already Crashed?

Many of the financial apocalypse crew believe the US dollar will crash for many of the reasons you probably already know like the various deficits and so forth.

I've been in the dollar going lower camp for several years and believe it will continue lower for the most part but that it won't be a wild cascade lower.

This chart shows the decline of the US dollar over the last five years against the Canadian (in black), the British pound (the kind of the salmon colored line), the Swissi (in blue) and the Norwegian (the kind of brown line).

So the declines range from 20-30% over the five years studied which is substantial. The question is how important is this. Clearly the American way of life has not been dramatically impacted by this decline but an argument that says there has been some impact is probably valid.

My thought all along has been that this is a deterioration that will cause slightly higher interest rates, and have some effect on purchasing power along the lines of becoming a nuisance. The dollar is down what I would say is dramatically in the last five years and the extent to which it has become a nuisance thus far for the general public is not that easy to see. Based on that it is reasonable to wonder whether another 20% decline over the next 5 years will matter that all that much.

One tangible effect thus far could be on the price of energy. Obviously the run up in oil over the last few years has had less impact on people living in countries whose currencies have gone up against the greenback but in the US we are spending an extra $20-$25 per tank and more to heat our homes (this varies depending on what you use). For the most part this is nuisance for most people but I do concede this does hurt some portion of the population more than others.

In this light I think the probability of a truly calamitous event resulting from a dollar decline is low. Part of the equation is the extent to which the dollar is the world reserve currency. I have been saying for a couple of years that there is visibility, IMO, for the dollar to have to share the role but even sharing the role the dollar is still very important not only for the global commerce conducted in the dollar but also because so many countries sell us the stuff we need.

All of that said, nothing is impossible. In thinking about these things you need to sort out both probabilities and possibilities.
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