Catching Up On Reader Questions

One reader asked what I thought if DFA Funds. The results have been fantastic over the years but they can only be bought through advisors. Personally I have very little interest in OEF however.

One reader asked for feedback from readers about tolerance for volatility. FWIW clients range from not being able to own equities to never opening their statements, point being there is no abnormal in this discussion.

A reader named Milo asked for my opinion about Nick Russo. I don't actually know much about him. I believe he has some strong opinions about gold or oil or both. As a general rule I don't worry too much about truly severe outcomes. The probability of something severe is quite low.

A reader asked for my thoughts on Latin America and specifically a fund that invests in the region from T Rowe Price. As I don't really use OEFs I spend almost no time studying them. My thoughts on the region have been the same since before I started this site which is that the region benefits from what I think is a clear and obvious increase in demand for resources and I think exposure is very important for a diversified portfolio.

Tom from Indy left some great comments and a hearty welcome back, thanks Tom. What's the deal with Floyd?





A typical house in downtown Reykjavic.
















Out in the countryside of Iceland


More pictures to come.
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Back

After 30 hours of planes, trains and automobiles we made it back about an hour ago. I have to catch up on a zillion things, both personal and work related. I'll resume normal blogging tomorrow.
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Snaefullsbaer

That is the name of the peninsula where we are headed today before the US market opens. I do not know if the place we are staying has internet access or not, I may have to try to call Schwab collect to stay in touch.

World markets look weak, my guess as a reaction to the give back in the states yesterday.

I found this article out there about Deutsche Bank teaming up with PowerShares to enhance the commodity product and to work on currency ETFs, probably the one that will go long the high yielders and short the low yielders that made news a few months ago.

I will try to check in later.
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OOF!!

So much for the lift holding for today.

I got a friendly comment from long time reader HLP, BTW he has left some great comments and info in the past, telling me to work less, hehe. While my wife agrees, I cannot begin to convey how much I love what I do.

I had a market related question about how much cash I have. It varies for all the usual disclaimers but maybe close to 20% for most folks, some less some more.

Having too much and being upset about missing a rally is tough but to the extent it is just an emotion it need to be and can be managed. As a matter of philosophy 70% cash or similar is a tad high if that is where you are.

One other asked about my opinion on iShares Switzerland as a bomb shelter play. Generally sure, I own Novartis for most clients for that very reason but the Swiss franc currency ETF may prove better. In the last few weeks, though, not so much as the dollar rallied at what I perceive to be the height of the recent middle east flare up.
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Keeps On A Lifting

At least that is how the market is starting out and the world markets seem likely to support the lift in the US today.

If the market were to set a bear trap this is what it would look like. I have no idea if my bearish view will turn out to be correct or if it is next stop 1350 (for the SPX). Fortunately I do not have to be right about this. This is something I have been writing about for ages, not making such an extreme bet that being wrong costs you too much.

Plenty of people sound compelling without being right very often. The jury is still out on my ability to call big turns in the market and the like, and I know this. As the market goes up far more often than not, there is value in staying in the game even if, like me right now, you have a little more cash than normal. This entire concept is very important to how think this job should be done.

A lot of things look to be working right now including foreign and gold as the dollar is getting smacked. Am I seeing correctly that the ten year is now yielding 5.01%, oops! Did the Fed do a surprise lowering while I have been away (humor attempt)?

More later, thanks for sticking with me while I am away.
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Partying In Reykjavik

Well it has been a while since either one of us partied.

Our flight here was a freakshow beyond description.

Driving in from the airport I was struck by the number of cranes here, similar to the way some people count cranes in China. We have been here just a few minutes and already I can tell there is a lot happening. We had to deal with rush hour traffic which I took as an encouraging anecdote. I have not wavered from my small investment here but I have not exposed client money here either.

I am encouraged by the market action I see. I have been very clear about being concerned and that I would be delighted to lag a huge rally and be dead wrong, sentiment-wise.

Someone left a comment wondering about foreign sentiment to the US and its role in the various wars all over the mid east. While I cannot know in absolute terms, it seems like people are very skeptical about the every aspect of US politics, politicians and so on. I do not think American are disliked per se but I have seen many things that make fun of President Bush, grain of salt would be that this is from my experience in Internet cafes like the one I am in now.
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Off To Iceland

We are catching a flight to Iceland around 2pm (90 minutes before the open) so I won't be able to check in until after the open. It looks like Asia was mixed with Australia standing out to the down side and Europe has not opened yet.

I'll have more later.
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Good Time For Vacation

The market seems to be mellowed out today which is nice considering that I am away and can only check in here and there.

If you have been uncomfortable with your portfolio this might be a good time to make changes. This is not my saying be more bearish or more bullish just that while the market is temporarily calmed down it might be a good time to make whatever changes you think you need. Whether you need to own more stock or less is up to you.

I feel fine, personally, with where I have things currently. Exposure is reduced as the market, for now, does not seem to be able to take back its 200 DMA. This may change into the close for all I know but for now this makes sense to me. As I mentioned a while back on big up days I will lag a little, that has generally been the case except for the day that Yahoo blew up.

Gotta run, sorry for the typos but my wife is waiting.
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Great Comments

Thanks for all the great comments and tips about traveling.

We have had a few very bearish comments left which is fine. Some people are more comfortable taking extreme action before truly bad things happen. this is not my idea of the best way to go but to each his own.

Please keep in mind that that all we are is more volatile. The move down has been slight.

I have have also had some nice comments about the ETF analysis done here, thanks.

I plan to delve into Wisdomtree soon enough but I would like to get a better feel for hte funds but clearly the yields are compelling as is the back tested performance.

To update on my somewhat bearish posture, as expected I lage a little in both directions (up and down) which makes sense to me for now as the market cannot re take its 200 DMA.

Sorry for any typos I am holding up some shop keepers in Sigtuna.

More later.
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Philosophical Difference

Before today's post; we got some fantastic views and photos today in an area of Stockholm known as Gamla Stan.

I found the following links, one from Marketwatch about too many ETFs that I think is a retread of an older article and another one from ETF Investor questioning the utility of currency ETFs. Weigh all of these issues for yourself. Don't listen to me or someone else, you will know if the various new products are right for you or nöt (he he different keyboard!).

I stumbled across a press release on Yahoo Finance from a stock picking site that said ETFs would now be included in its research and in its model portfolio selections.

I tried to sign up for the free trial to see what their reports are like but despite being free they wanted my credit card number, I passed.

As I read the press release I had a general thought about picking ETFs that is bigger than whatever this site may be looking to do.

"What ETF would you buy right now" is the mindset of too many people, IMO. This leads to chasing returns and makes all of the naysayers of sector funds exactly right when they caution about how dangerous they can be.

In a way, trying to game a single country or a sector for a couple of weeks in anticipation of an event can be more difficult than gaming a stock. I'll use an example that is completely made up. Let's say an investor thinks that Conoco Philips' earnings will lift the entire energy sector so he buys the Energy Sector SPDR (XLE) in which COP is the third largest holding. Let's say the investor is exactly right about COP and most of the sector but at the same time that COP is making its news Exxon Mobil (XOM) has some sort of hideous scandal that knocks the stock down 15%. Since XOM is the largest holding in XLE, at 16%, the trade as implemented fails. Reasonably speaking, the analysis in the example was good but it is tough to game a scandal.

The long-term holder is no better off of course but the mindset of the event trader and the long-termer are different.

For anyone new, I think of ETFs as one of several tools available to build a diversified portfolio. As an investor constructs his portfolio there are certain parts of the market that will be captured. Some parts are best captured with a stock or ETF or fund or maybe something else. There is nothing that says you have to all ETFs. For your energy exposure (sticking with the example of above) you should buy whatever you think best captures the sector. For someone that owns a bunch of OEF the best energy hold could be an individual stock? The point is not to limit your thinking.
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The Big Picture For The Week Of July 23 Global Edition

Yesterday, in between cruising around, we saw Floyd Landis clinch the Tour de France in the time trial. He overcame a huge adversity from the other day when he blew up on one of the mountain stages.

Phil and Paul (the announcers) were giving up on him as being dead in the race. Landis was apparently not phased by this as he just did what he needed to do one stage at a time.

I think there can be a metaphor here for investing. Setbacks in either one stock, your portfolio, the overall market or all of the above are going to happen. No one can control those things but you can control your own actions.

The massive one day lift last week did not convince me, not even close, that I am wrong about being a little defensive these days. In simple terms, demand for equities is, to use John Hussman's words, not favorable.

This does not have to mean a ghastly bear market but I suppose that is possible I don't know. I do know that every big move down (excluding crashes and terror attacks) starts with a small move down, a rolling over. The magnitude of the decline so far has been a rolling over of sorts, how most bear markets start. How the month ends could be very constructive in telling us whether a bear market is hear but more on that later.
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Checking In

Thanks for all the comments and sorry about the typos that might follow, don't have word to try to proof-read.

I don't know about www.ifa.com, I will check it out when I get back. To the comment about Fido's potential ETF functionality, try Morningstar. I bag a lot on their analysis but the software for portfolio analysis is very good.

I also tried something called Portfolioscience.com that I am going to sign up for that has things like beta, correlation and standard deviation; all the things that Morningstar does not have.

As far as naming names on the RIA I was critical of, probably not necessary.

I will have a normal post tomorrow.
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Same Strategy, Different Implementation

Before today's post, Stockholm is very cool, literally and figuratively. I am in a dark gamers type place where a bunch of kids are swearing at each other. We saw ten minutes of Swedish Tour de France coverage which was a trip.

Not a huge shock that the market is working off a lot of the super rally from the other day.

More later.

I stumbled across an all ETF portfolio managed by an RIA firm. From what I could tell I think the firm is a top down manager, which is what I am, but they seem to use seven or eight ETFs for a full portfolio which is a different method of implementation than what I do.

I looked at their website and specific funds used is not disclosed but the categories are large cap, small cap, mid cap, international, REITs, two types of bonds and cash (which is probably just cash and not an ETF). Given that they use so few ETFs I doubt any part of the equity allocation gets more than two ETFs, with most getting only one. They clearly focus on allocating cap size but I was not able to find whether the try to capture style in any way shape or form.

By style I mean growth or value. For example the small cap allocation could be broad (like IWM) or small cap growth or small cap value.

With regard to foreign I am not sure if they use just a broad foreign ETF or if they include emerging markets. The most current allocation for a moderate investor with an intermediate time horizon breaks down as follows;

20% Large Cap
20% Mid Cap
10% Small Cap
10% International
18% REITs
19% Bonds
3% Cash

The returns for their approach seem to very inline with the market. They are not adding a lot in the way of return, nominally speaking, but on a risk adjusted basis, factoring in that they have close to 20% in bonds, there probably is value being added.

Clearly this approach to portfolio construction is valid and may even be ideal for people not wanting to make a career out of managing their portfolios except this is being offered by an RIA, so it is his career.

I am on board with the top down idea that de-emphasizes stock picking. There is a whole big universe of investment products, for the do-it-yourselfer or RIA, that might be better than owning a couple of cap-size ETFs. The above method potentially ignores dividends, sectors, single countries, almost every aspect of the fixed income market and I have no idea if they use commodity ETFs.

Spreading out over more than eight ETFs may not add any more performance (although I believe that it does) but it can reduce volatility. If you lag the market by 50 basis points a year forever with only half the volatility (an extreme, static example) you'd be in very good shape.

A part of the job, whether you do this for yourself or manage money for others, is looking for better mouse traps. Occasionally a new ETF or CEF is better than what you are currently using. The time needed for this is far from unreasonable.

Trying to explore new products is major theme of this site and I think it is very interesting.
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Data And Predictions From State Street

Having these sorts of numbers close by really comes in handy.

A while back I wrote an article about Taiwan and it took about ten minutes to find the Central Bank Rate.

As you research various countries, getting a macro sense of what is going on, using this type of data, is crucial.
























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Talar Ni Engelska?

That is Swedish for do you speak English which I will need for the next few days. My wife and I are going to Sweden tomorrow morning for five days and then hitting Iceland for five days. We plan to do some touristy stuff, some outdoorsy stuff and hopefully, ahem, very little conspicuous consumption.

We fly from Phoenix to Minneapolis to Reykjavik to Stockholm. Needless to say we are very excited.

The US markets open mid afternoon and close late in the evening. I will be close to the market, my wife has stopped being annoyed with me on this, and I will be posting to the blog throughout the trip.
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Intriguing

TraderFeed has an interesting nugget (hat tip to MarketBeat) about buying Friday afternoon at the close.

Brett Steenbarger finds that since 2000, simply buying Dow stocks every Friday and selling on Thursday would be more profitable than owning the Dow industrials outright. "If traders had simply bought at the close on Friday and sold at Thursday's close, instead of losing over 750 points, they would have gained nearly 3000 points."

Brett finds a lot of anomalies like this all the time, it is fascinating stuff.

Unfortunately I don't know what to do with this. There are many statistical oddities that seem to have a causal relationship and some that have a casual relationship to success. The one pointed out by Brett may continue to work for the next ten years for all I know but there is not really a way to apply a forward looking analysis to the idea.

I could paper trade it for a year and it might work and then put real money into the idea next July on the day it stops working.

Looking this sort of thing, as opposed to this specific bit of research, can help better understand how markets work even if they don't directly lead to a trade that makes money.

I am unlikely to trade on this type of indicator, I have no way to justify it to myself but there is absolutely value in exploring the concept.
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What About Currency OEFs?

....a reader asks.

Re currency allocation, is there a mutual fund(s) that are worth strong consideration that focus on currency as an allocation class? Why not let a professional mgr choose the country?

This is a good question. There are quite a few OEFs that are currency funds. I use one for clients from PIMCO. There are a couple of others; one from Franklin, there is the Merck Hard Currency Fund and I believe Prudent, as in the Prudent Bear Fund, may have a currency fund (not positive). There must be others.

Both the ETFs and the OEFs have plusses and minuses that investors need to weigh for themselves. The currency ETFs allow investors to capture narrow themes. If you buy into Switzerland as safe haven (which I do but it has not really worked in the last few days) FXF allows for unfettered exposure to the effect.

Other than the Mexican peso (FXM), I think there is a fundamental case to be made for all of the currency ETFs. I'm not saying you should buy any of them just that there are some compelling points.

If an investor comes to the conclusion that they should own the British pound they may get it in an actively managed fund that owns the pound for now but what's to say the manager won't change his mind in two months.

The upside of the OEF is that the manager knows what he is doing and the fund is very successful. The down side of the ETF is that the do-it-yourselfer does not know what he is doing.

I think this boils down to philosophy but keep in mind that some clients have exposure to both. As another example a reason to buy the Aussie (personal holding) might be its long-term correlation to gold. There is diversification benefit to this for US based investors. It may not be ideal, in this context, to buy an OEF that might stray away from the Aussie, again assumes the investor is going for a narrow effect.

If the Aussie perpetually zigs when the US zags it is doing its job as a diversifier even if it goes down.

As a quick note about the Aussie and gold, Bloomberg often notes in articles about Australia that the Aussie has a correlation of about 0.93 (on a scale of 1) to gold. David Taylor questioned this and while I don't know for sure, FXA in its very short life thus far has a 0.64 correlation to the GLD trust (client holding) according to PortfolioScience.com. I expect the correlation to tighten up some even if it does not get to 0.93.

A question about bid ask spreads came in. This is very far down on my list of things to worry about. The reader notes that the spread for the loonie (FXC) is 10-12 cents. I haven't checked but I'll take his word. Often, but not always, volume can print in the middle with a little patience.

The spread becomes more relevant when trying to make a short term trade. Every post about these funds on this site has been for use as a way to diversify the cash portion of your portfolio. If you are looking for a trade you need to consider how big of an issue this is for you.
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Cash Market

David Gaffen at WSJ Marketbeat offered some contrarian thoughts from Chet Courrier about cash as an asset class and investing in money markets.

"…yet there also looks to be a contrarian message here. As in stocks or any other market, rising enthusiasm may send a warning signal that the best returns might soon be past."

This is a worthwhile idea to think about. Money market rates are attractive but, per the ideas spelled out in the bond market post from earlier today, may not go up too much more. In fact they may start to go down as soon as next year.

I do not like CDs but many people do. Six month, 12 month and 18 month CDs might be attractive as money market substitutes over the next few months. I am also a fan of the currency ETFs. I bought the Swedish krona personally and for some (but not all) clients and recently and I also bought the Aussie personally but not for clients.

I have been clear about my opinion that I think the currency ETFs will change the way investors manage the cash portion of their portfolios. From the start of this blog I was optimistic that ETFs and other investment products would open doors that were previously closed, in terms of being easy.

I have no doubt that some people will use the currency ETFs too aggressively and regret their trades but that goes with all products, I think.

Some portion of the cash allocation invested in foreign currency makes sense to me. I view this as a diversification tool more than anything else. If an investor targets a 10% cash allocation, putting 20% or so of that cash, so 2% of the overall portfolio, in to something foreign could be a good diversifier.
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Bond Market

A reader quotes John Hussman and asks;

"Until we observe credit spreads widening, indicating a skittishness toward credit risk that would create a demand for safe government liabilities (cash and Treasury securities)..."

Roger could you clarify this? What then has to happen for being a bond bull? Sounds like something you have said before.

Credit spreads are important, sophisticated and tough to monitor directly. The yield of most fixed income products get compared to the yield of a US treasury of similar maturity. When the spread is relatively wide, the other security (maybe emerging market debt or corporate paper) is generally though to be cheap and when the spread is narrow the other security is thought to be expensive. This can also be viewed as a measure of risk. A narrow spread means that investors are accepting less yield for more risk. A problem with all of this is that most people cannot easily access yield info for these parts of the bond market. You can find info in articles but that is about it.

As far getting bullish or bearish or any other animal about the bond market, my thoughts have been fairly consistent. The curve is inverted with ten year treasury yields in the low fives. The low fives is historically kind of low, not crazy low but below normal.

The yield curve will get steep again, taking on a normal, positive slope. A positive sloping curve signals economic expansion as it makes lending money profitable for the banks. To normalize we need some combination of higher longer term rates and lower short term rates. I think a ten year treasury around 6.5%-7% toward the end of the decade makes sense.

Anyone buying a ten year treasury today and taking 5.12% would see their value drop if 6.5% pans out. As a rule of thumb a 1% increase in rates equates to an 8% drop in prices. Obviously you get your money back at maturity but if you absolutely had to sell before maturity you might have to take a loss that offsets the interest earned.

Given that the Fed is about done the two year treasury is unlikely to move a lot higher in yield. If you buy into the curve as predicting recession concept, than you might think the Fed could start lowering rates in 2007. If the Fed does start to lower, and I am not sure what I think about that just now, yields on two year treasuries would go down giving a chance for some, not a lot, price appreciation.

If two year yields go up from here the potential 8% decline of a 1% move up in yields lessens because of how soon the two year treasury matures. At maturity the proceeds could be invested into higher yielding bonds but with the ten year you would be stuck.

At some yield on the ten year it makes sense to back up the truck. A treasury yield that competes with the long term average for the stock market becomes compelling. In the early 1980' treasury bonds yielded 15-ish%. Some people still own those. Think about that, an asset that yielded 15% while the stock market was crashing at the beginning of this decade. We may never see 15% again but we may get closer than you think.
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Emerging Markets

I found this article on Bloomberg about emerging markets. The general tone is to update the reader with what has happened in the last couple of months and has a generally positive bias quoting mostly Joe Quinlan from Bank Of America.

Mr. Quinlan is generally bullish on emerging markets; he is quoted as saying "most of the damage is done."

I don't know if he is correct and I am not sure that his being correct or not is very important. I have trouble believing the long-term theme is damaged; think generally here about the asset class not narrow country themes just now.

The end of ZIRP, really the threat of ZIRP ending, contributed to the selloff that started in May. For now, emerging markets certainly seem to be in the middle of a breather. I do not know if there will be a lot of selling later this summer or not but I do feel strongly that the next 10%, regardless of direction, will have very little to do with fundamentals. Because of the panicky nature of the spring selloff I think an argument to buy based on the fundies today, even if the argument is correct, should not be a catalyst to take action right now...unless the next 10% don't matter to you which is perfectly valid.

Too many folks, though, have trouble when a long term idea starts out ugly so waiting might make sense.

As an example of this I would look at Turkey. I have no position, no immediate plans to add exposure and have no idea when I would add exposure. Turkey has a couple of very big macro things going for it that I do believe in. The oil pipeline will be a printing press of money for the country and its seemingly endless process of trying to join the EMU (be a country that uses the euro for its currency) will also pay off one day. Combine those two with its large, 70 million, and young population and I think Turkey is very compelling. A little closer to the front burner are deficit issues, the recent reactionary and emergency rate hikes to combat inflation and the falling lira make this a rough time to be a buyer.

I have no doubt that the Turkish market will be much higher in ten years but I can't rule out that it will cut in half in the next 12 months (probably a little extreme but you get the idea).

I am about equal weight emerging markets after selling in April and May with no plans for further reductions. I also have no hesitation buying for a new client to create the portfolio but I can live with an ugly start to a long-term theme. If you cannot, you might want to wait.
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Too Late?

A reader asks;

For the trapped longs that is still lets say 90-100% long, what do you suggest is the best action to hedge currently?

So if an investor has done nothing yet to get defensive what should they do now? That is tough. It might be reasonable to think this person may not be very good at predicting the market which does not have to be an obstacle to success. I also wonder whether this investor had any sort of exit strategy devised. I think no plan is an obstacle, but one that can be overcome by, um, devising a strategy.

My strategy for this, written about many times, is the market level vs. its 200 DMA. When the market is below its 200 DMA there is a problem with demand for equities. Currently it is below the 200 DMA so there is a problem with demand so I think some sort of defensive positioning is warranted. However, I can't tell someone else what they should use to be defensive.

One reason I use this type of indicator is that it is a gage of supply and demand. It may not be the best gage, something like that is debatable but it is simple.

The person who takes defensive measures now has to realize they may be a little late and that they may lag a big rally if today is the bottom. I don't believe it is the bottom but I don't know. A lot of this is repeat from recent posts.

Lastly let me reiterate my idea defensive action is not 100% cash. That is a very big bet.
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From Around The Net And Beyond

This is Bill McLaren's chart. He said the S&P 500 is in a downtrend and lows don't occur at double bottoms like we have now, during downtrends. Bill says double bottoms offer support in up trends.

John Hussman sees a small prone to fail rally coming and so he remains fully hedged.

What did W say to Tony Blair?

There is violence, fear, market dislocations earnings concerns and where is Charlie Gasparino? Bringing us more stories that people don't care about. Is the Brain in the house to give us the latest on Time Warner?

A reader left a comment that I took as complimentary saying that I have been/would be cool in the face of the current events we are dealing with. Maybe, maybe not but if I am cool it is because this is not really very different that past downturns, other than how shallow it has been but how much fear it has incited. Magnitudes may change over time but how new is violence in the Middle East?

This is not a Battipaglia/Riley call to bullishness as the market is scared will need to work through this with what I think could be lower prices before anything else but the market goes up the vast majority of the time but it also goes down sometimes too. Both are normal, need not be feared but must be endured.

If I somehow turn out to be right about 2006 being down a little, maybe 2007 will line up to be an up year but if it doesn't a subsequent year will be up. Since the time horizon of my clients goes beyond 2008 I feel very little need to worry. We all need to manage for a down market but I don't think we need to worry about what is normal market action.
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This Guy Is On Your RSS Reader, Right?

Dismally, as it relates to the markets.: What tensions in the Middle East would mean to currencies.

David isolates some of the Middle East current events and the potential impact on the capital markets.

This is a good, quick read.
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Comment Thread I Do Not Follow

There is one reader who keeps leaving comments saying he does not believe anyone could be up this year. The line of thought is lost on me. This is not to brag because plenty of people are up this year but the following images may weave together some context and hopefully will help out the person who cannot fathom being up year to date even though the S&P 500 is only down 1% for the year.

I started a generic portfolio (it represents the equity portion only) on Yahoo Finance with $1 million on Jan 1, 2005 using 12/31/2004 closing prices as the starting point. I have referenced this generic portfolio countless times on this blog. Since then I have manually entered all the trades and dividends and while I can't guarantee having accounted for every single dividend the trades are accurate and representative. Some client accounts have done better and some have done worse.

On 12/31/2005 that portfolio stood at $1,135,000 (I have rounded off--I did not think to capture a screen shot back then). Up 11.3% was a slight outperformance.


This first image, $1,195,851.00, was the value of the generic portfolio on 3/31/2006.











The second image, $1,201,198.25, is from June 30, 2006.










The third image, $1,193,216.50, is from Friday's close. Generically the portfolio is up $58,000 or 5.1%. Actually it is a little more. I have not added in any dividends for July yet and ANZ, for one, just paid a $2.07 dividend on Thursday which would add another $693.


I don't really care whether the reader in question believes this or not but the numbers will make sense to long time readers. Obviously a big chunk of the YTD number has been dividends. Also I have been generally raising cash for three months and I was lucky enough to be heavy in energy, emerging markets and materials earlier in the year.

I am pleased with the year so far but really the results aren't spectacular. The I don't believe line of thought, I'm sorry to say it so bluntly, is just a waste of time and effort. However you have done thus far, hopefully you are learning more to become a better investor. That is what is important. I have learned to have a lot more respect for the consequences triggered by the end of Japan's ZIRP. This has been the biggest lesson for me by far.
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The Big Picture For The Week Of July 16, 2006

I'll use this post to catch up on some of the questions/comments from during the week.

One reader left the same comment twice asking me to weigh in on whether I think the market has bottomed. No I don't. That being said trying to guess about the next 25 SPX points is just that, guessing. Minimizing the times you have to guess is probably a good idea. I have felt all year that the market would be down a little. I was lucky enough to catch the upmove and I have been reasonably transparent with the defensive steps I have taken over the last three months.

My 2006 prediction is the SPX finishes between 1180 and 1219 (the void on the BusinessWeek survey). This expectation would not motivate me to completely bail out of equities. I may take further defensive action but I hope it won't be necessary to get extremely defensive. And to make one last point, I hope I am wrong and the market sky rockets from here. I would be thrilled to lag a 20% move up.

I would also stress that I do not have much interest in trying to game such things as this. I have not demonstrated a real proficiency (have I?) for picking this sort of thing.

Tom in Indy weighed in that he is more interested in the Tour de Lance France than the market right now. This is a joke of sorts but mentally taking a break every now and then seems like a good idea.

Someone asked my thoughts on Macquarie Infrastructure. I started liking it shortly after it came out (about a year ago). I bought it personally and for clients (and still own it) and have been buying it for new clients. In the time I have owned it went up a lot and corrected back down. I have faith in the concept behind the product and Macquarie's ability to run these funds, they manage about a dozen (I believe that is the number) of these around the world.

There were some great comments left by OG, Londoner and others about benchmark selection and the idea of staying close to the market.

This is mostly old ground. Simple is a theme of what I try to write. Simple has drawbacks just like complicated has drawbacks. Proper diversification is more important. I believe in stocks, fixed income, cash, real estate (REITs included), commodities (the usual suspects and timber) and so on. I tend to think that averaging 10%, about what the S&P 500 averages, per year for people that save properly will do the trick for reaching financial goals. A way to look at this is what can you do to be close to 10% either way without having to be very right about a lot of things while hopefully giving yourself as smooth of a ride as you can.

A total market index would work as a benchmark, as would the MSCI Global Index. I do believe in benchmarking for knowing where you stand but I am not a slave to portfolio construction that is very close to the index.

One comment asked if the market is down 20% and you are only down 16% should you feel good about that. That situation did not seem ideal to the person leaving the comment. Since 1974 the S&P 500 has been 20% or more for two different years; 1974 and 2002. Obviously there have been other 20% declines during the course of given years but to make the point, in the reader's scenario the markets average annual return includes the years of down 20%. Beating the market by four percentage points in those two years adds 8 percentage points of return in you life time. More actually if you take the time to figure the compounding.

So while I agree with the reader that down 16% is far from ideal it is not the worst thing that can happen to you either. I would classify down 20% as down a lot and I am attempting to do better than a 4% spread in that situation but I may be unsuccessful. All anyone can do is have an exit strategy devised and then be disciplined enough to stick to it. If what you devise works 25% of the time you will come out way ahead of the market in your lifetime even if you are wildly mediocre the other 90% of the time.

Another comment was about time horizon in the context of just staying close to the market. Can a retired person who does not have time on his side afford to do this. Doesn't the retired person have to have less volatility is how I take the question.

I'll set aside personal tolerance for volatility as a planning issue for this and just focus on the numbers and how they usually work. If you are 60 years old (retired or not), healthy, with 95 year old living parents what is your time horizon? Jump ahead for this person ten years. They are 70, Dad died at 99 and Mom died at 103. My limited knowledge of actuarials says the person needs to plan on at least living until 105 (the average of Mom and Dad's age at death plus 4). At 70 this person has to think about their money lasting for 35 years. This will happen more and more and the more likely risk is running out of money due to being too conservative.

Properly diversified for your situation, always, but too conservative could be a catastrophic problem.

Sorry this was so long.
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Bill Nygren

Here is a quote in Barron's from Bill Nygren about commodities and oil.

"Had we possessed perfect foresight and seen the changes in supply and demand that caused commodity prices to increase, it would have made sense to own those cyclic names."

Apparently his funds either did not have enough or did not have any exposure. He goes on to say...

"We don't believe the commodity price surge of the past three years will recur," and he expects that it "will likely reverse somewhat."

Why would anyone expect he would be correct now after being so wrong before?



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Odds n Ends

The blogger survey conducted by Ticker Sense is getting a little bit of attention out there. I am one of the participants and I voted bearish.

The TSCM 360 on ETFs I mentioned the other day was published. I am a bit of an island.

A while back I did a favorable write up (I was not compensated) on content aggregator Instant Bull. BusinessWeek also did a positive write up on the site that mentions this blog, hey neat.

Should one of the characters on Fast Money be The Cleaner? This is a role that Harvey Keitel played in two movies, sort of.

He was Victor the Cleaner in Point of No Return and did the same job as The Wolfe in Pulp Fiction.
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Just A Tad

I took a little bit more off the table this morning.

Before I detail that, there have been some great comments left that I hope to reply to but this has been a particularly crazy week. Thanks for bearing with me.

I bought shares of the double short ETF for most clients a couple of hours ago. The target allocation was 4% of client accounts but that is a generic number as some got different amounts.

A big concern right here for me is the, and it is not being talked about a whole lot (I don't think), is the deeper inversion of the curve. I also think the end of ZIRP in Japan will continue to impact world markets.

I am not sure that the nastiness in the middle east, in its current state will have a lasting impact but I suppose it could escalate to draw in other countries as some have suggested.

I think the technical condition has deteriorated as the SPX knifed back below the 200 DMA.

This is all still in the realm of down a little. This trade is a small step to looking out for down a lot. Cutting back some seems prudent to me. If the trade turns out to be wrong, the consequence would be some, but not a lot, of drag on the portfolio.

I tend to believe in gradual moves. If this is a bear market that ends up with a big decline there will be plenty of time to reduce further.

Invariably someone will comment that this is a dumb trade. It might turn out to be dumb but neither dumb nor smart will be evident today or tomorrow.
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State Of Mind

My post late yesterday drew some interesting comments including one that said investors should be emotional. I imagine for some folks that is the way to go but getting all worked about the market would likely cause me to make poor decisions and this blog is meant to be a look over my shoulder after all.

One aspect of managing your own portfolio that I try to convey is putting yourself in a position to not have to be exactly right all the time. You do not have to correctly guess what the market will do in the very short term. When you go 100% cash or some other big bet you leave very little margin for error. There is no reason for a do-it-yourselfer do put themselves in that position. A do-it-yourselfer does not need to get a certain return in the same way that a mutual fund manager would. Your job is not on the line if you lag the market for a couple of years in a row. This being the case why manage your account like your job is on the line.

If you manage your own portfolio for several decades, it is a safe bet you will have good years, relative to the market, and bad years. Good and bad are both inevitable. If you have a long term outlook and you know you will have good years and bad years the urgency to be exactly correct this summer should lessen.

If you absolutely nail it exactly right this summer you could be very wrong next summer or the summer after. If your method of portfolio construction and management allows you to comfortably stay close to the market over time, that is the most important thing.
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Still Only Down A Little

Although it may not feel like the market is only down half a percent for the year. No doubt the last few days have been ugly and may get uglier.

It is times like right now that I have been writing about so often. Panicked selling of many stocks right here is probably a bad idea. A plan for selling, getting defensive, protecting assets, whatever you want to call it has to be made when your are not emotionally taxed and then followed when you are emotionally taxed.

I write about not being emotional with managing your portfolio but that is difficult for most folks. My telling you "I'm not worked up so you shouldn't be either" may not be helpful. Knowing you devised a strategy and all you have to do is stick with it might be more helpful.

For more un-helpful input, I would add that the market goes down sometimes. At the nadir of the spring sell off the S&P 500 bottomed at about 1220, it closed today at 1242.

In trying to ferret out what is really going on I would suggest a 30,000-foot view. I have been writing about concerns I have had for a while that may or may not be playing out now or may yet play out in the future. None of the catalysts that have been concerning me (and that I have been writing about) require any keen insight. The logic either made/makes sense to you or it doesn't. The idea is that sometimes a sniff test does the trick.

Just because the sniff test gives a bad result does not mean anyone one should make a HUGE bet like 100% cash or 100% short or something else. We are down a little. Six months ago, as you thought about the new year how would you want to have been positioned in the face of down a little? Are you positioned that way now?
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Cramer On ETFs

Jim Cramer had a piece up yesterday on theStreet.com yesterday called ETF Overload. The Abnormal Returns blog also got in on the action.

Some of you may know that I write for RealMoney/theStreet.com, mostly about ETFs. I was asked to participate in a 360 on this topic raised by Cramer. A 360 is where several writers weigh in on a subject.

The following was my response as submitted, I don't know if it will be edited down or not.

In Jim’s recent article titled ETF Overload he questions the utility of some of the new ETFs coming to the market and has some fun with the narrow themes that some of the proposed ETFs cover, like insider buying and under-sponsored stocks.

I too wonder about the merits of the insider buying ETF but the back tested numbers for these things are outstanding. They are really no different than assembling portfolios based on stock screening. Back testing is much different than real life and I feel no need to be the first one into any of them but I would not permanently ignore them either. Some stock screens do work.

A while back I wrote a piece about the IPOX 100 Index Fund (FPX). The theme here, or gimmick if you prefer, is buying IPOs on day seven and holding them until day 1000. As I wrote in the piece, the methodology of picking IPOs is not the thing; the thing is the part of the market it captures. The Index that underlies that fund has been around for several years and has served as a very good proxy (as in it outperforms) small cap growth. Even since its debut this has stood up as FPX has beaten iShares Small Cap Growth (IWO).

This will repeat over and over with the narrower ETFs, they capture what they are meant to capture but could also capture some other effect.

Another thing that I think Jim is missing is that the ETF industry is brand new and evolving. In delivering new, innovative products there will be some very useful funds and some other that just take up space (think the Morningstar ETFs). Hit and miss is inevitable.

One last point, I disagree with Jim on the utility of sector ETFs. On Jim’s shows he is fond is helping his audience with Am I Diversified? The market, as measured by the S&P 500, has 10 sectors. I think Jim would be on board with a stock portfolio that had some exposure to all ten. Not everyone wants to take single stock risk but taking prudent sector risk, as opposed to make big sector bets, can be a different matter.

For example, the financial sector makes up 21% of the S&P 500. An investor wishing to underweight the financial sector could buy one of the broad sector ETFs with 15% of his portfolio and then perhaps one of the insurance ETFs with 2% of the portfolio. This type of process could be done for every sector. There are countless studies and white papers that show sector selection is more important than stock selection and ETF provide this to investors.

I would urge do-it-yourselfers to think outside the lines where ETFs are concerned.

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Technical Difficulties

I am aware the site looks goofy. Blogger is very quirky. It this persists tomorrow I will work on a fix.
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The Pound As Reserve Currency

Bloomberg.com: U.K.

A few days ago I mentioned something I read on the Jyske Bank site about the British pound gaining ground as a reserve currency. This is a similar piece, albeit with more detail, from Bloomberg.

Iceland 15% of it's reserves in pounds
Norway 9.7%
Sweden 10%
Poland 10%

Latvia and the Ukraine are quoted as planning to add pounds soon. Syria will drop its US dollar peg at the end of the year and might buy pounds too.

For most of the countries the numbers are small to be sure but this point to a trend that I have been writing about for ages; visibility for less global demand for US dollars.
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Rosneft

OK, so I read the Rosneft article that I linked to earlier. It was very pessimistic, critical, detailed but also one sided. The contentions made resulting in the stock being a lousy hold could turn out to be correct. I know that certainly most of what he has said rings true but I am not sure if he is correct in magnitude as there is opinion mixed in with fact (which is not a bad way to write at all).

In sorting something like this out I think both sides need to be looked at. All of the negatives notwithstanding, the stock could go up a lot. There is no way to know for sure but stocks that should go up often don't and vice versa.

I wrote about Rosneft a couple of months ago and found the following data points and estimates;

Earnings in 2005 were $3.9 billion vs $0.8 billion 2004. Revenue was $23.9 billion vs $5.3 billion in 2004. In 2005 the company reduced its debt by $1.7 billion down to $10.9 billion.

I got these numbers from CNBC World, I can't guarantee their accuracy.

If true they are compelling. I also think it is reasonable to think that no one in Putin's government wants to go through another Yukos/Khodorkovsky saga. I'm not saying they won't but I am saying the fallout and capital flight that would ensue would not be in their interests.

There is also a lot of oil there, an awful lot.

There are two sides to every trade. The positive points to the story may not compel you (or me) to buy the stock but exploring both sides makes for a better decision.

If you do buy, how much would you buy, how much is prudent? The way I manage, a stock like this would get no more than a 2% weight. While a speculative emerging market stock may or may not work out a 2% weight is hardly reckless, 10% on the other hand....
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Not Just Another Mega Cap Tout

Bob Doll who oversees a gazillion dollars at Merrill Lynch was on CNBC and did not hide behind the consensus mega cap tout that so many people favor these days. Props to Bob.

There is a logic behind favoring large caps now which is that they historically provide leadership toward the end of the stock market cycle. Many people, I think Jason Trennert fits in here but correct me if If am wrong, take this to conclude that a portfolio should be chock full of $200 billion companies.

This could be very problematic. Microsoft does not innovate any more (no doubt someone will comment they never did, maybe so) and Pfizer needs to find $5 billion-$7 billion in new revenue to grow the top line in double digits.

The idea of increasing market cap within the portfolio makes sense and is something I did earlier this year. Not every mega cap is toxic. Adding a couple of stocks with caps larger than $100 billion will likely increase the cap size of the entire portfolio by a noticeable amount. If your portfolio's cap size is $30 billion, you might be able to take it to$40 billion or $50 billion by adding a couple of mega caps and selling one small cap, as an example. Point being only a couple of trades could make big changes without selling 30 stocks and buying 30 different ones.

Another way to have a similar, if not exactly the same, impact might be to buy something like the Rydex Russell Mega Cap ETF (XLG). This would not be my first choice but it will capture some portion of the effect for folks that do not want to take single stock risk.

A last point to make is that at some point the mega caps will provide clear leadership again, as they did in 1999. I would expect at that time XLG would be a great hold because they will likely all go up regardless of fundamentals but I don't think we are at that point now.
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gagibedety what now?

That was my reaction when I read an article from Motley Fool called Not Your Daddy's ETF. I wrote for Motley Fool in 2004 and was very underwhelmed every step of the way. I wanted to get more into ETFs because I did not feel that there was consistently good coverage anywhere yet and it was clear that ETFs were well on the road to becoming a very important tool for do-it-yourselfers. At the time they had no interest.

Here are a couple of nuggets from the Fool article;

But what's new, you ask? Well, new from Rydex Investments, for example, are ETFs that track foreign currencies. If you're bullish on the euro, you can invest in the Euro Currency Trust (NYSE: FXE), and similar ETFs now exist for the Mexican peso, Swedish krona, Canadian dollar, and more.

Or how about this in depth bit of mental heavy lifting;

ETFs also let investors focus on specific sectors, such as oil-drilling or retailers.

These are entire subjects in the article. The depth is shockingly shallow, shockingly. This is not a shot at the author, if you read her bio it is clear she is very smart, she has much better education than I do, to be sure.

I believe this speaks to how the Fool does things. The article tells you that certain funds exist, that's it.

This bugs me as a pet peeve. I believe the Fool wants to help people be better investors, as a goal, but this article along with any other article about ETFs from the Fool that has ever hit MyYahoo ETF-news feed has been just useless.

The analysis I try to do seems to be sort of popular which amuses me because it is so simplistic; it is consistent, but simplistic nonetheless. When I first started writing there was very little under-the-hood analysis to be found. Now there is more but hopefully there will be more still.

When an author/blogger tries to deconstruct a fund and gives a true effort, even an incorrect conclusion can be useful if the writer shows his work, so to speak. Real analysis that delves into process has value. If the conclusion is wrong you might learn what not to do, if the conclusion is correct you might learn what you should do.

Something like Well there is a water ETF and a new biotech ETF is utterly useless. If you actually give them money and you care about ETFs maybe it is worth mentioning?
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Alpha Trends

Here is another new (to me) blog. It is called Alpha Trends, written by Brian Shannon, and it uses Google Video for the posts.

Brian's videos go over several charts with is opinions about what is going on technically. He covers stocks, ETFs and indices.

The site is innovative and Brian seems to know his stuff.
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Good Question

Regular reader, retiredinprescott asks...

Roger, do you think these three ETFs are also a play on a declining US dollar?

He is referring iShares EAFE (EFA), PowerShares Intl Div Achievers (PID) and WisdomTree Intl Mid Cap Div Fund (DIM).

The short answer is yes.

Any type of foreign exposure insulates against a weak dollar. Depending on the specifics of the foreign exposure you may insulate a lot or a little against a weak dollar. For example, Turkey is in the middle of a rough patch. Turkish assets won't necessarily help for the time being.

The three funds mentioned above may or may not be ideal foreign exposure (I own PID for a couple of clients) but from the top down the first decision needs to be do you want foreign exposure, yes or no. From there top down process would be to then figure out the best way to capture foreign exposure. The three funds are fairly broad, which is a valid way to go or you could choose a narrow approach with individual stocks or single country products.

PID and all of the WisdomTree International funds help solve an issue I have been writing about for a while which is the tradeoff between yield and diversification.
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Emerging Market Export Data

Here is some useful info.

Chile has very little reliance on the US.
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Phonak

Some of you might recall that Spock's father was Phonak. Humor attempt.

The other six people, besides me, watching the Tour de France will recognize Phonak as one of the teams in the tour. A secondary sponsor of the team is iShares. Next year iShares will be the primary sponsor of the team.

From a contrarian, of sorts, point of view could this be a top for ETFs one way or another? Probably not but there are a couple of rather gimmicky funds on the way.

The Claymore Stealth ETF that is still in registration seems like it might be a bit of a stretch. The idea is that it will own stocks that are under-covered by brokerage firms.

The idea is that the street misses smaller companies that are growing quickly. Brokerage firms don't get around to sponsoring these smaller companies until they grow bigger. The Stealth ETF will presumably own these stocks while they are getting big enough to get picked up by analysts.

The idea really is a bet that the industry is wrong and slow. I'm sure they have great data to support the idea but it might be a tough bet to make. This will no doubt be a proxy for small or micro cap stocks. With something like this it probably makes sense for the fund to build some track record before buying. It may be a proxy for small cap, but it may not be a good proxy.
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Interest Rate Folly

Regular reader retiredinprescott left the following comment.

Bill Fleckenstein writes today in his Contrarian Chronicles that he believes the Fed is done raising rates for this cycle. Bill is a pretty bright guy although his track record is spotty (whose isn't?). I guess my point is that predicting interest rate trends is one of the most difficult, if not impossible tasks an investor faces.

The reader goes on to say he is trying to figure out whether to lengthen his maturity or not.

In part I agree about predicting rates but I also disagree. Over the life of this blog I have chimed in a little bit about where rates have been headed. I was wrong about Fed Funds, I thought they would have stopped sooner but have generally been correct about the middle of the curve and I don't think I have ever made any comment about long dated paper (30 year).

Any comments made in the past and anything I might say along these line in the future has more to do with knowing how numbers usually work as opposed to anything else.

For example it is a good bet that the slope of the curve, which has flattened/inverted as it often does toward the end of an economic cycle, will normalize to a steeper slope as a new cycle starts. Flat steep flat steep flat steep is just how it works, I think Leonard the money wrote a white paper on this last fall.

A steeper curve either means short rates go down, long rates go up or some combo of the two. Fed funds at 1% is unlikely, so is 2%. I'm not sure how low it will go when they start to cut rates but they will cut at some point. A steeper curve makes lending more profitable and can spur an economy.

If you buy into the ideas I put out this morning about some fundamental drivers for higher rates combined with long-term cycles continuing to work in some magnitude then this type of thesis does not seem that complex. Timing it correctly for people that feel that need to try to game it certainly adds a lot of complexity to the topic.

I believe the trends will play out the way they always have so I would not want to lengthen maturity while curve is still flat/inverted.
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Big Macro

Bill McLaren made a point on Today's Business Europe that should be an obvious possibility but if not, here you go.

He talked about US interest rates moving in roughly 25 year super cycles. The following is Bill's chart to make the point.

He feels that interest cycle has bottomed (this is logical) and that we will be starting a 25 year up cycle in rates, if it has not already started.

He thinks that borrowing costs could double from current levels. This kind of ties in with my thoughts about rates. Just last week I mentioned some sort of reversion to a historically normal level for the ten year treasury in the mid sixes to low sevens seems plausible in the next couple of years.

That ten year treasuries will yield 10% at some point in our lifetime hardly seems like an outlandish prediction.

To be very clear this is a multi year idea, maybe even longer than that. There is a path to higher rates based on how the fundamentals are shaping up as well. If the deficits stay high, rates have to go up. If there is less demand for dollars in the next few years, that too will put upward pressure on rates as well.

The investment relevance for this could be that if treasuries ever do yield 10% we may want to own more than we do now, but we can't know for sure until/if it happens.
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The Big Picture For The Week Of July 9, 2006

BusinessWeek had a midyear followup of its 2006 survey of market forecasts. The follow up had brief opinions from four people listed in the graphic along with their expectations for the Dow, S&P 500, Nasdaq and Russell 2000. The graphic also lists their current asset allocations.

I think there are a couple of mistakes on the graphic based on the text of the article. First, Warren Bagatelle expects the Dow to finish the year at 11,150 and the S&P 500 at 1365 but the article says he does not expect much for the rest of the year. Something doesn't add up there, maybe he means 1265 which is where we closed on Friday.

The other mistake is in the allocation from Barry Freeman. The graphic says 40% in domestic stocks, 40% in foreign stocks, and zero in bonds. The text says 40% in domestic stocks, 40% in bonds and makes no mention of foreign stocks.

I know one or two people from the magazine stop by this blog now and then, perhaps someone can shed some light?

None of that is even the point of the post. Depending on what Mr. Freeman really has in mind, either two or three of the four people profiled have zero weight to foreign stocks. Just because I think there is a clear and obvious path for outperformance from foreign investing doesn't make it correct. I could be wrong.

But zero is a big bet. Only one of the four appears to advocating a diversified portfolio based on assets class exposure. In that a major theme of this site is trying to help do-it-yourselfers get better results with a little less risk; one of the virtues of proper diversification is that you don't need to be right about as many things to have success. I would think this would appeal to people that do not want to make their portfolios a full time job.
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Money For Nothing-Chicks For Free

If you are of a certain age you may recall this lyric from the Dire Straits from the early 1980's.

The Striking Price in this weeks Barron's is about the potential complexity of adjusted options. The article gives some examples of strange option adjustments but misses a key point. Often when options get adjusted for something like a merger, spinoff or special dividend the appearance is created that the options are giving away money for nothing, a lot of money.

Capital markets never give away a lot of money. If you see an option that is priced too good to be true, it is. What makes this tough is that people often think there is free money, and the phone rep at the discount firm won't be able to explain to you why you are wrong.

Fair warning right here. Free money will never be more than a few cents. If you see an option with many dollars of free money you don't have the whole story.

Here is a made up example. Ginormous Inc. trades for $40 per share. It spins off Teeny Tiny at $7 per share. A shareholder of 100 old Ginormous at $40 now owns 100 Ginormous at $33 and 100 Teeny Tiny at $7, it is the same $4000 worth of stock before and after but allocated between the two stocks after the spinoff.

Before the spinoff a call option struck at $40 expiring in two months might trade for $1.50. That same option after the spinoff will still be at $1.50 even though Ginormous is now at $33. Before the spinoff it delivered $4000 worth of stock in the form of 100 Ginormous shares. After the spinoff it still delivers $4000 worth of stock but now that $4000 is comprised of 100 Ginormous and 100 Teeny Tiny. Determining whether the 40 strike is in, out or at the money requires adding the dollar value of 100 Ginormous shares plus the dollar value of 100 Teeny Tiny shares.

Someone who does not realize what these options are might see the $1.50 premium, the option appearing to be seven points out of the money and only two months to expiration and sell all the naked calls he can. Blowup.

This may be complicated and I may have written it poorly so just remember there is no free money in the options market.
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Translation: Go Foreign

Your Golden Years Don't Have to Be Tarnished

This is a good read from Ben Stein on Yahoo. It is eye opening in terms of magnitude and makes the case for foreign exposure.
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Out In The Blogosphere

Bill Cara has an interesting post up called Surviving A Market Meltdown in which he says he expects the Dow to drop by 20% in the next couple of months and he also gives some specific idea about how to position your account during this move he is expecting.

I know that Bill is good at getting the direction right, I do not know his track record for being right on magnitude (not saying good or bad, I'm saying I don't know).

Here is the list of what he says to do (I used fewer words);

• Buy index puts on up days
• Sell popular stocks with high RSI and relatively high p/e ratios
• Sell stocks with visibility for bad earnings
• Scale back core holdings on up moves
• Don't write puts unless you really want to own the stock
• Avoid emerging markets now, be ready to buy soon
• Increase precious metals exposure on pull backs
• Buy junior mining stocks that meet very specific criteria
• Buy high yield bonds of "solid" corporations
• Buy high quality income trusts
• Buy a short term ladder of CDs
• Hedge the dollar with the loonie

There's a lot there. The one about buying high yield bonds of solid companies doesn't seem correct. There is plenty of very low-risk yield to be had in the mid fives. If he is correct about the magnitude, he is talking about a 20% decline in just a couple of months after all, I would be inclined to think spreads would widen (meaning treasury prices go up, prices of other fixed income products go down or some combo of the two).

I may not want to do all of the others he suggests but the points made are good ones. The reason why I am writing about this at all is to show there are different approaches that should be explored and understood.

I write about taking process from different sources to create your own process.

My process for trying to game something like this would be to continue as I have been writing about, I have reduced exposure, I have talked about adding a double short fund and next week I will be adding a currency ETF for clients before the ZIRP news next Thursday ( I will write about that next week when I do the trade) all with the hope of missing a big chunk of a big decline.

At this point I don't think a 20% drop from here is in the cards (not that I have to be right). There is a fair bit of concern out there. In the current environment I think that big of a drop so soon could come from an external shock (which is always possible) or after a move higher from here that causes amnesia about all of the problems that confront the market these days.

I am on board with caution and a poor market climate but for now I don't see 20% down. To be clear my ego is not such that I will go down with the ship. I don't care about being right, the best thing for clients, IMO, is if I can miss a chunk of a big drop.

I think Bill's time frame is shorter than mine which makes for a different process and approach. Neither is better than the other. The answer for you might be in the middle.
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British Pound

I have mentioned reading commentaries from Jyske Bank in the past. In today's currency report (the link is to a PDF) they reference an IMF report, that I was unable to find, that shows the British pound has been attracting flows as a reserve currency at the euro's expense. Without saying why, Jyske sees the trend continuing.

I have written quite a few times about the dollar having to share the role of world reserve currency in the future, most likely with the euro. I hadn't thought about the pound in this light and will try to find more on this. If you come across anything along these lines feel free to leave a link.

If this idea ends up bearing fruit, there is an ETF that owns the pound that trades under ticker FXB.

By the way Bob Pisani just gave a stagflation shout on the air, so much for my Bookvar prediction.
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That ADP Number

Well, so much for the utility of the ADP number as a predictor of the gubment number.

The report was really bad, weak growth plus a high increase in wages. This report of course now means that the Fed absolutely, positively will--wait, it probably means nothing.

Whatever the report indicates for the Fed could easily be reversed by some other number that comes before the next Fed meeting.

The last time I wrote about the Fed being data dependent a reader left a comment asking whether the Fed is always data dependent, implying that the newness of the term is silly. The reader was of course correct.

I have tried to encourage a line of thought that is not so obsessed with each data point and the Fed. I think it is important to follow and try to understand the data and the Fed but there are not too many investment decisions that need to be triggered as a specific reaction to the Fed.

History tells us they will go a little too far and then stop. They are probably very close to the end but that could change, I suppose. Someone on TV today will bring up stagflation as a possibility; maybe it will be Peter Bookvar.

I think we are a long way from that being conclusive but it makes sense to being on the lookout, higher wages (ie inflation), fewer jobs (ie less growth), just be aware is all I am saying.
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Foreign Bonds

In the last twelve hours I have had one email and one comment on the blog about foreign bonds (the email also asked about foreign currency exposure too).

I can not imagine that an individual investor would be better off buying an individual issue as opposed to some sort of product that owns foreign bonds. In many cases there are high minimums for a domestic broker to take an order. While I am not sure what the minimums might be, how many people should put $100,000 into one foreign bond?

I look at this part of the market as trying to capture a particular effect that becomes more important in the face of problems in the US. There are plenty of funds (OEF and CEF) that are easy to access and relatively cheap (you are not going to find a fund that charges 8 beeps like an S&P 500 fund).

The currency OEFs do have some merit but over longer periods of time they may not move a whole lot. Given that I view currency investments as aggressive cash, lots of movement may not be desireable. I would encourage anyone to learn about the currency ETFs. They will not be right for every one, clearly, but there is no harm in studying and considering them.

Random thought, what has happened to ESPN? How much viewer demand is there for paintball, dominoes and poker?
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Maybe, Maybe Not

A reader left the following question/comment;

If we are looking to play defense against a falling market does the casual link works like this:

rising oil = inflation = rising rates = faltering stock market

If the above holds then I would think a defensive position should be in oil companies with proven reserves.

As part of a defensive strategy sure but yesterday oil was up, the market was down and so were a lot of energy stocks. This corrected some toward the end of the day but the sector may not work perfectly in the role of defense.

Looking at just one day is not exactly right of course. If oil goes higher or just stays where it is it creates some measure of headwind for the economy, perhaps not deathblow, recession or even slowdown but some sort of effect.

Energy stocks at a minimum have favorable conditions with oil at this price but it is not clear that this adds up to energy as a defensive strategy but perhaps just a bullish case for oil stocks. For now a bullish case for oil stocks may be a proxy for a defensive strategy but that may not stand up forever.
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Trouble 'round The Dinner Table?

Here is an amusing note, my older brother Larry has thrown his hat into the blogosphere in the last few days. The site is called Millionaire-Now.

He has come out of the gate fast and furious with some good content covering CEFs, metals, portfolio composition and real estate. Larry has been in the business off and on for quite a while, knows a fair bit and it comes across in the writing. He also draws on opinion and expertise from a lot of other folks for the posts he has put up so far.

Perhaps we can have some sibling rivalry. Mom likes his site better, dad mine. Larry runs faster but I can bench press more weight. Ha ha ha.
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Whacky Stuff

Today is a weird day, no question about it. Ken Lay dies, North Korea is center stage, Texas tea is back above $75, the post from this morning was muted out by the ADP report and I was hoping to watch the World Cup match that starts soon.

It doesn't feel like there is a lot fear being expressed but the VIX is up 10%. Adam Warner doesn't seem too concerned but does not dismiss it completely either.

The market has felt heavy for a while and today does not help. I have been urging caution and advocating a relatively defense posture for a while now, without an extreme cash position. For now most accounts are still 75%-80% invested in equities, keep in mind the market is only down a little so far and may never go down a lot.

The trades on my radar have been on my radar for a while without any action taken yet are to add a food stock with a high yield, add one of the currency ETFs, perhaps the TIP ETF while reducing a little more industrial exposure. If things get really bad I would be comfortable with reducing net equity exposure a lot with a double short fund. We are not there yet. I think another rally like in late April/early May where people seem to forget the concerns that exist would be a catalyst to add the double short fund in a significant way.
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Test Case

No doubt you have heard that the North Koreans fired some test missiles which has caused some reaction in various capital markets. According to a graphic on CNBC Asia, one of the missiles has a range of 3500-4500 km and could reach parts of Alaska.

Typically in the face of this type of scare US dollars rally, US treasuries rally, defense stocks do well, gold goes up and the Swiss franc might also draw some flow even if not from the US dollar.

While this is unlikely to have a lasting impact on markets it may make sense to study the reactions of different stock markets, assets classes, currencies, sectors and so on.

After 9/11 we were told to expect more attacks. I don't feel the need to devote space to how much danger the US may or may not be in at this point but certain things will go up in the face of a crisis.

This episode may be something big or nothing at all but study the reactions if there are any. Actually seeing market reactions can be very useful compared to my just telling you what usually happens.

For all I know this episode will have no impact at all, making this post useless but if there is a reaction it should be short and not that painful.

The notion of how to get defensive and when to get defensive is important and does not get enough attention in main stream media.
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Pros and Cons of Someone Else's Mousetrap

JD Steinhilber is one of the regular contributors at ETF Investor. There is an article of his up about his taking more defensive action of late which includes changes to his model portfolios.

You can click on the image to see details.

While I am not 100% certain, I believe the ETFs in his ownership universe have been the same for many months. Perhaps the healthcare ETF is different.

The big plus to this allocation is that is is simple to assemble and follow. There are not a lot of moving parts and this strikes me as being very much a top down strategy.

The first negative that comes to mind is that it does not really take advantage of some of the product innovation that has come out in the last couple of years. I believe the only newish product is the one closed end fund, Kayne Anderson (KYN).

Using a few narrower products can help add some performance. Obviously the use of any narrower based products requires more time spent which is not what everyone wants to do, fair enough.

In JD's portfolios the range of large cap weightings is 20-30% depending on allocation. Something like DVY could be a large cap proxy. It has done better than the S&P 500 and has a much higher yield, 3.57%. This is just an example and not meant to be a recommendation.

I've written countless times about my preference to isolate certain countries as well. This is also not captured in a very broad approach.

The point of this post is not to criticize by any means. If you have read JD's content you know he knows his stuff. The point here is that investment products allow investors to capture many parts of the market, enhance yield and perhaps isolate parts of the market where there is extra expertise based on personal experience.

As I have been writing since the beginning, I think it is important to learn about the new products that come, weigh out their potential utility and perhaps invest in at some point.
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A Couple of 30,000 Foot Points

The market was up a lot on Thursday, flat on Friday and up a little today. This may or may not be important but regardless there are some big themes that should not be forgotten as the market does whatever it will do for the rest of the year and in 2007.

If you read the Barron's interview with Ned Davis this will look familiar as it is his comments that are behind this post.

Demand for oil is growing faster than new supply. In the interview, Davis cites similar per capita numbers that I have cited in the past that I got from Puru Saxena interviews on CNBC Asia. Per Davis, and similar to Saxena, the US uses 25.8 barrels of oil per year, China 1.8 and India 0.8. Is there any doubt that those last two numbers will go up?

This guarantees nothing but creates a clear path. Keep in mind this opinion has nothing to do with this year's driving season or hurricane season. This is a multi year theme that I first realized a few years ago and will likely continue for quite a while longer, think years.

The various US deficits and imbalances are large and getting larger. Last I heard, Bush plans to cut the budget deficit in half by 2009. Every economic thing he has tried to do has fallen short of his expectations and I can't see why this would be different. This is not to say his policies have not helped, just that they have done less than what was expected.

Growing deficits create a clear path to a weaker dollar over the next few years. It is in no one's interest, globally, for the dollar to crash but weakness for the rest of the decade without a crash might be a different story.

The period of super easy money is over. There are consequences for big changes in global liquidity. The US started going back to normal a while ago and Japan is just starting now. Money is/will become more expensive. This should cause (perhaps this has started already) capital to move around. I think this means surplus and commodity countries would benefit.

None of the thoughts here are new. In a big picture sense, these are important themes. This helps lay out some of the obstacles faced in the years ahead. The US stock market could do very well in the face of this of course but great returns probably means overcoming high oil prices, higher interest rates and a weak dollar. And let's be clear, great returns are possible.

Some exposure to things that benefit from higher oil, a weaker dollar and a reduction in global liquidity seems like a good idea for the rest of the decade regardless of what happens this summer.
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Greg Mankiw's Blog

Greg Mankiw's Blog

I may not be literally the last to know that Professor Mankiw has a blog but I am close.

An idea I have been writing about for ages, related to the blogosphere, is that do-it-yourselfers would gain access to better information and commentary as the blogosphere evolves.

This blog will be a case in point.
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Bonds Now?

A reader left this question about buying bonds.

I have a question about bonds. Is now a good time? One would get the benefit of interest plus possible cap appreciation. If you sense that the year will be negative to flat, as you mentioned, why not hunker down in a high yield bond fund? Some bond funds I looked at are down 2-3 percent ytd and paying well over 6. With six months left, that's 3 percent plus possible appreciation. The possible part is the catch. If we go into recession, as you fear, then would these funds be in trouble?

Funny because I had a similar discussion with a client over the weekend.

Is now a good time? Bonds are an asset class and belong in diversified portfolios one way or another. An aggressive investor might use fixed income to manage volatility and enhance yield and a conservative investor might weight them more heavily to provide income. It is important to remember that bonds don't offer real growth but price movements occur and occasionally need to be taken advantage of.

From the this is just how it works standpoint, the yield curve in now flat and will take on a normal slope at some point. The long end will go up in yield or the short end will come down or more likely both will occur. Regardless of anyone's ability to predict when, normalization will occur. Also, a ten year treasury yield at 5.13% is below the historical norm. I would not be shocked to see ten year yields in the mid sixes sometime during this decade, and that would not be historically high. If they ever go to 10% again (not impossible), that might be a time to back up the truck.

So if higher long term rates with lower short term rates seems plausible to you for later in the decade, short term debt would be the better buy. That is not to say that in structuring your fixed income portfolio you should only own two-year treasuries. Remember just because the yield curve should normalize does not mean it will normalize. This, like equities, is about not betting on only one outcome.

A bond portfolio can have many holdings of different types of fixed income products with different maturities but still tilt to whatever maturity and quality and so on that you think is right.

The reader asks about funds. The drawback of bond funds is that, unlike a bond, there is not par value it will eventually come back to. A bond fund can drop and stay down. This does not have to be a reason to stay away but all products have drawbacks and this is a big one for bond funds.

If we go into a recession, the Fed should ease rates, causing yields on the rest of the curve to come down causing prices to rise. So you get price appreciation but depending on what goes on in the fund the dividend paid could go down. The reader says he has found funds paying 6%, this at a time when treasuries are in the low fives. If treasuries were to yield only 3% (intentional hyperbole), the 6% yield is not like to stay around. The managers would likely sell some holdings to take gains. They don't have to of course but it is possible.

For fixed income I utilize treasuries (more so now than a few years ago), preferred stocks (individual issues IMO are less volatile than funds of preferred stocks), closed end funds, foreign bond funds, convertible bond funds and TIPs.
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The Big Picture For The Week Of July 2, 2006

Barron's has an article up (sub required) that wonders whether or not there are too many ETFs. Regardless of your opinion this is a good question to ask every so often.

A recurring theme to my commentary here has been that ETF offerings will allow access to more parts of the market, there will be both useless and useful products that come along and that we should all continue to keep tabs on new products as they come out.

WisdomTree just came out with 20 new ETFs. I have mentioned them a couple of time but have not really delved into them yet. I am convinced that their products are innovative, relative what is already out there. But I cannot imagine that all 20 ETFs will measure up to WisdomTree's own criteria for success. I'm not sure that even ten will be a hit but I think this goes with the territory. A few weeks ago a reader sent along a link to a news item from four or five years ago that Barclays closed a few sub-sector ETFs due to lack of interest. Now the ETF providers are falling over themselves to get new sub-sector ETFs to the market.

I think the notion of too many is the wrong way to look at the issue. The product is evolving, it is becoming more sophisticated and more investors are learning more about them. There is no genius in expecting some of the new ETFs will be popular and useful and some will offer no value at all. The divergence is unavoidable.

While I still prefer individual stocks in most instances, we are moving closer and closer to a point where thorough equity market diversification can be achieved with products only. Before you jump on me, I try to seek out some fairly narrow themes or countries or do some very specific things with volatility or market cap that are hard to recreate with ETFs. For example Ireland has been an investment destination personally and for clients for a long time. I capture Ireland through one of the bank stock ADRs listed on the NYSE. For folks that don't want single stock risk, there is no ETF but there is a CEF, the Irish Investment Fund (IRL). Price-wise it has held its own but the yield is much less than the ADRs.

That was just an example. Not every possible theme out there is is captured in a product. There is still no way to capture Norway, I which I have been fond of for a long time, other than owning a common stock.

New products are coming fast enough that I would think a lot of the gaps will get filled at some point soon but pondering too many just seems like a waste of time.
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