We Can Make Fun But...

A few months ago I was critical of the many CNBC guests who seemed to be ignoring what clearly looked like the start of a bear market. There was a lot of "looking across the valley" sorts of talk which I think did a disservice to people.

It's wasn't so much looking across the valley so much as leading off with that like it was the most important thing. I would have liked to have heard a little more realistic thought but that is probably just me being naive.

So as far as looking across the valley goes there is this recap of the Lone Star purchase of a chunk of Merrill's mortgage backed portfolio for $0.22 on the dollar. Lone Star didn't buy them because they think the paper is expensive and ripe for an implosion. It could happen of course but the deal, based on price and all the concessions Merrill is giving them is attractive relative to some period of time, in their opinion.

This bring us to the financial stocks. For anyone in the 1+1=11 brigade I am underweight as I have been for years and am not buying more exposure (it may grow larger here if the sector rallies). Throughout the entire crisis or whatever we should call it I have made clear that I think underweight as opposed to zero weight accomplishes the goal of missing a chunk of down a lot without the risk of missing some massive counter-intuitive rally, should one ever come along.

But for anyone who is zero weight and afraid of missing some sort of massive counter-intuitive rally, most of the names (the vast majority really) will survive this and live to make bad loans in the future.

At this point the sector is down a lot, there will be survivors and when the bottom does come (this is not a prediction of when) there could be a furious rally. Anyone wanting to go from zero to underweight might want to add some exposure, again anyone with zero exposure going up to underweight.

There are plenty of banks with no headlines related to the crisis (although they are probably down a lot) that would be good places to start looking. There many foreign banks that are much simpler businesses than the companies we read about every day that could be a good place to look too.

A third possibility would be some of the single country or regional funds that have a disproportionate amount allocated to financials. Anyone going this route would want to look under the hood and if two or three banks weigh prominently learn a little about those banks to try to minimize getting blindsided.

The big macro here probably that after the crisis the world (the sector) will go on. My expectation is for more downside in the sector from here but not a lot more (sector, not certain specific names) and the risk associated with zero weight is much greater now than it was six months ago.
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Mid Morning--Yet More Oil

Random Roger's Big Picture: Mid Morning Yesterday

Yesterday I was skeptical of the oil decline and today oil is up a bunch.

After one day, yesterday's post is neither right nor wrong, it is too soon to know. I don't know if analysts actually change their mind so often or if they just bring out the oil bears on a down day and bring out the bulls on an up day.

The prudent path for you is to draw your own conclusion about longer term, global supply and demand and realize that your opinion will not be right today and then immediately wrong tomorrow only to be right again on Friday.

Oil went up a lot, has corrected a noticeable amount (not the first time for this mind you) and now the market seems to be trying to sort out the short term.

If you are a short term trader then you should care about the short term. If you are longer term then you probably should not be overly concerned with short term moves.
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Top Down

I had to be in the car toward the end of the market session yesterday and I heard a segment on the radio (CNBC on satellite) that included a value manager of some sort. He made a comment that I think sums up the difference between top down and bottom up very well.

He said (and I am paraphrasing) this is a time to seek out the stocks that can do well in this environment.

Finding stocks that should do well during a bear market is not easy to do. Finding stocks that are doing well during a bull market is pretty easy to do (not talking about beating the market just talking about stocks going up in a bull).

Anytime the market is on its way to a bear market decline I think just protecting what you have makes more sense and is easier to do than, for example, finding the one or two bank stocks that are up over the last 12 months.

The big macro is that stock markets go up most of the time (this sets aside the discussion of whether returns will be lower than normal or not). People that save enough, capture the market over long periods of time and avoid major panic sales at the wrong time are very likely to have what they need when they need it.

Again that is the big macro. From there the details fill in with things beyond the individual (market related) and things that are solely about the individual (savings rate and tolerances). Given that simplicity, there are times where growth should be the priority and times where protecting assets should be the priority.

Yes a bank stock that is not over leveraged, does not have toxic paper anywhere in sight and is not diluting itself should probably go up but should relies on a lot of things and just because it should does not mean that it will.

Conversely there have been segments that have gone up since the S&P 500 peaked last October. Money has flowed into things like fertilizer, oil, commodities and certain foreign markets. There was a perception (valid or not, doesn't matter) that demand for these things was going up. And while it would have been difficult to find a bank stock that is up in the last year it would be difficult to find a fertilizer stock that is down in that time.

The takeaway for me is, and has been, always maintain a diversified portfolio but have less exposure when protecting assets should be the priority.
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Mid Morning

Oil goes below one twenty whatever and now it's going to $80?

A few weeks ago (was it less than that?) oil was going to $200.

The assumption/extrapolation of the immediate trend and the willingness to flip flop is obviously very common.

The thing that I think is more important is supply and demand. Recently estimates for US consumption were cut to 19 million barrels per day for 2008. This doesn't make a whole lot of sense to me unless demand destruction turns out to be real.

So maybe oil has put in a high for the foreseeable future but what is your opinion for long term supply and demand globally? If you think demand must go up then selling too much of your energy exposure now, despite what you might hear on TV or read on the interweb, might turn out to be a mistake in two or three years if oil stocks turn up when no one expects them to and then get away from you.
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You Lika The Juice?

Yesterday on CNBC there was a segment about options where one of the guests suggested buying Matercard (MA) which was at $255 during the segment and selling the August 270 call for $12.

That's a lot of juice, baby!

When I looked after the close yesterday I saw the common at $253, the options bid at $10.30 and the volume in the call stood at 1562 compared to previous open interest of 1805 so maybe quite a few people liked that juice, eh?

Big call premiums are often a siren song that some cannot resist. One observation I would make is that often when there are big premiums, the premiums are big for a reason. There was a catalyst cited during the segment of an upcoming earnings report.

I seem to remember Adam saying it is better to buy increasing volatility than to sell it and according to iVolatility.com, volatility in the name has gone up quite a bit in the last couple of months. I may have that wrong from Adam but often with such a fat call premium the stock will either go down a lot or go rocketing past the strike. Although there are no absolutes to this sort of thing, changes in volatility usually happen for a reason.

Different subject; in this past weekends video I posited that last week's feel good rally might extend up to 1300 or 1310. One day out that looks very wrong but it is probably too early to know for sure that it is wrong. What I will say is that from the standpoint of lower highs, a high of 1282 after making a high of 1426 on May 19 might mean the market is weaker than many people thought.

The negative consequence of that would be more pain's a comin' soon the possible upside could be that the bear market processes through a little quicker than how it looks now. Probably too early to know but if 30% from the top (or pick your own number) is coming I'd rather get to it sooner rather than later.

Yet another subject; Indexuniverse reported that WisdomTree has filed for dollar hedged foreign stock ETFs. The basic idea is have foreign exposure with no consequence if the dollar goes up (if you own a foreign stock and the dollar goes up against that currency then there is a headwind to the position from the currency).

I find this to be fascinating in terms of the possibilities that this sort of fund offers. From the don't confuse genius with a bull market department a big part of the foreign stock story has been a very weak dollar. While I don't think there is a case for dollar strength lasting the fact is the dollar is much cheaper against just about everything than it was four or five years ago.

The possibilities include switching from no hedge to hedged and back again, blending the two together in some combo, changing the mix of that combo and probably some others.

Yet one more subject still; Merrill Lynch announced that it will be raising capital with a rather large share offering and Temasek is coming to the table for a big piece of the deal. I seem to remember Merrill CEO John Thain saying they would not need to do a capital raising yet here they are.

It is not too much of a stretch for me to conceive that the smart guys in the room are having trouble getting out in front of what the real magnitude will be and that things changed between April and now. Despite months and months of calls to buy financials the best thing has been to have zero weighting and and just wait. Zero is a big bet but underweight is not and waiting to buy is far from difficult.
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An Equity Idea In A 6% World?

More of a theory than an idea.

All of the various double long products own t-bills to collateralize relatively small futures positions. The funds then pay out the interest taken in from the t-bills (less whatever the fee is).

If we are ever again in a world where t-bills yield 5-6% might it make sense to build a very simple portfolio (half portfolio really, with the other half in cash) of double long products?

This could allow the the investor to capture the market (remember the market goes up close to 3/4 of the time) plus 5%, or whatever t-bills are yielding.

First let me address interest rates. Rates are low by historical standards and at some point the US might try to defend the dollar--these points pave the way for higher rates.

Where I think the idea is interesting is that if equity returns continue to be below normal then an extra 5% for people not comfortable with stock, sector or country selection would allow for having a better shot of adding value to their returns.

So what's not to like?

Well the existing crop of double long products target daily movements of the underlying indexes. This means that over longer periods of time the fund may not capture twice the move of anything. In 2007 SSO lagged SPY and if you recall SPY was up a little for that year.

It's not that SSO didn't work, but that the objective is not to do its thing for more than one day. You can look at the various charts I have included on this post and decide for yourself how well, or not, the double long funds captured a double long effect over longer periods of time.

Now that you have looked at the charts and have an opinion about how well they do capture double long over extended periods of time, there is virtually no way the past result can be repeated. What you see on those charts came about from the combination, sequence and magnitude of all the up and down days that occurred during the time charted. Going forward the same combination, sequence and magnitude of all the up and down days will be different.

The combination over the next year or two could yield a result that looks a lot like double long or looks nothing like double long there is no way to know.

So if that is the case then what is the point? The current roster of products are daily only but that does not make the concept any more or less valid but the right product to capture this does not currently exist. There exists a series of leveraged commodity funds whose objective is double long on a monthly basis (I think these are either from PowerShares of DB or maybe they are one in the same on this, anyone willing to look it up and leave a comment would be much appreciated).

If double long on a monthly basis exists for commodities, can equities for the month or the quarter be that far behind? I am not aware of of any of these in the works but it seems logical and were funds like this ever to list and if t-bill rates were ever to go up toward 6% (remember they were about 5% not too long ago) then executing the theory becomes a little more feasible.
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Sunday Morning Coffee

A few quick items this morning.

I haven't really said much about the whole naked short selling situation primarily because I don't have too many thoughts on it and I don't really care that much about it.

I can believe that has mattered a little more in the last couple of months than it usually does but this issue doesn't make it onto list of things that have caused the bear market.

To paraphrase something I read somewhere, naked short sellers did not create cheap money, did not create Fannie and Freddie's business plans or create liar loans.

Joe Kernen made an interesting comment about the financials the other day. He said something about Bank Of America (BAC), which I own for clients, not going to $18 again unless something is really wrong. He was talking about BAC as a proxy for the financial sector, not so much about BAC.

The action that caused that panic low for most of the sector on July 15 was a transformation of a very long, mostly gradual decline into a V shaped panic and we all know about the massive bounce the group got off that panic.

While I generally agree with Kernen's sentiment (more so about price than the really wrong notion) a reversion back to less panicked declines like from earlier in the year not only makes sense but may have started an hour into the day on Wednesday. Many names in the sector are down 6-8% in the last 2 3/4 days but everyone is still thinking about the bounce from the week before. I doubt the downside is over even if the panic is.

On my Friday greenfaucet post I made the following comment;

The simple decision to allocate to foreign may be the single most important decision someone could have made this decade (either that or allocating to commodities).

Think about this decade for a moment. Anyone who got three very big macro decisions right has probably made things much easier on themselves over the course of this decade. Those three would be buy foreign, buy resources and heed the yield curve inversion (the curve also inverted during the popping of the bubble). Just doing that got you into the two things that have had close to normal bull market returns and got you to lighten up on financials. I don't think this is the tallest order imaginable.

And about greenfaucet; I have started writing a daily post for them. I will be focusing mostly on foreign investing. You can access the content here. It will be unique content and I hope you will bookmark it and check it out every day.

The little guy in the picture is a chihuahua that Joellyn found at the local animal control (the dog pound). Joellyn arranged for our niece (one her side) to pick up the dog from us next Thursday so he's ours until then. The picture shows how skinny he is and how skinny strays can get. For people who really know their dog stuff, we will be getting him checked for worms on Monday. Apologies to any dog breeders but hopefully when you get your next dog it will be one that you rescued.
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The Big Picture For The Week Of July 27, 2008

The chart shows gradual weakness of the dollar against the ruble.


Link to the Tom Lydon article.
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Just Wondering

A few months ago wasn't there a line of thought from some bullish folks that things would be ok as long as energy continued to do well?

If I have my story straight, energy, as measured by the Energy Sector SPDR (XLE) and iShares Energy ETF (IYE), peaked on May 20 and since then they are both down about 18% versus an 11% decline for the S&P 500.

I never subscribed to that line of thought as I have been expecting this to be a normal bear market (which means down something close to 30% from the October peak) complete with feel good rallies along the way but I'd be curious to hear anyone update this line of thinking.

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Wha' Happened?

I was on the phone with a friend who works in the business yesterday and we were talking about how much further down/what the bull case is and he mentioned that there had not been much in the way of capitulation. I made a joke that we had a pretty solid five minutes worth a week ago Tuesday.

Obviously I don't know whether yesterday's smackdown was an end to the feel good rally that started last week or just a bad day but I have found myself getting a little annoyed at the escalation of the cheerleading (my perception) that ensued on the network.

Hopefully by now you buy into the idea that bear markets work a certain way, take a certain amount of time and have rallies of varying magnitude along the way to bottoming out. There is nothing bad or upsetting about normal cyclical activity. I fear that the way the cheerleading is done might serve to ramp up the emotions of market participants who maybe don't have a lot of experience with bear markets.

Along the lines of a post from earlier this year there is nothing wrong with buying a stock you like that is down 25-30% from its high as long as you realize it might go lower if the current bear phase unfolds as normal or worse than normal.

Buying a stock or two along the way is a different kettle of fish versus reequitizing a portfolio after getting whipped up by Kudlow's mother's milk spiel.

The best time to buy stocks would be at the point you spelled out for yourself months ago when you devised an exit and reentry strategy. Hopefully if you have been reading this site for a while, and this sort of action is appropriate for you (investor know thyself), then you did think about exit and reentry and did so at a time when you didn't have a care in the world.

Scrambling into the teeth of a big decline is a bad place to be. A lot of the interviews we see ask what should investors do now. At 1252 on the SPX, down 20% from the October high and 14% YTD, a lot of the horses are out of that barn. I've disclosed how I sold a couple of things along the way and added some double short relying on an indicator read about in a magazine in 1993. That indicator triggered ages ago so most of the work was done ages ago. The notion put forth in these interviews of what should an investor do now makes the task of navigating the market's cycles more difficult than it needs to be.

Hopefully you will take this as a reiteration of something that I've attempted to convey since this site started almost four years ago. If this bear market has not worked out for you will have a chance in future bears to heed the advance warning, again if this is appropriate for you to do, and perhaps sidestep some of that decline.
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Infrastructure Investing Evolves

I found this article about Dow Jones and Brookfield Asset Management collaborating on a series of new infrastructure indexes that have been created to be licensed into investment products.

I called into the phone number on the DJ Brookfield PDF to see if the index components were available anywhere but they were not. You would need to pay the licensing fee in order to have a gander so no information on any of the specifics but the list of all the indexes was available and is as follows;

Broad Market

• DJ Brookfield Global Infrastructure Composite Index
  
• DJ Brookfield Global Infrastructure Index

Regions

• DJ Brookfield Americas Infrastructure Composite Index
• DJ Brookfield Americas Infrastructure Index
• DJ Brookfield Europe Infrastructure Composite Index
• DJ Brookfield Europe Infrastructure Index
• DJ Brookfield Asia Pacific Infrastructure Composite Index
• DJ Brookfield Asia Pacific Infrastructure Index
• DJ Brookfield Global Ex-US Infrastructure Composite Index
• DJ Brookfield Global Ex-US Infrastructure Index

Global Sectors

• DJ Brookfield Airports Infrastructure Index
• DJ Brookfield Communications Infrastructure Index
• DJ Brookfield Diversified Infrastructure Index
• DJ Brookfield Oil & Gas Storage & Transportation Infrastructure Index
• DJ Brookfield Ports Infrastructure Index
• DJ Brookfield Toll Roads Infrastructure Index
• DJ Brookfield Transmission & Distribution Infrastructure Index
• DJ Brookfield Water Infrastructure Index

Other

• DJ Brookfield Infrastructure MLP Index

I was not able to find anything in the literature that explains the difference between the composite indexes and the plain indexes in the Broad Market and Regions categories.

An important economic underpinning to infrastructure, generally speaking, is that money is being spent here. Also the projects around the world, many of which you have read about, are very important for the people who would be the beneficiaries of these projects.

The money will be spent and the projects done even if it takes longer than planned, there is news of corruption or the stocks involved don't benefit exactly as hoped for.

The visibility is there and so it creates a tailwind for good things to happen to the stocks involved. Also as these countries modernize the non-buildout parts of the theme stand to benefit, here I mean things like toll roads (more cars on the road) and airports (more people flying to these destinations for both tourism and commerce).

Who knows what will get licensed, if anything, but I think this is an area where people are not in a big hurry to buy into a Malaysian toll road or a Chinese airport so a well constructed investment product (and to be clear since there is no seeing the make up of these indexes there is no way now to know if they are well constructed) would be a welcomed addition to the investment landscape.

Long time readers will know I've been writing about various parts of the infrastructure theme for a while, obviously not the first person to find any of them, because of one of the big macros that I believe in which is that portfolio construction and management has been and will continue to evolve in terms of products and themes. Keeping in touch with this may make for work for you but I am convinced will mean less work for your portfolio.
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Mid Morning

There was an article on Yahoo Finance yesterday about monetizing hobbies as part of a retirement plan. This is something I have been writing about for a long time (this oldest post I was able to find was just from February 2007) and so it is nice to see it covered elsewhere.

The article profiled a photographer, a guy who makes mobiles and the writer of the article is himself retired doing a little writing. None of these people make a lot of money but they enjoy what they do and something that could take 10% off of the burden of your portfolio and gives you purpose is absolutely a positive.

And I think 10% could be a low number with a little of planning and leg work done ahead of time. I have made many references to my 77 year old neighbor who charges $60 per hour for backhoe work and he can have all the work he wants. I have another neighbor (whom I've mentioned) who has plow on the front of a snow cat.

Are you a car buff? What about house calls for cars? Are you handy? How about working as a Mr. Fixit? What about something related to your job or, if you don't like your work that much maybe something related to some aspect of your job you do like?

Are you a sports fan? We have had two minor league teams come to our town in the last couple of years and there may be another one and there is work available there too. One family member in a bigger city was offered part time work for a major league baseball team, there is work available in these sorts of places.

None of it pays much, or at least should not be expected to but so what? The key is that this is something you one way or another enjoy being around and again if you need your portfolio to generate $60,000 in 2008 dollars (which implies a pretty big portfolio) do you think $6000 might be realistic? If it is realistic then you can see how it would be beneficial to reduce the draw on your portfolio.

There are infinite possibilities for this.
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The Tool Shed

This is a shot of our tool shed, a long way from Norm Abram. You might notice a nail gun and compressor, a couple of cordless drills, a welder, somewhere in there is a chop saw and, well you get the idea.

All that stuff allows us to take care of most of what we need to do or any of Joellyn's projects but there have been times where circular saw wasn't big enough or the drill did not have enough torque or we needed a different type of blade for the sawz-all.

So a lot of tools but always room and need for more.

That notion of room for more I think applies to a new line of foreign sector ETFs that just listed from StateStreet. The ten as follows;

• SPDR S&P International Utilities Sector ETF (IPU)
• SPDR S&P International Consumer Discretionary Sector ETF (IPD)
• SPDR S&P International Consumer Staples Sector ETF (IPS)
• SPDR S&P International Energy Sector ETF (IPW)
• SPDR S&P International Financial Sector ETF (IPF)
• SPDR S&P International Health Care Sector ETF (IRY)
• SPDR S&P International Industrial Sector ETF (IPN)
• SPDR S&P International Materials Sector ETF (IRN)
• SPDR S&P International Technology Sector ETF (IPK)
  
• SPDR S&P International Telecom Sector ETF (IST)

They will be a little different than product lines from WisdomTree and iShares. The WisdomTree sector funds are dividend weighted and so many of them seem to be heavy in Australia (not a bad thing as far as I am concerned) and light in Japan (again not a bad thing).

The iShares funds include the US and in some funds the US weight is very heavy and in some others there is not a lot of US exposure. For example the iShares Global Telecom (IXP) is 31% US and iShares Global Healthcare (IXJ), which I own for a few clients, is 67% US.

These new SPDR funds appear to be cap weighted and so most of them are heavy in Western Europe and Japan. One observation about all of them is that the yields of the underlying indexes look pretty good. That may or may not translate into a high yield for the fund.

No one family of global sector funds can be the best. There are three methodologies and it makes sense to think that WT would be best for certain sectors, iShares some others and SPDR for some others still. Over time that could change such that if iShares is the best today for something it may not be a year from now.

For example if Japan ever truly emerges from its almost two decade long funk it will likely be lead by just a few of the sectors. Anyone who assesses that correctly can exploit their work, probably, with one of the SPDR funds. Some of the Japanese industrial companies are involved with some interesting global themes and IPN is 26% weighted to Japan. If an investment renaissance ever came about and it emanated from the industrial sector then IPN would probably be a great hold (not a prediction just an example).

People willing to build a portfolio at the sector level would need to first decide overweight, underweight or equalweight then decide on foreign or domestic or both and then seek out the best products to build out each sector.

For one sector maybe the best mix is a WT fund combined with a narrower product, for another sector maybe just one of the iShares funds for its presumably broader coverage or maybe another sector the SPDR and a domestic stock or two. And a year from now the mix could need to be completely different.

There are a lot of possibilities here which I think is a good think and makes for interesting work.
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Mid Morning

A reader left a comment asking how I define cap sizes.

Not sure that I have anything enlightening here;

Mega cap $100 billion and up (maybe this should be $150 billion)
Large cap $20 billion to $100 billion
Mid cap $2 billion to $20 billion
Small cap $500 million to $2 billion
Micro cap less that $500 million

I'm not sure if these are right because candidly I don't look at cap size this way. I am more concerned about the average cap size of the entire portfolio. Earlier in the cycle I want the market cap of the portfolio to be smaller and for it to get larger as the cycle carries on and matures.

To get smaller in the portfolio obviously you would buy some smaller stocks but a portfolio that owns 50 stocks all greater than $50 billion (to pick an extreme example) will not be changed by adding one $250 million stock.

Even if all that is used are index funds I think the market cap size of the portfolio is something that should be managed just like yield and volatility.
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Observation

I read an interview with the decision maker of actively managed materials sector fund.

The chart compares that fund (in light brown) versus iShares Global Materials (MXI), which I own for some clients, since the inception of MXI.

There are a couple of things here worth noting. For most of the time the ETF outperformed the active manager but what this chart does not really capture is that over the last 12 months the actively managed fund has cleaned the clock of MXI. MXI is flat in the last year, the active fund is up 25% or so.

What I think this reveals is an evolution of the theme. Success in the last 12 months has required more of a sniper approach than a shotgun approach (footnote Richard Kang on that saying). As a cycle ebbs and flows there are periods where going narrower matters more than at other times.

You would either need to pick a stock or very narrow product or realize that even the correct broad sector pick might not always be a homerun. I would note that an overweight to MXI, flat over 12 months, would have added relative outperformance versus the S&P 500 even if buying Potash (POT) would would have been better.

While this post is a touch nuance-y, it is important for anyone willing to invest at the sector level to realize that at times narrow will matter, there will be times when narrow will hurt and that with the path you choose there will be times where your portfolio is better off for what you prefer and other times where your portfolio will be worse off for what you prefer.

This is the sort of thing to think about ahead of time because making a change midstream (especially going from broad to very narrow) is likely to result in performance chasing and performance chasing is often done after the move has occurred or done at a time of emotion where a big move has come, someone on TV projects that recent past as continuing forever, more people buy in and then comes the big airpocket.
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Flaming Moe

Marc Faber was on Asia Squawk Box on Monday and among other things spelled out everything that is wrong with financial assets and he said that markets will be unattractive for years to come.

I obviously do not know whether he will be right but I write a fair bit about exploring portfolio choices that have a shot of working if he is right.

Included in the discussion would be commodities, certain currencies, countries where the money is clearly flowing into (takes in multiple catalysts), things that benefit from inflation, successful absolute return strategies, infrastructure and a few others.

There is no shortage of places to look but the work load for this is big.

Short post that I'll finish with a little bit of humor and pop culture as I settle back in after getting back from the wedding in Fresno.

A couple of days before their wedding, our friends took us to a place called Powell's Sweet Shoppe in Fresno which has every type of candy you ever remember having eaten as a kid.

They also had various energy drinks (looks like Red Bull but I do not know and am not going to drink it) with different cartoon themes on the cans including a Flaming Moe. I could not stop laughing and bought a can.

The only candy I bought was a half a pound of fruit flavored Tootsie Rolls; very difficult to find and very tasty.
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Sunday Morning Coffee

Michael Santoli's column this week is called Round Trip Ruminations and explores an idea talked about on this blog for a while which is that we have had a decade long round trip to nowhere for the S&P 500 which in terms of market action is not much different than the 1970s.

Given that the economic backdrop was so much worse during that time than it has been thus far in this decade makes me wonder which decade was actually worse for investors.

Some of Barron's other content explored whether the worst might be over for financials and the broader market. I don't think the worst is over but it is always worthwhile to explore the other side of your position.

One compelling reason why the worst could be behind us has to do with how anemic the bull market that ended in October was. This is along the lines of job losses have not been that bad compared to the past because the number of jobs added in the recently ended expansion were very low.

In the early days of this site I theorized about smaller peak to trough moves for the US as a function of maturity and size and while that may not stand up over truly long periods of time it might explain what is going on now and sets a path for this bear market and recession both being relatively mild.

To be clear this is not my baseline case for what will happen, I still believe a bear market that will be considered as having been average will be the outcome but the argument above is the best one I can think of for why the lows have been seen.
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The Big Picture For The Week Of July 20, 2008

Ok, theory time.

The other day I passed a long a snippet about Rydex adding four more currency funds, a couple would be new ground and a couple would not.

I don't know how off the beaten path the ETF industry will get with currency funds but there are going to be a quite a few currencies that will continue to go up a lot against the dollar, not necessarily because of the dollar's problems but because of what is happening on the ground in some of these places.

In a practical sense I believe in adding some currency into a diversified portfolio, be that actual currency (via ETFs) or using short term sovereign debt but the dollar will have periods where it outperforms some of the biggies.

If Europe is a little behind us right now in its economic cycle and their recession is worse than ours, how do you think EURUSD is going to do? In 2018 we may look at a ten year chart of EURUSD see that it was a one way trade but that would not preclude the dollar going on a run versus the euro for a couple of years.

So could a portfolio of currencies be put together using ETFs and short term sovereign debt in such a way where either it gives broad equity market like returns or one of those 80% of the upside with a quarter of the volatility?

Less volatility is a pretty good bet, currencies are generally less volatile than equities; if you buy the Turkish lira go small.

The idea of some of the currencies, ex the big boys, being in their own world, becoming more globally relevant and going up against the dollar is a theme I've been writing about for a while. Given the visibility for US equity returns to continue to be below normal for a while (another theme I've maybe worn out) maybe some folks should pursue this route?

Many of these countries have fewer moving parts, just one or two big industries, a drive for prosperity and the visibility for that prosperity. So, everyone in the pool?

Back in the real world probably not for reasons that include access to product, having the experience how to choose many different destinations so as to be diversified, how to know when to come out of one destination and some others.

But the reasons listed above as to why you should not go all in does not argue against modest exposure. Putting 5% of your bond portfolio into sovereign debt from Chile, another 5% into the New Zealand currency ETF and 5% into something that replicates the Kazakhstan tenge and the rest into more plain vanilla is not the single worst thing you could do.

Another bit of evolution in this space is that on the heels of the CBOE creating the Oil Volatility Index (OVX), so an oil VIX, the CBOE will soon have volatility indexes on other commodities and currencies. These won't be easy to figure and may never be usable for most folks but this sort of innovation opens many possibilities for all manner of investors.

The picture is the Ahwahnee Hotel.
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That's No Ordinary Rabbit Beta

I get a lot of stuff in my email that I never asked for but just get anyway.

One that I get had an interesting title, something about not paying Alpha fees (no not the sorority) for beta results.

This got me to thinking a little bit. I have read all sorts of things over the years, you probably have too, and one theory is that there is only so much alpha to go around. This may have come from MIT but either way alpha versus beta is useful to learn about in the context of trying to be a better portfolio manager (applies to do-it-yourselfers too)?

An often inferred or assumed point of information is that do-it-yourselfers cannot reliably add alpha. I don't know why people think this but I have seen that sentiment from professional research and from past comments to the blog. I don't think alpha is finite and I think anyone, with enough time, has a chance to add alpha.

Ooh, wait, alpha defined as excess return beyond the market and beta defined as the market itself, the volatility of the market.

If someone really cannot add alpha then the focus of their attention needs to be when to increase and decrease beta. The idea would be increasing exposure to beta, to the market, when it was going higher and decreasing when it went lower. This is far from an original concept but I don't think I have written about it in this context.

When the market is going up increase exposure, increase the octane and vice versa when it is going down. In a perfect world if the double long S&P 500 fund was intended to capture twice the daily move of the S&P 500 over time periods longer than one day you could just buy that (quick note, the double long S&P 500 ETF lagged SPY in calendar 2007).

This will be intellectually appealing to some folks but I think it is much harder to do. Markets turn quickly and it would be easy to get caught wrong footed with more octane in your account.

Most of the stuff I write about, and implement, explores how to put the odds in your favor based on how the market tends to work (examples; consumer discretionary does poorly late cycle, utilities do poorly in a rising rate environment).

I'm not big on alpha as a finite resource or it's all about the beta but the topic, at a minimum, is useful in the learning process.
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What Was That About A Bounce?

Well, we are rallying and what do you know, it feels good.

Stocks are up, commodities are down and every gas tank is full.

I wrote about this happening right before it started and now it is happening. No clairvoyance whatsoever, or even much in the way of smarts just a good memory of how these things work.

To repeat about how scripted this all has seemed to me; a yet to be fully quantified financial problem predicted by the yield curve, denial of the problem, rolling over of the market, fear that this time is different, eagerness to call the bottom too soon and some feel good rallies (I may take credit for the term feel good rally).

I've mentioned a few times about really trying to remember details of things like the emotions that people go through during these episodes, the market's behavior, the things that tend to work and so on. I think this sort of exercise goes a long way toward helping people keep their heads on straight when the market does turn down.

Long time readers will know my belief in planning ahead for a get defensive strategy but mental preparation along the lines of I have seen this before and this is what happened can be just as important.
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Ever Been To Yosemite?

Well, it's not too shabby.

More pictures later.
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Sing dollar

Rydex To Launch ETFs Tracking 4 Currencies - Yahoo! News

The four included above are the Singapore dollar, Russian ruble, HK dollar and the South African rand.

Of most interest to me is the Sing dollar. If they ever create a euro in Asia it would mostly likely be based on the Sing dollar.

If, as mentioned in the last post the US' AAA credit rating is cut, that would make holding a little foreign currency more important than it is now (and I think it is already important).
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The U S of triple A

Financial Armageddon: The Beginning of the End for America's AAA Rating?

Not a new subject but what if the triple rating is in jeopardy or is going to go away?

It is a waste of time to discuss whether it should or should not be downgraded, more important than should is what portfolio steps make sense if the rating is downgraded?
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Yosemite!

We had to go to Fresno, I am standing in a wedding on Saturday. Since we were in the neighborhood we thought we'd head up to Yosemite.

I'll have some good pictures to post later.

The last time I did a video I said well not much of a video, this was at Fenway, and shockingly it turned out to be correct. It was dated June 24 and I thought the market would work lower and that a little more defense might make sense so maybe this one might be right too?

Of course being right for a few weeks does not matter but deciding after yesterday's rally that all of a sudden you are someone to trade a feel good rally is probably not smart.
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A Rant By The Lake

The other day I was chatting with another firefighter and when we were done with department business he asked me about the stock market. He told me he is down by some amount and like most folks he is not sure what to do and he is a tad dubious about what "his guy" is telling him.

On a related note the ROI column in the WSJ Monday talked about five actively managed funds to buy for this sort of market environment. The money quote from this article was;

It's at times like this that some actively managed funds start to gain real appeal.

Or are you really so comfortable with this market's overall valuation that you are happy to buy an index fund and go along for the ride? If so, by all means take those routes. I prefer to sleep at night.

The flaw here, both with "his guy" and in the WSJ article is what appears to be a lack of proactive thought and execution as well as just mentally wrapping your arms around the fact that cycles end with declines and those declines make people uncomfortable.

If you have been reading this site for a while hopefully you thought about the fact that this is how the market works, even if you disagreed with me that we were headed for a bear. If you are new or did not think about the possibility of a bear hopefully you can remember what this feels like (this is harder than it sounds) so that the next one does not catch you off guard.

Unfortunately there is a dearth of MSM coverage from this angle and maybe even a lack of proactive moves made by people in the industry? I don't know about that last one, it is just an anecdotal observation based on interviews I read and interviews I see on TV.

It would seem to me that one of the worst things any investor can do is wake up one morning and say "uh oh the market is down 20% what should I do?"

Not everyone should utilize an exit strategy or a get defensive trigger point, that falls under the investor know thyself category but anyone prone to emotion during declines needs to do some planning ahead of time. Planning either means deciding what action to take or telling yourself that your will hold on no matter what and that if you have, say, $100,000 understanding ahead of time that might shrink to $70,000 in a normal bear.

Mental preparation can go a long way to mollify the distress. This a point often repeated here but it is true and I find it very unfortunate that anyone working in the business doesn't do more ahead of time to to avoid emotional problems that arise.

The picture is from Watson Lake here in Prescott.
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Bounce A Comin?

Yesterday I talked a little about a possible bounce coming, what I have been referring to as a feel good rally. Jon Hussman this week also talked about the possibility of some sort of bounce in the offing.

Hopefully as the months have worn on in this cycle you have taken that market cycles end with bear phases and that during bear phases there are bounces that come along. I talked about it during the winter then we had one start in March and it makes sense to expect another feel good rally, at least one more, during this bear phase.

So think about that ahead of time, hopefully you thought about the last one before it happened too.

Why might a feel good rally start soon? The decline from May 19 has been swift. While I don't look at too many things along these lines I'm sure it would be easy to pull out all sorts of stats that "prove" the market is oversold. I suppose it would be fair to say sentiment has also spiked down, the action on Monday is a good tell for this. These sorts of things are short term trend changers not big cycle changers.

If there is a feel good rally it will be appropriate for some people to trade and for others to leave it alone, know what camp you fall in to. If there is a feel good rally there will be plenty of commentary on TV and in print telling you that the bottom is in and that now is the time to go back in.

At some point a bottom will come but in bear markets people get faked out by these sorts of rallies. From a common sense standpoint how can a bear market that results from whatever is happening in the housing market/financial crisis (you can quantify the reality if you want to) be milder than normal?

I talk about pre-planning an awful lot and while no one can account for every variable that might come, stick to your original plan for re-entry--that is if you took any defensive action earlier.

For me that means wading back in when the market takes back its 200 DMA. If we are down 30% at some point maybe I'll add one name but the focus is health of demand (or more correctly my perception of it based on the 200 DMA) for equities.

If you still believe that stock market investing will still work, even if that means investing more in foreign markets, for the long term you do not need to nail the turn around no matter when it actually comes.

The point of this post was not to predict a bounce but to realize that another one is likely at some point (based on how bear markets tend to work) and it makes sense to think now so that you remember later.
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Mid Morning

The pop from the open has obviously petered out for now, about flat for the S&P 500 as I write this.

One general observation; news like we had over the weekend about Fannie, Freddie, Paulie and Bennie and the Feds could turn out to be the catalyst for another feel good rally.

I don't think a bear market can end with "I'm from the government and I'm here to help," to quote Mark Haines from this morning, news.

Whether this is a normal bear market (my opinion) or something else it does make sense to think there will be another feel good rally at some point. The one from March to May 19 was longer than normal but shallower than normal.

For all I know, and on second glance, today's bailout news may not be fuel for a feel good rally but another one is likely before the market really bottoms. And if there is a feel good rally the pundits will come out of the woodwork to tell us a real bottom is in.
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Off The Beaten Path

In continuing this thread (not only here but on greenfaucet and TheStreet.com) about sectors and proxies and such...

I've mentioned a few times over the years that it would become easier to build very narrow portfolios with very specific effects by using ETFs (this was not something particularly clever but more of a statement of the obvious), certainly this has come to pass and and will continue to evolve further.

The global shipping ETF I mentioned yesterday is the most recent example of the potential.

One aspect of this that I write about often is funds being proxies for other things. One example I mentioned a few days ago is the possibility that the WisdomTree South Africa Currency ETF (SZR) could be a proxy for gold.

For now this does not exist as gold, measured but GLD which is a client holding, seems to almost have a negative correlation. If or when South Africa gets a handle on some of its imbalances and inflation the correlation between the two could go up.

If it does happen (I'm not trying to assign any probability with this post) then think about what what SZR would become; something that tracks gold and yields 6 or 7%. This type of thing would be of interest even if it ends up not being for you.

As you read that you might wonder doesn't the Australian dollar already do that? To a point, yes it does but as highly as I think of Australia, and I do own the currency, this becomes a point where people risk allocating too much to one country.

Another, IMO, example of a proxy in the making might be the New Zealand Dollar ETF (BNZ). Many people think of the kiwi as being a commodity currency (I referred to it this way in the early days of this site) but that is not quite right. New Zealand produces a lot of dairy products, meat and wool. The government is very proactive in trying to increase its exports, it has a free trade agreement with China, and it seems to me that the kiwi could be a proxy for the burgeoning of the food theme without taking on the same volatility as an agriculture stock. I've had a lot of luck with Monsanto (MON) but that type of stock is not right for everyone.

The kiwi faces plenty of obstacles pertaining to deficits and imbalances but these issues are not new and have not crippled the currency (yet?). For now I do not own BNZ and I don't know if I will. The idea of BNZ being a low impact way to buy into the global food theme is just a bit of process/theory.

This post isn't about buying SZR or BNZ it is about recognizing themes and exploring whether there might be any other ways in that could increase volatility or decrease it depending on your own tolerances or the maturity of the cycle.
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Sunday Morning Coffee

You know how if you turn a garden hose on and no one is holding it it whips around with no rhyme or reason?

Well the more I read about the Vix index from Adam and Bill Luby the more I am convinced that a Vix ETF would behave like the hose that no one is holding.

Quite a few times I mentioned that it seems logical for someone to get on the stick and figure out how to ETF (or ETN) it and that I thought it could add value to a portfolio.

Yeah, well forget it. Not that it shouldn't exist and that anyone so inclined shouldn't take a stab but if it ever does come I really doubt I would have an interest. Either something has changed or I know less than I thought I did, not that I was ever an expert by any means, or perhaps some of both. Seeking out volatility management is an important component to portfolio construction but there are less complicated ways to do it.

Anyone who has stuck with this blog over the last few summers may recall that I love to watch the Tour de France, doping and politics notwithstanding I enjoy the scenery, I get a kick out of Phil and Paul's announcing and the competition, anonymous as it has become, is very exciting. Well during yesterday's coverage Paul went on a little tangent about the Aussie reaching parody with the greenback, his preference for the kiwi and for good measure Phil chimed in with a joke about needing six dollars to buy a pound.

Maybe we should listen to Paul, he owns a goldmine in Uganda (I think it's Uganda).

On a related note, on Cashin' In Jonathan Hoenig suggested the South African rand via the WisdomTree product that has ticker SZR. That one might be a bit of a watch out. The rand has some deficit and inflation problems and somehow has managed to go down YTD against the greenback by more than 10%.

On a related note to the related note when watching the Saturday Fox shows as soon as I see the young looking professor from Temple University come on I know that segment won't be about the stock market and I can blast right through on the Tivo.

The crew over at IndexUniverse reported that Claymore has a shipping ETF in the pipeline. From an investing-other-people's-money standpoint this is a tough group to buy into because of the volatility that a lot of them exhibit. I think this group lends itself to an ETF very well because unlike some other specialty segments one shipper doesn't often win at the expense of another shipper. In taking a quick peak at the prospectus, and I do mean quick, there is a good chance that some of the 30 names will be new to you (and me) and that it will not lopside into a couple of stocks but we'll see.

To be clear owning shippers may not be the right hold but I don't think owning an ETF would be a disadvantage versus a stock.

Barron's profiled Nasdaq/OMX (NDAQ). I thought it was a good read and it included an interesting comment. The author, Sandra Ward, described exchanges as being like toll booths. For quite a while I have thought of publicly traded exchanges as being part of the financial infrastructure of a country. I've mentioned this a couple of times in writing so I find it interesting to read that elsewhere for once.

One positive catalyst that was mentioned is all of the cross border investments and alliances that NDAQ has in place. No question that this gives the company the chance to benefit from anything positive that might occur in Northern Europe, the Middle East or anywhere else it plants its flag but that does not make it a proxy for any other country. Seemed like a good time to toss that in again.

One last point, back to Fox News. While I am quite certain that Tobin Smith does not read this blog he pretty much spelled out part of an argument against my belief that the current bear market will be normal. All he said was that normal bear markets last 18 months or so and go down about 30% but that there is nothing about this time that is normal.

Unfortunately that was all he said, not a knock on him, the show is structured for sound bites not real analysis. As his comments were very brief I will simply remind everyone that in every bear market the this time is different sentiment is very pervasive. If you really believe this time is different I would implore you to at least take this into account. I would also remind/disclose that I have structured the portfolio in such a way where correctly quantifying what happens means close to nothing.
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The Big Picture For The Week Of July 13, 2008

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Mid Morning

It is tough to tell but the green in the picture is the Green Monster at Fenway. The clay color is the left field warning track. I took the picture from the top of the wall--its a long way down.

So from the I'm not sayin' I'm just sayin' file; a quick word in case we all get a reminder over the next few days about how trading curbs and circuit breakers work....

The news about Fannie and Freddie kicked up a notch obviously and we have a potentially long two days of just waiting.

The market action of the last many months has been a normal bear market process--scary news, various moves downward a feel good rally and so on. If there is a violent move down, IE a crash, well first it can't be 20% in a day because the market will close before that happens. The modern day equivalent of 20% in a day might be 20% over two or three days.

Panics snap back. This is a just how the market works type of thing. A panic and snap back can occur in a bull market (like 1997 Asian contagion or the 1998 LTCM/Russian debt default) or in a bear market like last January in le affair du Kerviel (hey, I took Spanish in school).

If we were to see a big panic I would close out my double short position as I did in January. At this point I do not know if after closing SDS out I would get more long right away, which I did not do in January or when I would buy SDS back (on the Kerviel trade I bought it back later that week) but the point is I have the first step of a plan in place before anything happens. The rest depends on what the market were to give in that scenario.

A plan could include doing nothing, depending on the appropriate thing for an individual but deciding ahead of time that "since selling is not right for me, I will not panic along with the market" is a valid course of action.

Lastly a reader follow up question about why I think a bailout of Fannie and Freddie would weaken the dollar. Not to get too jargonny or sophisticated, lol, but one problem with the dollar is no one wants to hold it.

Plenty of places have to hold the dollar but they don't want to. I saw one thing early today, maybe from Yves, that opined that bailing out the GSEs would double the US' debt. I don't know if that is accurate but obviously the US' debt load would skyrocket. Further indebtedness (we are talking a lot more than Dr. Evil kind of money), everything else being equal, is bad for a currency.

This leads to another comment I made yesterday (far from an original thought I might add) but at what point does the dollar get defended by anyone? I don't know as I'd have liked to have thought it might have started by now. At some point interest rates should go up, this is how markets work--of course this sentiment has been wrong for a while.

All of this creates the environment I have been writing about for ages which is weaker growth and higher rates. This is not apocalyptic but it makes the case for the US being a less attractive investment destination than other countries as has been the case for most of the naughties, or if you prefer, the oughts.
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The 40% Solution?

Long time reader JackS left a comment noting that the average bear market decline is 34.1% (I thought it was closer to 30%) but that because the financial sector is at the heart of this bear market it could mean a 40% decline before we are done.

There are people who share JackS' concern WRT to magnitude. I have not yet moved off of my normal bear idea yet, I can see where it might fall apart but for now I continue to believe it will be within the range of normal.

As I read the comment I started to think about the sector weightings of the S&P 500 which are as follows, according to the iShares page for its S&P 500 fund which trades under ticker IVV.

• Tech 16.37%
• Energy 15.18%
• Financials 14.07%
• Healthcare 12.51%
• Staples 11.30%
• Industrials 11.19%
• Discretionary 8.11%
• Utilities 4.08%
• Materials 3.72%
• Telecom 3.26%

A 40% decline from the top, 1565, would take the S&P 500 down to 939.

In the decline thus far financials have gone from 21% or so down to 14%. How much further can the sector fall? Since the market's peak in October, so not the sector's peak, the financials as measured by Financial Sector SPDR (XLF) is down 45%. So a 45% decline has worked out to a 1/3 less weighting in the index.

Again, how much further can it realistically fall? Don't confuse my asking the question with a belief that a bottom is in but what is a reasonable expectation? If XLF were to fall by another 1/3 from here (which I think is more than will actually happen) that might work out to another 5% that comes out of the S&P 500, using simple math.

Both tech, measured by client holding iShares Technology (IYW), and industrials, as measured by Industrial Sector SPDR (XLI) are down the same, 20%, as the S&P 500 since last October but their weightings have inched up some, tech more so than industrials, because of the massive underperformance of the financials.

IYW topped out at the beginning of the decade near $136 versus $52 today. How much further can it fall? Based on how this bear market has shaken out is it likely that it could start to fall much more than the rate of the market? Again the tech decline has been in lockstep so something would need to change for tech to start falling faster.

Despite GE's having fallen from $42 down to $27-ish it still makes up16% of XLI so it has contributed a disproportionately large portion to the 20% decline of the sector. How likely is it the another 34% comes out of GE? If anything the rest of the sector might catch up to GE.

What about energy? Not surprisingly its weight has grown over the years and the notion that energy could correct is gaining some traction. I would not argue that the price appreciation has over stated how quickly supply and demand for oil is changing but energy cutting in half relative to the S&P 500 after peaking out at only a 16 or 17% weight would be very odd.

Staples should do well in a bear environment and they have done well so I'm not too worried about them taking down the market. Healthcare, while it has not done as well as you'd think it is doing better than the broad market and a catalyst for more declines emanating from here also seems unlikely. The smaller sectors could implode inward like a supernova without doing a lot of broad market damage.

The point here is not that the market has bottomed or that 40% can't happen but going sector by sector a lot of things would have to come together to create quite a storm for the decline thus far to only be the halfway mark.

A lot of things are down a lot and here we are down 20% for the broad market. A second decline of 40% or more within the same decade seems like a huge obstacle. It did happen during the 1930s. The high for the Dow was 381 in 1929. A low was put in in 1932 at 59. The ensuing rally topped out in 1937 at 194. The market then bottomed out again at 92 in 1942.

So is this decade as bad as the depression followed by World War II?
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Mid Morning

Lot's of chatter here and there about problems with Fannie and Freddie or more correctly an escalation of problems and a question of solvency.

Not sure what the problem is, we were able to get this baby (pictured to the left) to appraise for $610,000 on a cash out refi. Humor attempt.

I have to believe that the fear exceeds the reality, that is my starting point going in. Of course I could be wrong and in the context of managing client portfolios being right, or wrong, it doesn't really matter.

For now it makes sense to be defensively postured (as I've been writing about) and if things get worse I would add more defense as opposed to sell some offense (offense as defined by the stocks held).

To the topic at hand, an outright failure at Fannie, Freddie or both would greatly increase the chance that "normal bear market" turns out to be wrong. In the WSJ article linked to above there is a mention of increase the loan limits for the GSE's and I remember when that happened I had the feeling that this was not a good thing (I did not write about it so no credibility on that point).

There is now plenty of opinion out there that says the GSE's are de facto insolvent. Of course Jimmy Rogers has been saying this, essentially, for many years now.

Were they to fail, and here I'm not sure what that would mean (shareholder equity goes to zero, the gubment bails out the debt one way or another, loan creation is further impeded as one of many possible scenarios?) I would expect financials take another big tumble, the dollar to take a big tumble then one way or another the dollar would have to be defended (wouldn't it?) which would lead to higher rates.

Of course I have been wrong (or early?) about interest rates for a while as I thought they would have started to normalize a long time ago. If the Fed were to raise their rate but the market, fearing slowdown, kept the rest of the curve low then the dollar would have problems. The Bernanke Fed has done a couple out of the box things so maybe it could pull another rabbit out of its hat in that scenario.

I don't know how right or wrong any of this will be and again it does not matter. Keeping things very simple, if there is call to be defensive I would be defensive and the details of why there is a call to be defensive are less important.

These sorts of things of course matter to the country and society but you can't solve the world's problems with your portfolio. Protecting of assets is paramount.
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This Just In

This just in....demand still stinks.

I hope that anyone who has felt this has been a bear market for a while (a normal one as I think or otherwise) is not surprised that we have made a new closing low for the S&P 500.

I've made several comments about how text book the bear market has been starting from rolling over slowly last fall worrying very few people, there being a good sized feel good rally in the spring and the constant questioning if a bottom is in.

We can only hope that the end of the bear and transition into the next bull is just as textbook.

If so, then we might expect to see a turn up met with disbelief a few months from now (maybe Q1 2009?). Things will start to green light when the S&P 500 goes back above its 200 DMA. Regardless of when this occurs, buying stocks at that time will be uncomfortable.

You might be thinking that it would be uncomfortable to buy stocks today so is this a bottom? I'm not worried about the bottom I am looking for where demand gets healthy. I can't recall hearing about demand for stocks elsewhere but the things I have been writing about all along have focused on health of demand but qualifying this approach that it would not get anyone out at the top or in at the bottom.

The folks on TV seem mostly resigned to the fact that this is a bear market despite a few bottom callers early in the day on Wednesday. I view this as the beginning of a shift in sentiment. Resignation that there is a bear market is a step on the road to skepticism that will invariably come from the mainstream at some point.

I write a lot about this sort of thing because health of demand (the market above or below its 200 DMA) can be easily monitored and acted upon by anyone. Down zero in a bear market is not realistic but down less is possible.
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Mid Morning

I got a couple of reasonable "oh no you di-ints" on the post this morning that tried to compare complex products versus simple.

The fund in question is TFS Market Neutral (TFSMX).

My only observation was that the fund is complicated. One reader noted that it has more than bounced back from its August 2007 low and another reader said that he doubted that staying simple could match the result from TFSMX over varied market conditions.

The chart goes back to the inception of the Rydex Managed Futures Fund (RYMFX) which I own. The chart also shows two of the hotter sectors over that time, as measured by sector ETF, as well. It would be fair to criticize the chart as not being long enough but it has been a wild 17 months and it is as far back as RYMFX can go.

Without getting into which one is better because as you can see they each might take turns being the better performer, RYMFX is simpler. Long or short is determined by the seven month moving average for each fo the components and you can go to the site to see what the components are.

Since the inception of the Rydex fund the two have taken different paths to the same result (probably just a coincidence).

It is reasonable to say that two sector index funds (MXI which is a client holding and IYE) are also simpler than TFSMX.

It would be easy to conclude that I am mining data with the MXI and IYE comparisons except some sector has to be the best performer and if you are willing to construct a portfolio at the sector level you will own the best performing sector (and the worst too).

If you were to buy this sort of fund what percentage of your portfolio would you allocate? Is there any way it would be larger than what you would allocate to the energy sector (an equalweight in energy these days is 16%)? You might put more into a long short fund than you would in materials though as an equalweight in that sector is only 3.67%.

The argument for simple is, I think, a little more credible because it is being made with things I have been writing about for ages as opposed to looking for something I've never heard of to show simple is better. Going forward maybe TFSMX will clean the clock of every other thing out there but it will not be simple and so it will be harder to manage the volatility.
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Complex

Apologies for recycling this picture so soon but I thought it would fit in well with this post.

Yesterday I drove to Phoenix for a meeting and Joellyn came with me so I missed who the interview was with but there was a segment with the manager of a long short mutual fund during the program The Call.

The fund in question has done very well but the interview was odd. Apparently the fund is all quant, and whatever the model spits out they execute. The fund has over 1300 holdings and there is "a lot of turnover."

The way the interview went I got the impression that the manager did not know if the fund was short financials right now (it was short earlier) and he did not know his position (long or short) in energy.

It is not my intention to be critical because the results have been very good, I think it was up 9% in the second quarter, but whatever the best way to describe this fund it does not include the word simple.

Everything about the fund sounded very complex. As a matter of philosophy I think simple is better because it is easier to quantify the risk. The quant model that the fund uses, based on the interview, is a secret sauce. If something ever goes wrong (maybe this has happened with this fund in the past?) with the model or if there is some particular environment where it won't work there would be no way to understand why or mitigate in the future.

Compare that notion with one of the Canadian income trusts. The businesses are not simple, they are debt intensive and often very transaction oriented. In that light it is pretty easy to realize that anything the mucks up the capital markets or more narrowly the fixed income market stands to be a problem. You can see something like that coming much easier than a hiccup in quantitative that you can't look at.

Speaking of complicated, I am working on an article for TSCM about a frontier ETF from PowerShares that will trade under ticker PMNA. Without front running my own article this fund is far from simple.

I like the idea that the biggest variable of a holding is whether I am right or wrong not something from out of left field that not even the fund issuers could have envisioned. As I describe being right or wrong I am outlining the belief that where funds are concerned if the parts under the hood are static (as static as an index can be) then it becomes much easier blend different holdings together to get the desired effects--things like volatility, style, average market cap, sector weights and so on.
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Life Can Be Simple, If You Let It

At the end of yesterday's post I referenced a comment from a reader about how to live that I thought was great for its simplicity. Investing, and life, can be very simple if you let it. With that in mind and in no particular order...

• Always maintain a diversified portfolio
• The stock market goes up most of the time
• Occasionally it goes down
• Don't drink soda
• Diversification includes foreign stocks
• Diversification includes commodities
• Diversification includes alternative assets
• Don't make big bets in your portfolio
• No matter how sure you are of something you may be wrong
• Do for others and expect nothing back
• A lot of people you read or see interviewed understand a lot less than you think they do
• Adopt a dog
• Get a dog for your dog
• Supply and demand is very important
• Floss
• Always seek to learn more (this pertains to more than investing)
• Always maintain a diversified portfolio (I am aware this is a repeat)
• Think about bear markets before they happen
• Think about bull markets before they happen
• See the forest for the trees (this pertains to more than investing)
• Exercise often (this means cardio and stretching too)
• Heed the yield curve
• Live below your means
• Realize and understand the drawbacks of the investment products you use
• Realize and understand what your portfolio is vulnerable to
• Don't wish the week away to get to Friday (this means you need a new job)
• Gold usually goes up when something bad happens
• Bonds don't grow
• Always maintain a diversified portfolio (I am aware this is a threepeat)
• You will get some calls and picks wrong
• Seek to be wrong a little less often than you are right
• Keep investment themes very simple (oil up is good for Norway)
• This time is not different
• Own something that should go up if the market goes down
• Remember what happened in past cycles
• Volunteer
• Dogs need to be walked
• Take a risk every now and then (this can pertain to investing)
• Save a lot of money
• Make fun of yourself
• Have "get defensive" trigger point for your portfolio
• Know your tolerance for volatility
• Be a good friend
• Have fun
• Live below your means (I am aware this is a repeat)

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Mid Morning-Special Decaff Edition

To the point I made Sunday morning about continually seeking out new (to you) things to learn about I stumbled across one thing while looking for another.

The Swiss Water Decaffeinated Coffee Fund (SWS-UN.TO and SWSSF.PK). Apparently the company takes the caffeine out of coffee (don't know for sure I just found it).

For all I know it could the single greatest investment of all time or take down the entire North American market but why not learn what this is about?

When things in the capital markets begin to normalize (last month, next month, next year, 2014?) I think owning one of these Canadian income vehicles will very likely make sense.
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Looking Forward

A reader left a question that I think is pretty damn good. He asked "what are the variables that I use that allow you to do a forward analysis of an asset with any meaningful probability of being right."

As someone who believes in top down management I focus on big picture issues and then try to figure the best way to invest toward the big picture while at the same time building in some sort of counter strategy in case my assessment is wrong.

So instead of looking at a stock from the bottom up and saying ok, here is a stock with such and such valuations that will make more widgets next year for a slightly smaller cost and buying it, top down looks at the world for things like supply and demand issues, turning points in cycles or big long-lasting themes as examples. The world is not going to have enough drinking water, the US had an unsustainable real estate price boom built on very low rates or China is going to be much more globally relevant over the next decade.

Another type of analysis might be at the sector level. Take a couple of years ago when the curve inverted. The history of curve inversions is bad. Is there any reason why this might be different? Are the arguments made by the people saying it's different this time compelling? Based on a bunch of excesses we all knew about, even if we could not quantify, no, those arguments were not compelling.

The best way I could describe the above is that I am trying to put the odds in my favor as often as I can by trying to find the forest. This is far more important than the stocks, or funds, that are ultimately chosen to capture the big themes.

Before the financial sector blow up I used to say, as an example, the best thing would have been to sell all tech in the summer of 2000 as opposed to trying to find the one or two names that might have gone up as the Nasdaq dropped 80%. Now the financial sector is another example. The best thing would have been to sell all financials instead of trying to find one or two that might to do well.

Once you know that things look good for the oil market (using an example from a couple of years ago that shows how simple this can be) what then is the best way to capture this effect taking into account a good balance of potential price appreciation and volatility? Over the last five years it would be very difficult to pick a stock that went down, save for maybe Yukos. Clearly some energy stocks have been relative laggards or leaders but if you got oil right one way or another you probably have a winner on your hands.

For me the energy theme meant looking at foreign stocks because every country has a big oil company, this is an easy sector to add foreign exposure. Having done a little reading I knew that Norway was (and obviously still is) an important destination for oil.

There aren't too many big oil companies in Norway. If oil up is good for Norway it must be good for Statoil (STO) was the thinking. I could have been wrong of course but the wind was at my back when I bought it. Obviously I still had to learn the company. Norway's production is declining, the company is very unhedged, they have a big global footprint and I had to learn the numbers but it would have been hard for that stock to have been a horrible pick.

I think this is all very simple, you either see it that way or not but sorting out the big themes and then looking for the best way in is the best description I can give.

Another reader left a comment that included the following;

Diversify. Eat right. Have friends. Work out. Buy Adopt a dog.

Pretty hard to argue with that. If you can't really eat right how about just cutting out the soda?
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Sunday Morning Coffee

There has been an interesting thread in the media over the last few days that ties in with something I have been theorizing about on this blog for several years now.

The Up and Down Wall Street column in Barron's cited a report from the Bank of International Settlements and came up with;

As Philippa and Doug (from the Liscio Report) sum up the message in the BIS annual, it increasingly looks "like the evermore freewheeling financial environment that we've taken for granted for the last 25 years is behind us." Or, as the Bank declaims "has run its course."

Also in Barron's was an interview with Harold Evensky which was titled Building Portfolios For A World of 2.5% Gains. The only thing I think I need to add to that is that 2.5% is his idea of what real returns will be.

As this has been a concern of mine for a while I obviously read with great interest and wondered whether I might have been on to something with this notion. But then I found this from the FT by Tobias Levkovich making a case (although he takes a very narrow route to this theory that I think misses the forest) for a similar equity environment. I can't recall Tobias being right about anything in this stock market cycle and that he might come to the same conclusion does work against the theory.

Be that as it may I hope that after all this time of my writing about infrastructure, airports, farmland, currencies, hydro funds and on and on you have started to expand your horizons in terms of what you have learned about.

I write about a lot of these alternative type of things, far more than I buy, because I think it is very important to learn as much as possible as opposed to learn about something and then just buy it. There is nothing wrong with learning and then saying no.

I wrote about the plane leasing stocks awhile back, if memory serves I locked onto these when Babcock & Brown Leasing (FLY) debuted. I think it is fair to say my take all along has been I'm interested, they are risky, give them some time and fortunately I never bought as they have all been decimated (including the one that made the best impression on me because it paid no dividend).

I am still interested in them and I do believe that at some point it will make sense to own one that caters to airlines from smaller ascending countries but at this point I'm not sure when that will occur but of course I could continue to be wrong about them.

More content will start to cover these sorts of things as time moves on, as there is recognition by more people that SPY/EFA/IWM will not cut it for helping investors to have enough money when they need it. Bogle and Morningstar notwithstanding, the sooner people grab onto this the better served they will be.

One related update; this past week I tried to buy one of the farmland companies but couldn't get it done. It was a small foreign name, I figured the quote (correctly I might add), padded my limit by a reasonable amount (so based on price it was executable) but Schwab just could not get an execution unless it went to the foreign market which would have made the commission, IMO, exorbitant. Back to the drawing board.

One announcement of sorts is that I am starting to do some writing for a site called greenfaucet that will be mostly about ETFs. I had one article post there the other day and plan to turn one in tomorrow that maybe will post on Monday. I am still with TheStreet.com as well. For now I'm just feeling things out with greenfaucet to see if I have the time to create original content and if the content I create is something they even want.

The picture is from a few winters ago when the propane truck fell in a sinkhole very close to our property.
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