The Big Picture for the Week of November 1, 2009

Short post today.

The media paid a lot of attention to several things yesterday. The huge move up in the fear gauge, aka the VIX. Dollar up means stocks down. 1042 is a very important number for the S&P 500.

All of these things are very very important. Unless they're not.

The VIX' importance ebbs and flows. Sometimes it is important but sometimes not. It is not clear to me that the best application of VIX is as a coincident indicator IE VIX up a lot today so stocks are down.

For now there does seem to be something to dollar up stocks down. If concerns about the greenback come to fruition (perhaps it makes more sense to say play out further) then this relationship should be expected to change. The bigger picture I have been working with has been the US as a less attractive investment destination than other countries. If this turns out to be correct then the dollar will go down slowly and stocks will go up most of the time (but less than many other markets). The point here is that dollar up stocks down will likely change soon.

If you think of yourself as an investor, as opposed to a trader, then 1042 means nothing. Whether the market goes up or down from here investors should take solace the the US capital markets are not permanently broken. At current levels the SPX is about 400 points from the low and 500 points from the high so sort of in the middle. In that context, if you believe that the US markets will function, does it matter if the next 100 SPX points are up or down?

Happy Halloween
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Follow Ups & Other Fun Facts

A few days ago I wrote somewhat critically about the IQ CPI Inflation Hedged ETF (CPI) and IQ Arb Global Resources ETF (GRES) and said I would try to listen on the conference call IndexIQ was hosting to explain the funds. I was able to get to the call and did learn a few things.

Regarding CPI I said I was baffled at the complete omission of any sort of TIPS product in favor of such a heavy weight to short term t-bills. I allowed that with stated inflation being so low that t-bills could work for now. They have done backtesting galore and the backtests have been successful. For the last year (I think have that time frame right) the index outperformed the reported CPI index by well over 200 basis points, pretty good given the objective.

For now the reported inflation environment is benign so the fund can be heavy in t-bills. At times of higher inflation the fund will allocate more to things like gold, oil and even equities and "real estate." Presumably real estate means REIT ETFs. So the success of the fund will rely on correct assessment and timing of inflation trends. It would seem to me that if inflation kicks up and at the same time somehow the other things they would use to protect against inflation, based on past backtest success, went down that the concept would fall flat. That is not a prediction just the obvious threat.

The reason for no TIPS exposure is that it turns out that per their research TIPS have a very low correlation to the reported inflation rate which the CPI fund benchmarks against, I believe the number the cited for the correlation was 0.21. That is a low correlation but I don't think correlation is relevant. If you buy an inflation protected security of some sort you expect the par value to ratchet up with the rate of reported inflation not to have the price of your holding move tightly with the rate of reported inflation but maybe I misunderstood that point. The other reason they cited for avoiding TIPS, which makes more sense is that longer dated TIPS are very sensitive to rising interest rates. If correct then it makes PIMCO's Short Term TIPS ETF (STPZ) worth exploring.

As for the commodity fund, GRES, I was most baffled by the huge weighting to Sandvik, about 8% of the fund, and the dozens of stocks with microscopic weightings. I asked about this during the Q&A and I think I get; I'll explain via a simplified (and made up) example. Lets say a fund like this only invests in two industries instead of the eight the GRES invest in. Lets say that the fund must equally weight the two industries like GRES does the eight. If one industry only had two stocks and the other had 100 then those two stocks would have 25% weightings while the stocks from the other industry would have tiny weightings. GRES has more moving parts but generally it is trying to equal weight eight different industries.

I'm still not crystal clear on why that leads to such small weightings in certain energy and mining stocks but the above explanation, assuming it makes any sense will get you started understanding it.

For some other follow ups;

The Oklahoma Exchange Traded Fund (OOK) is finally out. I am submitting an article to theStreet about it but on first glance it looks like an interesting energy proxy. One of the smaller holdings in OOK is LSB Industries (LXU) which makes heat pumps for geothermal of all things. It went down a ton during the bear market and is up a ton from the March low but the chart since the summer looks dreadful. The last two sentences is all I know about the stock.

A new farm name from a Seeking Alpha reader; MP Evans Group which is traded in London but has the pinksheet ticker MPEVF. I did not get a chance to look at it at all. Anyone who knows something can feel free in the comments. A long time reader, very long time (thank you), sent me this link about Ukrainian farmland, the black earth I mentioned earlier. There are plenty of companies to learn about regardless of whether they are accessible or not. I can vouch for Trigon Agri (TRGAF) from Sweden as being publicly traded.

Regardless of whether GRES should be bought or not there are some interesting individual holdings in the fund that could be worth learning about. To be clear these names are new to me and I have not looked at them. Nippon Beef Packers (NIPMF); Japan makes for a lousy top down pick but if the company exports beef to smaller healthier countries in Asia well, that could be interesting. Sino Forest (SNOFF) listed in Canada, owns land in China, went down a lot with the market and has come up a lot off the low. I've mentioned that one before. One more is Petropavlovsk (PPLKY) which mines gold and I think a few other things in Eastern Russia. I've never heard of it but it does have ADRs, as opposed to ordinaries. As a quick reminder a five letter symbol ending in Y makes it an ADR, ending in F makes it an ordinary share.

Yesterday I mentioned that Paraguay was no dice per Schwab. I then asked about these other firms allowing clients direct access to foreign markets and currency holdings and whether Schwab was going to keep up. Schwab used to be out in front with this sort of thing but not lately. They have things in the works but no public timeline as to when.
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Down On The Farm?

This week's post from Jeffrey Saut took a look at a different type of Permanent Portfolio that not shockingly to long time readers I found to be very intriguing even if very difficult to implement. Maybe more correctly, impossible to implement... for now anyway.

Saut took this idea from a mentor from his early days in the business named Lucien Hooper who liked the idea of 25% into equities, 25% into bonds, 25% into precious metals and 25% not into cash like Harry Browne but that last 25% into farmland.

I've written quite a few times about farmland as a potential investment and while it is intriguing on some level it is difficult to access. Saut mentioned Cresud (CRESY) from Argentina which owns a lot of farmland but also owns a lot of cattle. There is an English version of the website if you're so inclined to learn about it.

In the post Saut also mentioned an area in the Ukraine where the "black earth" is very suitable for farming without mentioning the one stock I have looked at casually before Black Earth Farming which is listed in Sweden with ticker BEF-SDB and on the US pinksheets with ticker BLERF. He does suggest (clients have their reps) calling "the desk" for specific names.

There are other stocks around the world, but not many, and they are not easy to trade or even closely follow but conceptually stocks of this sort from Malaysia, Indonesia or elsewhere in Latin America could be of interest. On a related note BTW, Paraguay (mentioned the other day as being the world's fourth largest grower of soybeans) is too small of a market, according to Schwab, to be accessed but maybe that will change some day. The guy I spoke to said no one had ever asked him about Paraguay before, interestingly though Cresud has some operations in Paraguay. Maybe we'll hop on down to Asuncion to open an account. Ahem.

Zooming back out a little the concept makes for a good discussion but I am not inclined to follow the specifics. While I concede that my single digit weight to commodities is small for most folks 25% just to precious metals is way past where I want to go. At some weighting, before getting to 25% IMO, you start to drift from hedging to giving a high probability to the end of the world (metaphorical or otherwise).

I am open to the idea of owning a stock like BLERF or CRESY but in looking for a zig-zag effect both names went down more than the SPX during the latest bear market but they did both bottom in November 2008 compared to March 2009. Some may think of that as zig-zag and some may not. Part of the idea of buying a farm stock probably needs to be a reasonable expectation of a new differentiation or other catalyst. Globally speaking I think there is plenty in the way of catalysts for the theme, not sure about the stocks.

Obviously if demand burgeons then the theme will become more accessible as companies create product. I think it is very worthwhile to explore these types of ideas but then again all I do all day is read stock market stuff. At some point I can see working in something along these lines as an across the board holding but the average volume on a lot of the ones I have looked at is not great.

I think I first wrote about farm stocks a in mid 2008 and I am still working on the theme. Hopefully this underscores an important aspect of thematic investing which is that if it is a theme as opposed to a fad or mania or just not really a theme there is no rush to be in yesterday. True themes play out over years.
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Wednesday Roundup Of Doom

Doom and fear seem to be making the rounds this week as they are always compelling and there are reasons to be concerned. One thing that you have probably read a couple of times is that with budget deficits of $1.4 trillion and deficits likely to be in that neighborhood for years to come it means that the US must issue more debt to fund that gap.

I read something the other day about this (apologies for not having a link) that made intentionally heroic assumptions to get to US investors buying up $500 billion of that through savings and then questioning where $900 billion of more demand will come from and if there is enough demand, where will it come from next year?

Perhaps softening the blow a little is that included in these numbers is very short term debt rolling over very frequently which will soak up some portion of the supply--simple replacement-- but clearly replacing paper that rolls over regularly will not solve the problem. The numbers are daunting. China, for all the talk will buy a lot of the debt issued but we can't know how much or whether it will equal the US debt they have bought in recent years and keep in mind the US is going to be issuing more debt than before.

Next on the doom parade is the latest letter from Jeremy Grantham (here is one link) with perhaps the big takeaway being his theme of seven lean years meaning poor equity returns for that time. The bull market from 2003-2007 was also lean by historical standards. According to past commentaries from John Hussman the average bull market goes up 180% but that one only went up about 100% so lean would not be new and there were a couple of decent years in there and of course the returns in things like emerging markets and commodities more than made up for the leanness provided people had exposure.

The next nugget of doom comes from Marc Faber by way of the Daily Pfennig;

"The dollar will become worthless when people eventually realize the fiscal situation in the U.S. is a disaster. It will go to a value of zero eventually, but not right now. Looking at Mr. Obama's administration, it should already be there." He went on to say...

"In my opinion, about 50% of tax revenues will be used just to cover interest payments on the government debt. That's unsustainable. Then you'll really be forced to print money. The best investments right now are foreign currencies, commodities, and equities." And then when asked about Fed Chairman, Big Ben Bernanke, Dr. Faber said, "He's a money printer. He's nothing else."

Ooof.

Zero is hyperbole (insert nervous smile) but the notion of interest payments increasing to account more of the country's expenses in the future like above, is daunting and not something that will sort itself out in a couple of weeks. I do not know how to solve these problems. Obviously higher interest rates help with creating demand for US debt but cause all sorts of problem here on the ground. Personally I lean toward the tough medicine path to make the pain short and sharp as opposed to chronic and open ended. These thoughts of course are simplistic and as a country we lack the political will to make any tough choices.

Here is a little more fun from David Roche in the FT.

One important thing to remember in this context is that interest rates are very low by historical standards. This means prices are very high. Of course prices don't have to ever go down, for now this is unknowable, but you can know that prices are high. It would be great to be able to solve the world's problems but in lieu of that you can protect what you have which, again, means more non-dollar exposure. The idea of sidestepping most of this is very compelling.
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China Is Getting Complicated

I've been writing about China's ascending middle class as an investment catalyst since the start of this site. Quite predictably the story on the ground has been playing out either as fast we thought or slower than we thought but it is happening. The eye-popping number of how many cities are being built, how many have 1 million or more people, all the build-out connecting those cities, all the resource hoarding, all the exporting and all the buying of US treasury debt are all part of the story.

We've all known about the water and air issues for a while, the Sichuan earthquake revealed some of the humanitarian short comings, there will be policy mistakes, as mentioned the other day the country faces a serious demographic problem 15-20 years from now and the latest (that I saw anyway) is that Andy Xie has a commentary up laying out a day of reckoning that might be ten years away based on the demographics and the end, or slowing down, of "urbanization."

One point I have tried to make repeatedly is that while I unambiguously buy into the stuff from the first paragraph it is going to be a lumpy ride and will not be a one way trade. As much as I buy into it, long time readers may recall I was out for a little over a year (June 2007-August 2008). I'm in now with China Mobile (CHL) and recently I added the iShares Emerging Market Infrastructure ETF (EMIF) which is about 1/3 China/HK.

The risk factors or flaws or whatever you want to call them seem to be getting a little more play these days which is good thing. China is a great story but there are risk factors and while I do not know how many 70% declines there will be over the next ten years there will be a few that are at least 30%.

There have been more and more products created to allow access to Chinese-related stocks and there will be more including GlobalX having filed for six sector funds and EG Shares having more funds to roll out which will be heavy in China. I have been very consistent in wanting to avoid financials and export related stocks and focus on areas where money must be spent.

I recently wrote an article for theStreet about the iShares Clean Energy Fund (ICLN) which is heavy in China but just about all the Chinese stocks are solar names. Chinese solar has been popular for trading but it is possible that money will not have to be spent on solar, it may turn out that other forms of alternative energy "wins." That is not a prediction I simply don't think the world knows whether there will be a big winner here or whether there will many different technologies employed. If solar does not "win" then tech, for the most part, in China will not be a good place to be.

Above I spelled out where I want to be China-wise for the time being. Consistent with the areas where I think money must be spent could be the consumer sectors. I've not sorted this out completely I have to say but it does seem logical that as the middle class continues to grow that consumer stocks, both staples and discretionary, would do well. Of course this could also bring in soft commodities as a play on better nutrition. If Fonterra ever goes public that might be a way to benefit from improved Chinese nutrition as opposed to investing directly in it. To be determined at a later time.

A lot of the ETFs have exposure to China in areas that may not be ideal (areas I think should be avoided actually) which means that people may want to consider individual stocks. I realize not everyone will be comfortable with that but there are a lot stocks from many sectors and while poor stock selection is a realistic risk out and out fraud and a stock that goes to zero overnight is a very low probability.
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Color Me Baffled

IndexIQ, the "hedge fund" ETF company, is planning to launch two new ETFs this week; the IQ CPI Inflation Hedged ETF (CPI) and IQ Arb Global Resources ETF (GRES). The links point to information about the underlying indexes including the holdings.

CPI is supposed to "provide a hedge against changes in the U.S. inflation rate by providing a 'real return' or a return above the rate of inflation" and GRES is supposed to pick stocks based on momentum and valuation and use ETFs to hedge.

CPI allocates 54% to the iShares Short (as in short term) Treasury Bond ETF, 29% to the SPDR version of the same fund, 8% to the iShares 20+ Year ETF, 7% to GLD which clients own and less than 1% in the Rydex Yen ETF (JPY) and PowerShares DB Oil Fund.

There is a presentation about the funds on Thursday that I will try to participate in, not sure that I can, that will explain the funds but I don't see where all the treasury exposure can contribute to a long term result consistent with the objective. The yen and oil could help out but not at those weightings. Can oil double from here? Even if it does it only adds a few basis points the result and I'm thinking that if oil doubled from here the price of a lot of other things would go up too. As for the yen, I don't thing the green back can cut in half against the yen but if it does, again the position adds nothing substantial to the fund's result. Will gold go up 50%? Even if you think so, the fund would only get 350 basis points from such a move.

The fund can and probably will make changes to the holdings periodically and right here right now inflation is not really showing up in the consumer price index but I'd think there be some use of TIP ETF.

GRES is baffling in another way. So commodity related stocks with a little hedging, seems simple enough. The largest holding is Sandvik from Sweden. I don't know it very well but it makes mining equipment, maybe like a Swedish Joy Global? It might be a fine company but somehow it weighs in at 8.1% of the index, not the fund the index. There are seven other companies with a greater than 3% weighting, 20 names with 1-3% inclusive and 90 stocks with 0.20% weightings or less including 25 stocks with a 0.01% weighting. If they seed the fund with $10 million then the fund would be buying $10,000 worth of those 25 stocks. That's a lot of commission dollars.

In reality I'm sure the prospectus allows for sampling that one way or another allows for not having to buy every single stock. A process that allows for 8% into one stock and that many names with microscopic weights is difficult to figure without an explanation.

It looks as though the expense ratio for CPI will be 0.65% and 0.75% for GRES. Conceptually these could be very interesting maybe I can glean a more favorable understanding after their presentation.
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Sunday Morning Coffee

I watched Trading the Globe, the emerging market special on CNBC and thought I would offer some thoughts.

The show opened up with some excitement about betting on the consumer through the banks and phone companies with a tilt toward Brazil and India.

They devoted quite a few minutes to Vodaphone (VOD) which has a pretty good footprint in many emerging market countries, my wife owns a few shares of VOD in her Roth IRA.

In a discussion about extending beyond BRIC they talked about Indonesia and Turkey (BRICIT?). Indonesia apparently also has a rising middle class exports coal and palm oil, Turkey is close to joining the EMU (this is old news) and they said has a high GDP growth.

Next up they talked about fund flows, the conversation went nowhere.

They then talked about geopolitical tension and again almost no meat on the bone. They talked a little about Pakistan which I should have mentioned yesterday. One of these decades it will be an important investment destination.

Then they made the case for water due to shortages of potable water which is/will be a real issue. They discussed PowerShares Water Portfolio (PHO), ABB, GE, Siemmens (SI) and Duoyuan Water (DGW).

Lastly the did short little profiles on "whales" Carlos Slim, Eike Batista and Stanley Ho. All three are certainly interesting people but a 60 second profile will not make anyone an more informed emerging markets participant.

The show was 30 minutes long which could have been plenty of time to explore all sorts of things without spending time on the whales. The discussion about VOD, although not stated was about using big multinationals with large EM footprints as a way in. Buying stocks like this is buying stocks that benefit from whatever foreign country but are not proxies for whatever country. Buying these beneficiaries is perfectly valid but not the same as buying an emerging market stock.

They spent some time on the water theme. There was nothing new for anyone who has followed the water theme for any length of time but again as a bigger macro there are quite a few themes tied into emerging market investing. The benefit to investing in themes, assuming a correct one selected, is the need-based capital flow behind them. Not enough drinking water is a serious problem. I do not know whether the problem will be solved but I do know a lot of money will be spent trying to solve it.

Buying PHO or ABB certainly gives water exposure but not emerging market exposure. DGW certainly would be direct EM exposure but the water businesses at GE ans SI are not big enough to move the needle on the stock prices.

The discussions about Turkey and Indonesia were useful insomuch as they point out that there are other countries besides Brazil, Russia, India and China. As discussed yesterday there are a lot of countries that are investable destinations and that list will grow.

So speaking of emerging markets, or frontier markets, Barron's mentioned that Paraguay is the world fourth largest grower of soybeans. I don't know much about Paraguay but apparently it is a democracy, is very poor, GDP growth has been healthy and a large chunk of the economy is agriculture related. The website for the local stock market does not have an English version (which is very rare), neither ADR.com nor BNY's ADR site show any ADRs (actually the country isn't even searchable) and I struck out looking for stocks on Pinksheet.com (just looked up a few names). CreditRiskMonitor has a list of publicly traded companies there but I cannot vouch for the accuracy of the list.

There must be some reason why Paraguay may not be accessible but this being the weekend, it's tough to get an answer. It appears not to be an OFAC country though. I'll try to find out what the story is this week but if anyone already knows please leave a comment with the info. Where Vietnam was once inaccessible there is now an ETF. This will repeat with other countries, maybe even Paraguay. To be clear I don't know anything about Paraguay but am interested in learning about it, please don't add 1+1 and get eleven.

The picture is of a the New Bryce Motel which is a very neat looking retro place to stay but as Joellyn said there's nothing new about it.
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The Big Picture for the Week of October 25, 2009

Ambrose Evans-Pritchard has a post about the US dollar's hegemonic status that knocks it out of the park. The long and short of it is that the dollar will not lose its reserve status during this century, China faces some demographic issues in another decade or so and he also believes that at some point the water quality becomes a big problem too. He expects the growth and other good things that people are so excited about to continue somewhat unabated over the next decade with China moving closer to the US but that the obstacles he cites will then come into play down the road.

This is not to say he is bullish on the dollar but that he is not in the death blow camp because of the problems the other big currencies have. Japan has bigger problems, a lot of debt and a bigger demographic problem, and the euro has problems galore as well.

As opposed to trying to sort out whether he is correct or not it might make more sense to sort out what to do assuming he is correct and I would add that if his thesis is correct it will play out very slowly giving time for recognition and implementation.

I am likely to have Chinese equity exposure more often than not for a long time to come. Plenty has occurred there already but there is still plenty more. The country is going to move up the chain and life in the ground there is going to improve substantially but of course there will be cyclicality, the occasional policy mistake and other growing pains but China is one spot where it is happening. That said, I doubt my exposure will ever exceed 6-7% of the portfolio.

If we do get to a point where the world is trying to sort out between the USD, JPY, EUR, CNY or some basket dominated by those four I think I would rather sidestep that (mostly) and favor currencies, and by extension equities from those countries, that can grow and thrive irrespective of the world reserve issue.

This line of thinking leads me to quite a few familiar (to long time readers) countries but it makes sense to expect the list to evolve over time. In no particular order Canada, Australia, Norway, Chile, Israel, New Zealand (at some point), Brazil, Vietnam and Singapore (if there were ever to be a pan Asian currency it would be based on SGD and it is not clear to me if that would be a good thing or not).

In the future there would probably be some additions from Africa (Egypt has an interesting story but is difficult to access), Kazakhstan (resources galore and corruption galore), some of the Arabic countries pegged to the USD will probably have to break the peg at some point due to inflation threats and maybe some place like Peru should be part of the conversation. Feel free to add others as you think of them.

These types of countries, regardless of which ones really should be thought of in this context the idea is to gravitate to smaller, hopefully simpler countries that are either in their own world, can sell things that the big dogs have to buy or some combo of the two.

As has been a common refrain around here this would require more work not less but if the hegemony debate really devolves into who is the least unhealthy wouldn't you want to seek out the healthier countries anyway?

The picture is from in the hoodoos at Bryce on the Navajo Loop.
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Process Drilldown

IndexUniverse posted a lengthy article by John Serrapere recapping the latest quarter for his 75/50 portfolio. The 75/50 means that the portfolio tries to capture 75% of the market's upside with only 50% of the downside over the course of a stock market cycle.

The portfolio and articles about the portfolio are long running at IndexUniverse and can be a very constructive read. He quantifies (75 and 50) specific targets in contrast to my simply looking to go down less (this will mean different things at different times) during bear phases and go along for the ride to the upside. The way this has played out for me has been down less, I have had a couple of years being very close to the market during up years and one year that the SPX was up very little and I was up a lot. Generally I expect to lag a little when the market is up a lot and hope to do well the rest of the time including hoping to go down less when the market goes down a lot.

Despite those difference I believe there is some conceptual overlap between what I do and write about and what Serrapere does. Another big difference however is in portfolio construction. Page 8 of the article discloses Serrapere's portfolio and it is interesting, revealing and constructive for learning about blending things together.

Below the portfolio (a screen shot from the article would be difficult to see);

• AMJ 3.5%
• ARBFX 3.7%
• DBA 4.9%
• EWZ 3.2%
• GAF 3.2%
• GDX 12.9%
• GIM 12.8%
• GLD 12.8%
• JRS 3.9% (short position)
• MERFX 3.7%
• MOO 3.0%
• PXJ 3.3%
• TBT 24.7% (thought of as a short/hedge position)
• TDF 3.1%
• TIP 7.1%
• VXX 7.4% (thought of as a short/hedge position)
• VXZ 7.5% (thought of as a short/hedge position)
• XLE 3.9%

In the article Serrapere mentioned this mix being up not quite 11% on the year versus about 17% for the SPX at the quarter end. For the the first three quarters he came up a little short of the 75% but hats off to him for getting so close with this mix (obviously there have been changes along the way that I did not catalog). What I mean is that when he hedges he goes heavy, much heavier into buying products than I do. My position in SDS grew to about 5% of the portfolio at one point which combined with what was then a very large cash position served to be a very effective hedge, if I remember correctly when the SPX was at the low in March it was down 25% for the year and I think I may have been down about 10%.

Whatever the exact numbers were back then the hedge was simple; a little SDS, a lot of cash and generally underweight volatility. These days the cash level has come down and the few additions I've made have been relatively volatile.

Serrapere's willingness to go heavy, 24% in TBT and 15% between the two VIX ETNs, goes far beyond anything I'm comfortable with. In building a diversified portfolio you are guaranteed to be wrong about at least a couple of things. In looking at 40 holdings (about what I use) I know a few things will not work out as hoped for or something may work very well for a while but then not (or vice versa). An example of this is Monsanto (MON). Many clients own it. I bought it a while ago in the high $80s. It skyrocketed at first and I sold some just above $120. At that time it was working great. Then it came in with the market which is no shock but has lagged this rally by a lot. I have no doubt it will "work again" but for the rally it has not behaved as hoped for.

The target weight for MON is about 2% so it not working or even worse had it endured some sort of calamitous decline does not create a big drag on the portfolio. In contrast Serrapere's 25% to gold (12% each to GDX and GLD, which clients own) could have backfired badly had gold gone down. Yes he could have sold ahead of such a decline but would you? I don't want to have to be right about something like this (what if they dropped 8% you sell and then they both go up 50%?).

In terms of creating specific portfolio effects or characteristics I think it is much easier to go narrower than Serrapere by using individual stocks as part of the mix and avoiding certain things in ETFs (like avoiding financials in Brazil by using a mining stock instead of EWZ) and my fondness for Norway has turned out to be very lucky--these are tough to capture in ETFs for now.

It is not my intention to be overly critical because he was very close to his objective. My intention is to point out that there is more than one way to target any end result. I believe, as mentioned above, he and I share some conceptual beliefs. I think his path to his result is the more difficult path and I imagine he would say something similar about my portfolio and have other criticisms.

If you believe in taking little bits of process from many places to create your own process then you must look at other people's process with both a critical and constructive eye and clearly there is plenty we can learn from Serrapere's process.

A quick funny; Richard Kang was on CNBC Asia on Thursday morning and had a great one-liner saying that US t-bills had gone from being risk-free return to return-free risk.
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Don't Lose Sight Of The Picture

The US equity market sold off quickly toward the end of the day on Wednesday. The turnaround seemed to be attributed to negative comments from Richard Bove about Wells Fargo regarding loan loss provisions and sustainability of earnings and also some rather drastic commentary from the pay czar (who is the whiz in marketing who came up with name?).

I'm not a big fan of of getting too worked up about why the stock market did something on a particular day. Most people should be focused on longer time periods than one day.

Obviously there is no way to know whether Bove's comments are correct, he has not nailed it WRT sizing up the totality of the crisis but we can infer that the market was caught somewhat off guard by the possibilities raised by Bove.

The rally that started in March is built on three drivers; snapback from an overly frightened reaction, some fundamental improvement versus where things were a few months ago and an overly optimistic assessment of how quickly the US can recover. Someone who is very bullish would attribute most of the rally to the first two and someone who is very bearish would attribute a lot of the rally to the third driver. Bull or bear it comes down to how you weight these three things.

Candidly after the failure of so many financial institutions happening all at once and the generally accepted belief that this was the worst financial event in almost 80 years how could there not be fits and starts along the road to getting healthy? I was never in the GD Part Deux camp when things were at their worst nor am I in the it's all better camp just a few months later. It is much more likely that there will be further shoes to drop in the financial sector and these shoes may or may not stall out the entire market.

The bigger macro is that all of this is about the US trying to hold on to the top spot as the economic superpower (repeat theme) versus every other country moving up a little. It has been said that it is much easier to move toward the top spot as opposed to holding on to the top spot.

I would note the extreme measures being taken to hold on to the top spot as discussed by Niall Ferguson here and here. As is usually the case I tend to agree with the direction of these types of comments but not the extreme magnitude of what they see as the result.

To me the path of least resistance is to own more foreign. Many of the countries I've been writing about have proved to be at different points of their cycle versus the US, entered and or emerged from their bear markets on a different timetables than the US and are now on much sounder ground than the US; they appear to have gone through cyclical events versus what might be a secular event in the US (I think it is a secular event).

The observations cited in the last paragraph did not come out of the blue six weeks ago but have been playing out for most of this decade. The simple recognition of what was going on back then and taking action consistent with that recognition should have resulted in a much better result that the decade to date decline of 26% for the S&P 500.
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Amazing Pictures

A friend on FaceBook left a link to a collection of photos posted at the Denver Post that are mostly from 1905-1915 taken in Russia.

Based on the text at the top of the page they were originally processed as color pictures back then.
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Brazil Gets A Little Nutty

Brazil made news late Monday by imposing a capital inflow tax of 2% in an effort to try to put the breaks on the rapid ascent of the real, the currency. In reaction to the news the Bovespa dropped 2.88%, the iShares Brazil ETF(EWZ) was down 3.82% and the currency, as measured by the WisdomTree Brazilian Real ETF (BZF) dropped 2.12%. YTD those three are up 65%, 120% and 35% respectively. My core holding for Brazil has been Vale (VALE) for several years and a couple of name changes and it is up about the same as EWZ.

A 35% move for a currency is huge to the point of distorting the economic functioning of the country. It was a very big deal when the dollar dropped to 2.00 reals last May. It is now at 1.70 (meaning the greenback is dropping against the Brazilian currency) in only four months.

This has been a good thing for US based investors, that is the reason why EWZ is up so much more than the actual Bovespa Index. In addition to making trade with the US expensive (for Americans) it also makes trade expensive for the Chinese, remember the yuan is (sort of) pegged to the green back so if the real is up a lot against the the dollar it is also up a lot again the yuan.

The decision to impose the tax will either work as they hope or it won't but clearly the action took the markets by surprise. The reasons for the moves up in the currency and the equity market are all still in tact. If you have been involved with emerging markets for any length of time then you know that pullbacks come along of varying magnitudes for varying reasons. The one yesterday may or may not be anything more than the one day, I don't know but I do know it will not be the last time an emerging market gets hit by news the seems out of the blue or goes down for no reason.

Occasionally these things are serious, like with Russia during the bear market, but they do happen. If emerging markets in general all correct then you won't really have anyplace to hide but for the occasional country event the consequence can be mitigated by having a small weighting. For most countries I have had 2-3% weightings and have started to inch that up in a couple of instances (with more to come) to 4-6% which I am quite certain would be my max.

As the subject of country weightings has come up before people ask why so little if I really like a country and stuff like the news from Brazil this week is exactly the reason. One of the risks to investing in certain market segments is events that cannot reasonably be analyzed. The obvious way to mitigate this type of risk is to avoid too much exposure.

For long time readers this will be consistent with how I have been managing country exposure for years having written most extensively about Norway and China in addition to Brazil.

The first picture is Joellyn's favorite from in the hoodoos at Bryce Canyon from Sunday. The second picture was taken by our dogsitter while we were out of town. It is Pee Wee playing with one of his miniature tennis balls; amazing photo.
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"C'mon Ben!"

Over the weekend the Barron's cover story looked at the current state of the Fed monetary policy in an article titled C'mon Ben!

I don't think anyone still believes that the US thinks a strong dollar is in it's best interest. The dollar has very little going for it these days in that there will be trillion dollar deficits for years to come, the Fed is buying treasuries and keeping rates at zero in an effort to spur lending which anecdotally speaking appears to not be happening (there is also data to support the idea of very little lending).

There are dollar bulls out there but as best as I can tell the arguments here seem to focus on counter trend activity which even if correct is not a story about dollar health.

One interesting point made in the article was that the current zero rate environment hurts savers, referred to in the article as the prudent, while rewarding the scofflaws (the article didn't use that word, I just think it's funny). While I am not sure what priority prudent savers should be on the Fed's list the idea of encouraging risk taking is not good insomuch as some people should not take risk or more practically speaking what ever amount of money you have that should not be exposed to risk should not be exposed to risk. Zero percent potentially encourages people to make bad decisions chasing yield with money that should remain riskless.

A point I have made repeatedly is that if you are getting 4% in a 0% world you are taking risk--hopefully you understand what that risk is.

Can we all agree that in getting to this point the Fed, the Bush administration and the Obama administration all took (or are now taking) extreme action, perhaps the most extreme action ever taken (I concede most extreme ever could be open to debate)? Based on how certain types of human frailties tend to repeat over and over it is reasonable to question whether the correct action can be taken at the correct time to prevent the sorts of things that the Schiffians are worried about (hyperinflation and a worthless greenback) from happening.

Without turning this into a political debate my sense is that Obama somehow does not understand the potential consequences of extreme action. I don't think he understands, I mean really understands, that in general there are economic consequences for policy decisions. Nor do I think he understands, I mean really understands, the potential consequences of the actions taken to date during the current event. Were the Obama administration to talk more about potential consequences in detail they would instill confidence, some anyway, that they understand, I mean really understand, the potential and how to mitigate a series of negative consequences.

A huge part of the problem here is that political cycle and the priority of reelection above all else works against finding the best solution. Pretend for a minute that they can figure out a plan of short term pain to create a long term fix, what Senator due for reelection in 2010 will vote for something that causes short term pain? With that line of thinking what member of the House would ever vote for the tough choice?

A rather brutal analogy; In 1982 I was diagnosed with a rare but treatable form of cancer. I was told that it was very unlikely that I would die from this but I was going to be in for a bad 48 weeks. So the trade off was a bad short run for a healthy (knock on wood) long run. As a country we lack the political will for a bad 48 weeks (more likely a couple of years or so).

One line of thinking that has been mentioned elsewhere that I buy into is that the Fed needs, in the short run, to pick between the dollar and the stock market. Thus far it has chosen the stock market which creates the appearance of health but is not true long term health. Long term health would come by choosing the dollar instead which means rates would go up, there would be less or no monetization and so a big drag on stocks for a while as everything but the equity market moved toward real health. Perhaps this line of thinking is right or maybe it is wrong but for now it is certainly easier to just own more foreign stocks than you used to.

As for the picture of Bryce Canyon again; get used to it for a while. After we made the video I posted yesterday we learned that there is a short hike through the hoodoos that was also awesome. It was a 1.3 mile loop that goes down one way and up coming back up. Maybe we're the last to know about this place but it was truly spectacular.
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China and Bryce

In the video I think I say something about China and how the shipping companies which rely on the export story are struggling (as noted in the Asia Trader column) and then I think I say something some of the ag stocks having bright prospects (as mentioned in the Abelson column) and tying that in with other stocks that capture the story on the ground like China Mobile (CHL), which is a client holding, some of the infrastructure stocks and so on being better ways, IMO, to buy the country but if you look at the scenery, well, who cares what I'm talking about.

Our little National Park and animal volunteer trip is coming to an end. Today we are driving back to Prescott. It is about a five hour drive and Joellyn is pretty stoked about listening to CNBC for that long.

Below are a couple of pictures of Bryce Canyon. I don't know if the video does it justice and I do not know if our pictures will either but it is truly an amazing place.





































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Sunday Morning Coffee

Barron's had an ETF Palooza this week with a special report consisting of seven articles plus an introduction. I thought I might offer a couple of observations on the coverage.

The first article is a very generic where the industry is now piece but there is one important quote (maybe I think so just because it echoes a point I've made repeatedly) from Anthony Rochte from SPDR who says that ETFs are "access vehicles." Yes! Where the simple funds just owning baskets of stocks are concerned they just provide indexed access. The Peru fund is not good or bad it simply is exposure to a country that, like any other country, has has pluses and minuses that must be weighed out leading to decision one way or the other. If the Peru market goes up a lot then the Peru fund will capture that and likewise if the Peru market goes down a lot. The bigger decision is whether to invest in Peru not whether the fund is the single best way to own the country because again if Peru goes up a 100% the fund will be pretty close either way.

One oddity about the first article was that in a what's next part of the article there was talk of "bundled strategies" as being important a little down the road. About a month ago I mentioned something called Alpha Bundles (a term I made up) being the next thing. Hmmmmmm.

There was an article about why the rich like ETFs; complete throwaway piece.

Next up fixed income ETFs. This should the space where we see the most innovation come and although it has been slow I do think it will come. However I am not so giddy as the people interviewed in the article that I would put all fixed income money into ETFs. There is a tax argument to be made for using TIPS ETFs and foreign ETFs allow otherwise difficult access. Remember though that during market spasms the illiquid nature of some of the holdings can cause market price/indicative value distortions. This happened a year ago and will happen again. This was a point made this week in the Current Yield column.

I own some short term corporates for LLY, UPS and HPQ. The yields are low but are not zero. If you are really just looking to hold to maturity (I am) then most of the work becomes assessing how likely it will be that a company defaults. If rates normalize I'd be more interested in longer maturities but going out for 20 years now seems crazy to me.

To my pleasant surprise there was an article about sector ETFs. In accounts were going heavy individual stocks is not ideal I use sector ETFs to build the portfolio. There was a little (but not enough) about overweighting or underweighting the various sectors which is of course very important; ask anyone who underweighted financials last year.

Not covered at all in this article were things like choosing foreign over domestic for some sectors, blending in thematic or sub-sector funds in building a sector like a coal fund as part of the energy allocation or the SPDR Infrastructure ETF (GII) as a proxy for utilities or any other of a zillion examples to choose from. I've been writing about this from the time I started writing, it is very worthy of exploring if you have not done so before.

What about emerging market ETFs? They were not left out of the coverage but there was no meat on the bone here at all. Too bad. Aside from Peru we have seen Vietnam come to the market along with some specialized funds targeting themes in emerging markets and also EG Shares has started rolling out its sector funds. There are various filings out there that are also interesting like sectors in China and an Egypt fund.

The article on small cap ETFs was little more than a list of funds.

Insuring Against Economic Calamity was about gold ETFs. For short term external shocks defense (not defensive) stocks can work for certain types of events. For longer term calamity other commodities, inverse ETFs (in small doses) and currency funds can also work.

Ok, jerk time; I would think that by now Barron's would have moved beyond basic introductory articles about the product but that is what half the articles were. More than half the articles on the ETF tab at Seeking Alpha are news stories as opposed to analytical pieces but the rest are analytical pieces. I do my best to provide analytical pieces (here and at theStreet) but it would be nice if there was more meaty content.

My brother Larry posted a look back at the Earthquake World Series game from 20 years ago. I'm not sure if I've mentioned this before or not but I was at the game when the quake hit. My buddy Russell got tickets, things started shaking at 5:04, then there was a lot of confusion but when someone with a portable TV shared the news that the Bay Bridge "collapsed" we knew there would be no baseball. Amazing memories and an amazing time. In the days shortly after, in order to make a phone call you had to pick up the phone and then wait (like an hour) for a dial tone.

Yesterday we spent the morning at Best Friends Animal Sanctuary volunteering. "Volunteering" can mean quite a few different things but in our case it meant walking dogs for a half an hour at a time for three hours. The dog in the shadow picture above was by far the liveliest of the dogs we met, his name is Screech. We walked some older dogs, a short corgi and one dog named Rose who is "part feral." Turned out Rose did not feel like being walked. The other pictures are scenic shots from the property and the last picture is one of the Michael Vick dogs (his name is Ray). Pretty amazing that Ray is still alive.

The scenery in general here, if you couldn't tell, is simply amazing. This is absolutely a place to be visited; national parks and national monuments galore.
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The Big Picture for the Week of October 18, 2009 Special Dow 10,000 Edition

A common question this week on CNBC was along the lines of what does Dow 10,000 mean for investors, for anyone who missed this rally should they get back in now.

There was one answer that I never heard which immediately occurred to me.

There was real fear for a while that the US market was truly done for that society would break down. The event was really bad but as is always the case the fear exceeded the reality even if the event is not over which is something that I think people should be braced for.

What Dow 10,000 should mean to people is that in fact the US financial system has not been totaled. I have to say really doubt that a lot of people waited until March to sell out completely and then never got back in thus missing the entire snapback. If the Dow can retrace half of what it lost it can make back all that it lost. This is not a prediction about when a new high is made and I still believe there will be another scare the hell out of them decline in this cycle. Even if from here the next 20% were to be down the snapback should give confidence that the US market and financial system are not permanently broken, a lot of people thought that it was.

Going a little further below the surface, the US may not be the best investment choice but long term lag, if correct, is not permanently broken. If there really are people who sold out at the low and never got back in they should probably pick a percentage to start with right now, and then put that same number (10%, 20%, 25%, whatever) in on some fixed frequency (monthly, quarterly, whatever) and realize that while they may have had bad luck with this event they don't have to repeat their behavior in future events.



The first picture was taken in Kanab, UT we are staying here until Monday as we took in Zion yesterday and go to Bryce on Sunday. The other two pictures were taken in Zion National Park. The scenery all around here is just amazing.

Today we are headed to the Best Friends Animal Sanctuary (the show Dogtown on the Nat Geo channel is about this place) for a day of volunteering.
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Something To Learn From

We are headed from the North Rim over to Zion today, I'll have regular internet access after we check in to where we are staying in Kanab. For today though something that a friend posted on Facebook that I pasted below verbatim.

An old Native Grampa sat in his lodge on the reservation, smoking a ceremonial pipe and eying two US government officials sent to interview him. "Chief Two Eagles, you have observed the white man for 90 years. You've seen his wars and ...his technological advances. You've seen his progress, and the damage he's done." The Chief nodded in agreement.

The official continued, "Considering all these events, in your opinion, where did the white man go wrong?"

The Chief stared at the government officials for a minute and then calmly replied ... ... Read More
"When white man found the land, Indians were living here. No tax, No debt, Plenty buffalo, Plenty beaver, Women did all the work, Medicine man free, Indian man spent all day hunting and fishing, All night having sex."

Then the chief leaned back and smiled... "Only white man dumb enough to think he could improve system like that."

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Geo Thermal

A time-bomb post while we are at the Grand Canyon (no internet access at the South or North Rim).

I've mentioned Iceland and geothermal power several times in the past as being a potential catalyst for the country to start on the path back to being a viable investment destination. A few days ago I caught a show on CNBC World called Deal Flow which is a quirky show where the hosts, who seem to have Regis and Kelly thing going (so said my wife), try to delve into topics with potential investment merit. If you look at the topics on the website you'll see that they actually cover some interesting ground.

Geothermal and hydroelectricity have intrigued me but I've never invested in either one. I think the reason that I do find them intriguing is that unlike solar part of the theme doesn't rely on homeowners spending a lot of money (even with various subsidies) to have green energy. This is part of the logic in having owned FPL Group (FPL) for clients for so long (FPL has a huge footprint in windpower).

In watching the show it was mentioned that about 20% of electricity in Iceland is geothermal and about 70% is from hydro (according to Wikipedia the numbers were 24.5 and 75.4 respectively in 2008). Geothermal accounted for 87% of heat at hot water requirements.

Geothermal is available in numerous places around the world so this is not an Iceland post beyond the fact that I think it can play a big role in any potential economic revival of the country.

The program interviewed people from a fund domiciled in Iceland but with operations all over the world (California, Canada, Mexico, China and the Philippines) called the Geysir Green Energy Fund. As best as I can tell the fund is not traded on an exchange and since there latest annual report is from 2007 (the TV show appeared to be a couple of years old) I'm not certain the fund still exists but the site and and all the info within is pretty good way to learn more about the subject.

For now the easiest way to invest in the segment might be Ormat Technologies (ORA). Ormat is based in Reno but has a presence all over the world. The stats aren't great, it is somewhat volatile and many of the folks in management all have the same last name but it should be obvious that buying into this theme is far from riskless.

If you look for other "geothermal" stocks on Yahoo Finance you'll see a few other names trading for a dollar or less. If you know of any other names please leave them in the comments but I'd rather not turn this into a series of touts for stocks trading in Vancouver for $0.12. According to this article from Seeking Alpha from a couple of years ago IdaCorp uses geothermal in what appears to be a similar way that FPL used windpower, you should explore that on your own as I cannot vouch for it. Here are two more recent articles here and here.
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“The long run is a series of short runs.”

That is a quote from one of two articles I found earlier in the week that each hacked away at the idea of stocks for the long run or phrased differently that stocks are always the best performing asset class.

Short post today, we are headed up to the Grand Canyon (two hours from Prescott) right after the close so my day is compressed somewhat.

The quote came from this article at MoneyWatch and the other article was by Jason Zweig at the WSJ. In coming at this I would suggest a healthy dose of skepticism because of the timing of when these questions are being asked which is after an especially bad decade for equity returns and an especially good 27 year period for bond returns. I am more than open to the idea of portfolio management evolving by necessity but I think the answer is closer to investing more into other parts of the world as opposed to giving up on equities.

One point I do not quibble with is the extent to which the timing of retirement versus stock market cycles can be simply a matter of luck. But to the extent that is true it is not a new concept. This is along the lines of saving for a child's college education and getting out of stocks completely or almost completely when the child turns 13 which is to say appropriate asset allocation given the totality of a person's situation.

Unfortunately this thought contradicts with something else that is just as important that I've been writing about for a while. A healthy 60 year old today realistically needs to plan for 30 years maybe more. At a 3% inflation rate (an example not a prediction) expenses go up 50% in 15 years. Loading up on fixed income with below normal yields simply will not get the job done in terms of the payout being too low and if yields normalize the fixed income products bought now will drop in price. Yes individual issues would mature at par but many people rely exclusively on bond funds which have no par value to accrue back to.

This is clearly a big problem, potentially anyway. In past blog posts I've tried to address this with two portfolio ideas. One is the willingness to adhere to an objective defensive trigger point; reducing equity exposure when the S&P 500 goes below its 200 DMA. The other idea is not so objective and may never happen but if there is every a repeat of the 1990s in your portfolio (the S&P 500 went from 353 up to 1464) then just take some money off the table. Monster decades happen every so often just as horrible decades happen. Odds are that after a monster decade we are closer to a horrible decade and vice versa. The 2020s may not be a decade where world equity markets quadruple but if it is, I say if, then take some off the table permanently. At that point you may or may not have enough money but after a decade of quadrupling but we would probably then be closer to another horrible decade.
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And Now The Rest Of The Story

Well, maybe a little more on the story, how about that instead? We had quite a good discussion breakout on yesterday's post which was about an article in Time Magazine that averred for doing away with 401k plans because they essentially "don't work."

First things first, get rid of the 401k? No sale here. As one reader mentioned the company match alone probably makes it worth it. I wrote a theoretical post in January about investing 401ks in the cash option in such a way as to take full advantage of employer match and put whatever else you can save above and beyond the optimal amount for matching into an IRA of some sort.

The idea was that if you get $.50 on the first $6000 or $8000 or whatever that it is like getting a 50% return with no stock market risk (remember the theory was to just put it into the cash or stable value choice).

It is pretty clear to me that the wrapper is not the problem. A lot of plans have lousy choices which is not the wrapper it is emblematic of non, as opposed to mal, feasance on the part of someone at the company. The two biggest obstacles to success appear to be human behavior and unfortunate timing.

Behavioral issues are not confined to 401k participants. Are the endowment guys the smartest guys in any room they go into? Well whether they are or are not they collectively missed badly on understanding the consequence of having too much in illiquid assets. The combo of declines and future capital commitments to illiquid assets had meaningful effects on these schools.

Who doesn't know putting a lot of your money into illiquid, alternative assets is a bad idea? While we're at it who doesn't know that too much leverage is a bad idea yet very smart people get into trouble with these things all the time. For people willing to spend the time, many behavioral issues can be mitigated by learning from other people's mistakes. I learned all I needed to learn about leverage from the Long Term Capital affair. I don't know where my disdain for locking money up comes from but I don't even like CDs (not fear of failure thing but an access thing).

Further, as I have said many times before, every so often the market goes down a lot and many times this occurs after it has done well for a while. Although I have been mocked for this type of thinking the odds of a big decline are a lot less after a big decline and a lot greater after a big lift. A 12 year old can grasp this.

In September 2001 (that's right) I got laid off from Charles Schwab, best thing that ever happened to me professionally. I knew months and months ahead of time that there would be layoffs and that as a somewhat expensive employee not part of any diverse demographic I was vulnerable. I put my 401k all in cash in case things got so bad after the layoff that I'd need to tap that money to live on (thankfully it never came to that). Anyone, anyone can make tactical moves like that in their 401k. People need to take more ownership and a more active role in navigating their finances.

Things are different now, but not as different as some folks think. 401k accounts allow the opportunity for people to pull themselves up by their own bootstraps and in part determine their own fate but they need to invest time to do this successfully because clearly Time is right about one thing; investment results for most people have been bad.

As for the idea of planning to retire when it turns out the market cuts in half, there are no easy answers. At any point in time you have what you have. Nothing else matters (like what you used to have). If what you have when you need it is not enough then something has to give. While this situation is reasonably very depressing for people it does not change the reality. If you need $1.1 million and you only have $600,000 then something has to give. The circumstance of not having enough might matter to you but you can only live with what you have not with what you think you should have. If you live a $1.1 million retirement with $600,000 you will go bust quickly.

I can appreciate that this sounds very harsh but what other choice is there? If you do not have enough then something has to give. A lot of the writing here (smoothing out the ride) and elsewhere is about how to have a better chance of getting closer to whatever number you think you need. If you retired in 2008 and the equity portion of portfolio only went down 20% thanks to tactical action you took then your plan is much closer to being on track than many other people. And if you took tactical action described above then that means at some point you took the time learn something. Success or failure in this regard has nothing to do with the 401k wrapper.

For a little context on where I come from on this, my parents made horrible financial decisions in their 30s and 40s which I have learned/benefited from. Being rich doesn't have to mean having a lot of money because I don't. It can mean having very little overhead which means a greater margin for error as you accumulate your savings. I never want to stress out about money, living a $2000-$3000 monthly lifestyle, regardless of income, makes this much easier to do.
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Why It's Time To Retire The 401k

That was the title to a Time Magazine cover story (hat tip to my brother and Calculated Risk).

The article was brutal. It was filled with many hard luck stories, gloomy stats about how little we save, how utterly unreliable the stock market can be, how easily people can be done in by fate WRT to when they end up retiring and as brutal as it was these thing can all be true.

Over the years as I have met people and in the course of normal conversation tell them what I do they sometimes comment about how stressful it must be. I typically always have the same reply that it really isn't particularly stressful, it just that every so often the market goes down and sometimes still it goes down a lot. This has happened before and it will happen again. Invariably the person realizes this is correct. I then ask them at other times that it has gone down a lot what happened next and they say it went back up. So if we know this, and we do, it removes a lot the potential stress.

Now if we do know that at some point after the next recovery there will be another contraction that might be very bad or not so bad, if you know at some point this will occur then it seems logical to explore some way to mitigate the consequences of such an event. This is the reason why I use the 200 DMA as a trigger point for portfolio defense. It is not perfect but has had success.

One big problem with the article that was not mentioned is that after a down decade for stocks, a somewhat rare but not unprecedented event, any statistics or models that rely on stock market growth are probably going to conclude stocks don't work. If someone concludes they cannot emotionally endure another big decline with their current allocation to equities fine but cutting back based on modeling that concludes equities don't work because of the poor result this decade has selling low written all over it.

After such a lousy decade of returns it was probably very easy to find a bunch of hard luck stories to make a particular argument about 401ks. Had the story been done ten years ago then 401ks would have been hailed as being far better than pensions (the article steered toward pensions being superior) because they would have profiled a bunch of paper millionaires, you know like actually happened ten years ago.

About the various Occidental Pete retirees who would have been better off in the old pension plan. Maybe someone can cite the stats for us but pensions are collectively woefully underfunded and I believe it is correct to say the PBGC faces insolvency at some point. The article never touched on the point which I took for ignorance that there is even an issue with underfunding.

The article offered up solutions about a government administered, not run but administered, program of insurance to make sure that the amount people put in (in lieu of a 401k) guaranteed a certain pay out. In addition to that someone concluded that the social security payout should be higher. The way the math was spelled out the two would combine to replace 50% of pre-retirement income. Increase the social security payout, really?

I do not dispute the idea that the entire task of retirement planning and then retirement living is getting more complicated. One of the tenets of this blog has been that US based investors have to invest outside the country to get "normal" returns so I am on board with that part of it. Even with the greater complexity the solutions that will work for most people are the same simple ideas that have always been good ideas; save a lot, live below your means and know your (volatility) limits.
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Sunday Morning Coffee

Some quick observations and stray nuggets this morning.

Barron's had an interview with Derek L. Young who is the CIO at Fidelity. The article implied that most of his attention is devoted to asset-allocation portfolios which judging by the tone of the interview is primarily fund of funds products.

It was striking that Young acknowledges that portfolio construction is evolving (described differently in the article) to take in more asset classes and market segments. While I am no fan of fund of funds or target date products it is a huge positive for Fidelity clients that the leadership thinks in these terms. Whether too cynical or not a mammoth mutual fund company sticking with the status quo seems more likely.

Another article included a mention of South Gobi Energy Resources (SGQRF) which is traded in Canada. It turns out that the company is a coal miner in Mongolia that "that trucks all of its output to the Chinese border to fuel its neighbor's insatiable appetite for electrical power."

To be clear I've never heard of the company and the reason it was written up is because it is up a ton. Mongolia is very resource rich, chances are you already know that, and at some point it will be an investment destination, maybe not for a 100 years but eventually. In the mean time over the next five years there will be "new" investment destinations that we'll be able to access easily that we cannot easily access now. How easy was it to access Vietnam five years ago? Maybe we'll be talking about Sri Lanka in 2014 (Jim Rogers has apparently taken a fancy to Sri Lanka of late).

Yet another Barron's article had perhaps the best title I've ever seen in the magazine (I go back to the late 1980s); Do You Really Need All That Risk?. With an introspection-triggering title like that does it matter what the article was about? Well it was about levered ETFs and focused on someone I think I know. An RIA named Greg Werlinich talked about his experience trading a 3X financial sector ETF for clients. I used to do a podcast every so often on WallStreet.net with this guy, I think. The name is certainly similar if it isn't this guy. Small world.

John Mauldin spread some more good cheer this week, not to bag on him so much as realize there is no way the US will ever have the political will to fix things properly in the manner that he spells out. Early in the post he talked about choices that people make with an example of how people learn (or don't learn as the case may be) as teenagers about how to make tough choices.

From the standpoint of staying on your own mat people can make prudent decisions about spending, saving, investing and other types of personal decisions in such a way as to avoid problems that apparently are hurting "millions of Americans." It is never too late to start making prudent decisions.

Lastly the NY Times had a lengthy write-up on Cesar Millan the Dog Whisperer. He really has quite a story. We are big believers in what he has to say about being balanced and the relevance of that thought as applied to all aspects of life. We tend to disagree with him about dogs living in the moment 100% of the time.

The picture is from the Grand Canyon about one mile, a little more than a mile probably, before getting to the top at the North Rim.
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The Big Picture for the Week of October 11, 2009

Very short post this morning, we're out the door for a hike ahead of a trip up to the Grand Canyon coming next week.

As a follow up to my Five Best Places To Retire post from a few weeks ago that focused on a "tax arbitrage" the high temperature in Spearfish, SD was 22 degrees yesterday and it was 21 degrees over in Ranchester, WY. Oops.

Those temperatures are not necessarily too cold but it's the first week in October. Back to the drawing board on that one.

In response to comments from yesterday about whether social security will be around or not or whether there will be some sort of means test a reader left the following comment;

I cannot see how SSI will not be around. I understand that it is way underfunded but I think the Government will (they will have no other choice) find some way to get the money.

Let's hope that finding some way to get the money doesn't result in $28 loaves of bread and $34 for a gallon of milk.
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401ks & Bond ETFs

A couple of items this morning.

First is this blog post from BusinessWeek about average 401k balances that was a followup from earlier in the week. Depending on how one looks at the numbers, whom they exclude (like workers in their twenties maybe) the average balance ranges anywhere from $86,000 to as low as $12,000. A median calculation came in around $43,000.

Anyway you look at it these numbers are depressingly low. Taking the high number, $86,000, how long does it take you to make that much money and how long does it take to spend $86,000 on common living expenses? Forgetting the taxes owed upon a normal withdrawal I doubt the typical person could get four years of expenses out of $86,000 unless they have baloney for lunch every day and macaroni and cheese for dinner.

So the first four years is covered (not really) what about the other 25 or 30? Everyone learns at a very early age that they need to save money. I'm not sure whether people start out on the right path as adults and then fall off or if they never make it on to the path when they start out but this is a real problem and based on the way the mortgage bailouts are being handled any attempt to fix the savings shortage may come at the expense of people who do the right the thing WRT to their saving habits. I'm thinking something like means testing for social security benefits. If you have a pile of money then no payout for you as an example.

On a different note IndexUniverse reported that iShares filed for a couple of new bond ETFs including the iShares 10+ Year Credit Bond Fund (CLY) which will tack an index that combines US Corporates and Yankee bonds. Yankee bonds are issued in other countries in US dollars. Depending on the issuer it is a way of offering stability to bond holders or effectively going short US dollars. FT Alphaville has had several posts recently about Germany issuing Yankee bonds.

If this fund ever makes it to the market you may read some commentary that says it is a way to buy foreign bonds without taking currency risk. That may deserve a not so fast my friend. If a bond issued in dollars will generally be serviced by a US dollar income stream then currency risk is very unlikely. Is a bond issued in dollar and paid for with a USD income stream really a foreign bond? If however it really is an attempt by the issuer to take advantage of what looks like an obvious trade in the dollar and the dollar has another massive rally like it did a year ago (counter trend or not) then the bond, more correctly the issuer, could be negatively impacted.

I'm not saying these are crazy risky just pointing out that if an issuer is betting on a lower dollar the bet will at times be wrong. The fund could actually be quite interesting, I just don't think it would be immune from currency risk.

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A Little Followup From This Morning

As a follow on to this morning one reader noted that iShares Australia can be a proxy for New Zealand.

I would disagree. The chart posted in one year but if you play around with other time periods I believe you will see what I see which is that EWA, which several clients own, is quite a bit more volatile than the NZ 50 which is the benchmark index for New Zealand.

Despite the two often being lumped together the economies are quite different. New Zealand doesn't really have much in the ground that it mines and then exports to other countries. It is more centered on farming, animals and animal byproducts (like milk exports to China). Australia has a fair bit of wheat but it is the mining companies that far more move the needle than things like Graincorp (GNC.AX) or ABB Grain (ABB.AX).

The positive attribute to New Zealand from the top down is that it is different type of economy than the US but not commodity/oil based and NZ is almost always less volatile than the US. In building a portfolio that takes in numerous countries while avoiding others you need many different types; more volatile/less volatile, surplus/deficit, emerging/developed and so on.
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Well That Is A Bummer

The other day I mentioned that the Bank of NY ADR site listed a bunch of New Zealand ADRs. I am somewhat familiar with quite a few of the names and was pleased to see that there were pinksheet ADRs which tend to be easier trade that the ordinaries. I also mentioned that the half dozen or so that I looked at showed no volume so I was not sure if the information was accurate.

New Zealand holds some investment appeal because it tends to be on a different economic cycle than the US and has some unique attributes. Long time readers will know my fondness for the country as an investment destination even though I've had clients out for about three years.

Curious about the list of ADRs I called Schwab's global desk to see whether the information in the Bank of NY ADR site was accurate. Well, apparently not. Not exactly anyway. I only asked about a couple of them and in each instance there was effectively no ADR. Yes the symbol existed but there had been no trades for years and when you do a name search on a Bloomberg Terminal in this context the ADR will be listed in the search results, if there is one, and in the case of the two I asked about; no dice.

As a followup I asked about buying ordinary shares for one stock in particular. The number of shares I would need to buy for an across purchase exceeds the average daily volume in the NZ market. This makes getting in difficult and could make getting out impossible.

These are generally trade-able in small amounts. Owning a couple of stocks like this at 2-3% each in amongst other more liquid holdings is would very likely not be a hindrance but clearly not for everyone.
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Wednesday Roundup

A few things from yesterday worth mentioning this morning.

Jeremy Siegel had a commentary run in the FT re-making a case for equities for the long run. I don't disagree in the biggest picture sense but I am not as sanguine on the fate of domestic stocks versus foreign. The dynamic of many other countries gaining on the US as the US tries to hold on simply makes those other countries more compelling.

He correctly, IMO, goes after Robert Arnott's comments from the spring about bonds outperformance noting that for that brief moment when stocks were at their low bonds did out perform but that cherry picking a point in time like that did not make a lot of sense. I similarly picked on the Arnott article when it first ran.

I think Siegel misses on a couple of points however. He notes that the S&P 500 is now trading at 14 times 2010 earnings estimates which is cheap compared to the 18-20 time he cites for other periods of low inflation and low interest rates without specifics of when that was or attribution.

Regardless of whether US equities are the best performers over the next ten years or the worst an argument based on earnings estimates for 2010 and maybe 2011 is not exactly firm ground. The potential volatility in earnings and estimates in the next year or two make valuing the stock market, for people inclined to focus on that, particularly unreliable. Given the freakish speed with which estimates were cut early in the bear market combined with the potential shoes to drop that we know about makes for a weak argument. That is not to say that stock can't go up a lot making the bulls correct but PEs can he high and stocks go up anyway.

He also makes the point that "every dollar of US international indebtedness is matched by a dollar of assets abroad. S&P 500 companies now obtain almost 50 per cent of their revenue outside the US and that share will most certainly rise as growth in the emerging nations continues to outpace that of the developed world."

Frankly I think this argument ignores too many macro factors. He may be drawing the correct conclusion for all I know but in order for this point to be convincing now I think he needs to demonstrate that he understands the really big picture and do some refuting. I'm not saying he doesn't understand the macro, I'm saying he doesn't articulate it in this article.

The next issue is that things are still not looking good in Iceland. The citizens seem to not want to join the EU eventually adopting the euro. They feel they will lose control of their fishing industry which was one of the building blocks of their success. I've written several times that I think there is a way to harness their geothermal for more manufacturing similar to what Alcan has been doing for years there and also for data farms. There are obstacles to both but with a little ingenuity I think they could figure it out.

One road to health would be to adopt the euro the eliminating the risk for foreign companies of doing business in ISK but losing control of the fishing industry clearly works against their interests. A horrible dilemma.

Lastly in case you did not see the article from the Independent that caused all the hub bub yesterday about the dollar here it is. It seemed to read strangely to me. Decide for yourself.
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