ETFs In Barron's

Barron's had two articles about ETFs that you can read here and here if you subscribe. They both include the standard fare, questioning whether there are too many funds, quotes from people at Vanguard and Morningstar poo-pooing them and so on.

There is one point made that ties in with something I have been trying to convey about the sector and sub-sector ETFs; Consider that the handful of industry groups making up a major sector typically produce a wide array of returns. This was in the context of the telecom sector but it applies elsewhere and from a slightly bigger view there are times where isolating a sub-sector can lead to better returns and I don't think getting something like this correct is impossible for do-it-yourselfers as so many ETFs naysayers seem to believe.

As with any investment product there will be some small percentage of investors that use these incorrectly and we will no doubt read about them at some point.

Now that we have that out of the way these ETFs allow investors, looking to manage their own diversified portfolio, to capture very specific themes, in a reasonable proportion without taking single stock risk.

Here's an example of how this could look with the financial sector. I don't own any of the items listed (but I have written about a couple of them), I am just using them as examples. The S&P 500 is 22% financials so let's assume we want to target a slight underweight at 20%.

Citigroup (the common stock) 4% of the entire portfolio
streetTRACKS KBW Regional Banking ETF (KRE) 7%
PowerShares Dynamic Insurance Portfolio (PIC) 4%
iShares US Broker Dealer Index Fund (IAI) 3%
WisdomTree Asia Ex-Japan (DNH) 4% (this is 50% financials so it only counts 2% to the sector)

This mix isolates a few narrower themes, it yields 2.34% (I only took half the dividend from DNH into account as only half of the fund is financials) which out yields XLF by ten basis points and IYF by 34 basis points. Obviously it has a smaller market cap than either XLF or IYF which at times will mean it outperforms. I included Citigroup for some mega cap exposure.

This is not a sector allocation I am considering, I can capture better yield and more countries using common stocks but it makes a point that seems to be lost on a lot of people writing about the evils of sector ETFs. As opposed to saying why "most individual investors should leave these alone" perhaps some of the media could roll up their sleeves and actually do a little work to understand how to use them and actually write about that in an article.

C'mon in, the water's fine.

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The Big Picture For The Week Of October 1, 2006

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Obstacles

There was an interesting bit on the WSJ Marketbeat page about the market's recent strength along with some bearish sounding quotes from various people.

There are a few things worth understanding about current market events. I think there are some similarities to the top that was put in in 2000. The curve is inverted, the new high list is shriveling, sentiment (as casually observed) seems to be quite positive and there is not a lot of confirmation from other indices.

Obviously there are differences between now and then as well.

To be crystal clear I am not calling for a decline anywhere near the magnitude of earlier this decade.

All I am saying is that there are some issues present today that have caused trouble in past market cycles. These troubles, last time around took months to matter. The market has overcome these problems and many others to have the run it has had and it could continue to do so but these internal issues should not be forgotten or ignored. Nor for that matter should the big macro issues be forgotten either.

There is no question we have the ingredients for a decline. Ingredients however don't bake the cake. At some point I need to think about whether my moderately defensive stance is incorrect. It makes sense to reexamine the portfolio. Perhaps a move to make would be to add another defensive consumer name, with yield, that might outperform cash.

Also I am very underweight tech. I could add a little more and still be underweight. All the while I was selling tech, and getting that part right, I said I would probably miss the bottom which for now appears to be the case and has contributed to my lag for the quarter. I do not see a strong fundamental case for tech but it is doing well and I am very light in the sector.

This post really is just an inner monologue of thought process.
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More On Big Themes

My post yesterday referring to a few big themes drew some comments with other ideas for big themes. India? I can't even find it on a map. Advances in medicine? Who needs it?

Humor attempts.

There were comments left noting that India and advances in medicine as big themes. Those are of course valid, while we are at it what about Russia, Turkey or maybe uranium? The ones left by readers or these other ones might all end up being better places to be than the ones I mentioned.

I would not put too much into the three I mentioned. To me they are the biggies but the point of the post was for you to think about what really big themes you believe in for your portfolio, if you even think in those terms. I do.

I can promise you that one of the long-term themes you believe in will test your conviction at some point. Taking a 30,000 foot view every now and then is a good idea.

A reader asked me to expand on what I meant by water as a theme. Last December PowerShares came out with an ETF that focuses on companies in the water business, I wrote about the fund for TheStreet.com when it came out and have mentioned in numerous times on the blog. There are some potentially gloomy demographic issues with water, globally speaking. Growth in consumption is growing at about twice the rate of the population. There is a lot of evidence that says there will be a shortage of drinking water. This is something I buy into, I have owned the ETF personally and for clients since the second or third day after it started trading.

A reader asked me to compare the Gateway Fund (GATEX) to the BXD which is a buywrite index for the Dow 30. I'm not sure why this person is interested in the narrower Dow 30 but be that as it may. According to PortfolioScience.com GATEX and BXD have a correlation of 0.869.

The reader said he had a hard time charting the two, I also found a distortion on BigCharts, Yahoo had no chart and StockCharts did not know one of the symbols.

I was able to find this chart on Morningstar, the fund is red and the S&P 500 is in green. It kind of looks like the chart of the Merger Fund from over the weekend.

The fund is one of several OEFs that sells options for extra income. The fund owns a lot of mega cap stocks and for a call writing fund I would expect a higher yield. According to Morningstar it yields 2.15% which surprises me. As an OEF there is no leverage so it won't yield anywhere close to a CEF but 2.15%? The SPX yields 1.7%, I don't think it is crazy the fund could generate more yield but maybe the 0.95% expense ratio is too big of a bogey?

Either way, in the context of things that will not fully keep up with the market, but come close over long periods of time, with very little volatility, it looks like it belongs in the discussion; its standard deviation is only 5.11, about half of the S&P 500.

Lastly a reader, who said he can't own OEFs (must live in another country?) asked if there are any long/short CEFs. I am aware of one, the Old Mutual Claymore Long Short Fund (OLA). I wrote a negative piece about it for RealMoney in July but haven't looked at it since.
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Nick Knacks

I did an interview via email with Stocktickr.com that you can read here if you are so inclined.

The Marketbeat page on the WSJ Online picked up my CNBC rant from earlier today along with similar sentiments from Adam Warner.

I have been mulling my posts from this past weekend about having a big chunk of your portfolio in products that have almost no volatility, no short term correlation to the market but that capture not quite market equaling growth over long periods of time. As a refresher I looked at a couple of ideas that captured about 80% of the market's growth, over a ten year period, with just a small fraction of the market's volatility.

I also mentioned keeping some of the portfolio in some specific growth themes. If I could only have three themes, I have been thinking, what would they be? While I reserve the right to change this ten minutes from now I think China, water and oil sands would be the three most important themes for me for the next ten years.

We'll see if I make to lunch time with those but seriously, thinking about what themes in your portfolio you think are most important for an extended period of time might help you manage emotion in the short term (if you are prone to emotion) when one of them struggles for a while like the way the oil sands have struggled in the last few weeks.
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Not Again

Steve Massocca from Pacific Growth Equities was just on CNBC and said the right thing. The Dow and a high close (or not) doesn't matter. He said it is 30 stocks, it's not the same 30, it does not matter.

Bingo.

The floor trader they interviewed ten minutes before the open also made fun of the network for how they handled yesterday's action.

If 3M and Altria both have a bad day-no record.

Joe Kernen made a quick comment in passing when the econ segment was wrapping up; he said we aren't cheerleading, what are we supposed to root for a hard landing? I guess why I wonder why a journalist would root for anything.

The thing I find most frustrating about the channel is the time wasted covering things that don't help anyone. The market caps of the two big American car companies adds up to $33 billion, throw in Daimler Chrysler and the entire industry (in the US) adds up to $84 billion.

Perhaps market cap is not the best way to measure the impact of the group on the US economy but I don't think the auto industry is important enough to merit as much coverage as it gets.

When there is actual news they cover it but I would like to see broader coverage of more things which they do have time and personnel to do.

Just an early morning rant. I need some coffee.
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New Blog

Where is the Yield?

This is a new blog that I found on Seeking Alpha. It covers ETFs, high yielding strategies and portfolio construction.

It looks like the site only started this month so hopefully the anonymous writer will stick with it.
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Dow Party

Even the biggest bulls out there have to find some humor in CNBC's coverage today.
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Quiet Energy Comeback?

Energy stocks seem to be coming off their lows as there was a real hurry to get out of the group for a while. I may have this wrong but it seemed like after such a big, fast puke down, that some measure of snap back makes sense as I mentioned the other day.

Let's pretend for a second that I am right and the next thing energy stocks do is retrace 50% of the decline before doing anything else-materials too while we're at it.

I have disclosed several times that I will lag the market this quarter. A decent retrace would absorb a chunk of that lag. I would accomplish this by just being patient. By the same token tech, which I have been underweight, has gone up so much that some sort of decline seems plausible as well. A combo of energy, material up and tech down might erase the third quarter lag altogether.

Even if it does not pan out this way this time something similar will happen to your portfolio at some point in the future. There are times to take the lag and be patient and times where you really need to make changes. Being cognizant of this idea will help you at some point in your investing lifetime.
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The Yield Hog

I had an article publish on TheStreet.com yesterday about the Yield Hog ETF from Claymore. I don't usually mention the articles I write for TSCM but this fund is interesting and unique. As a client said he likes the idea, as I mention in the article, of letting it age a little bit but my initial reaction is positive.

The fund owns stocks, closed end funds, ADRs, preferred stocks, MLPs, pretty much anything. It is simply trying to capture yield where it can find it. The plus to this is that the product is intended to yield double what the other dividend ETFs yield. The negative is that it may be difficult to incorporate into a diversified portfolio because it really is a hodge podge of holdings.

The back tested results are outstanding. I will be curious to see if the fund can live up to the back test.
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Blogger On The Fritz

My sidebar disappeared I am posting this to see if it comes back. All of the links are on the individual post pages.
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Testing

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Stephen Roach On Commodities

Reader Russell120 left this link which is an essay written by Stephen Roach about commodity prices and the extent to which it is a bubble or not, how China is involved, what might be coming next and a few other things.

First things first, whatever happens from here with prices or China or any other related topic I believe the word bubble is inappropriate. The heaviest weight in the S&P 500 I can recall energy growing to was something under 12%. With materials I am less certain but I seem to recall the number being in the fours.

The tech sector maxed out around 30% and energy did something similar about 25 years ago. At 12% this year, energy was smaller than financials, health, tech and industrials. The materials sector may have only been bigger than telecom and utilities.

The price corrections maybe as severe (but I doubt that) but because these sectors, at their height, were so much smaller than tech during its bubble the consequence of a decline just cannot have the same impact on the broad market. If energy, from 12%, cut in half and everything else stayed the same that would obviously only be a 6% hit to the market. When tech went from 30% to 15%, well you can do the math.

That being said, no doubt that there are do-it-yourselfers that have blown themselves up but that does not have to mean bubble.

Roach cites (or maybe derides) a report from Ibbotsons that says "there is little risk that commodities will dramatically underperform the other asset classes on a risk-adjusted basis over any reasonably long time period."

I don't know the report first hand but even I, as being very constructive on the theme, never at my wildest eyed frenzy (well that never described my state actually) thought something like the above quote could be true.

I have gone out of my way to preach moderation, not only parts of the market I like but also parts I don't like. The very nature of the ascent in prices should tell you that a similar descent is always possible.

I suppose this could tie in with investors only liking volatility on the way up.

One thing I put a lot of time into is trying to make the portfolio somewhat predictable. Not "oh this year I will be up X%" but more trying to know within a decent certainty how volatile the portfolio will be. For example some of the different names I have written about in the past that I describe as low beta high yielding; you see those tend to have a low beta and a high yield. Ahem.

Adding a few of those in, or more than a few depending on your temperament, creates a certain amount of predictability. I own energy stocks for clients, they are down and the result this quarter is the portfolio up less than the market... for the quarter. Same, to a lesser extent with materials.

I believe it is fair to say this is far from a ruinous outcome.
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Funny (Not Really) Quote

Jeff Kleintop just said that bonds are no competition for stocks on the Kudlow show. This was in the context of trying to figure why the stock market did so well today.

My initial reaction to that was "unless Barry Ritholtz is right and the S&P 500 goes to 880."

Bonds would look a little better maybe?
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This Is Graphic

The Wall Street Journal has a good article about the state of the US' debt and ability to pay that debt.
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Something To Keep In Mind

Some portion of the selling in energy and materials stocks is part of a window dressing effect. Either some managers really are doing this or some traders think that managers are doing this. Also some of the commodities are having the same issue and natural gas has also been hit by the unwind of Amaranth.

I have no idea how to quantify the effect and I am not an energy bull calling a bottom. I think that after going down in price almost every day, related assets will correct up a little as the next quarter starts. After that maybe more selling, I don't know.

All of the long term supply and demand issues that draw me to the sector are still in place. Shorter term there is more uncertainty, obviously. Energy has gone from more than a 10% weight in the S&P 500 to 8.9% as of Friday. I have not sold any energy since May so in a way the sector has reduced itself in portfolios I managed which is good but on the negative some of the names I own that did better than the sector on the way up are doing worse on the way down.

My conviction in the long term combined with never having gotten carried away with how much I owned leaves me standing pat for now.
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Hmmm....I Wonder

My post the other day where I mentioned the Merger Fund (MERFX) got me to thinking about an idea. Not an idea without flaws mind you but an idea that if explored may provide some context for being a better manager of your own portfolio.

In that post I included this chart from Morningstar which shows MERFX in red compared to the S&P 500 in green over a ten year period. Ten years usually takes in a lot of cycles and a lot of stuff and is a reasonable benchmark of time.

If you knew you could get 80% of the market's return over that kind of time period with just a sliver of the volatility you might take that. Certainly there is a measurable chunk of the investment population that is not completely comfortable with the stock market's volatility.

I am wondering if there could be merit for a do-it-yourselfer to have most of their equity exposure in several things that behave in a similar manner to MERFX and then a little bit earmarked for a couple of more speculative ideas like maybe an Internet stock and an alternative energy name, just as examples.

If the market goes up a lot the idea would lag badly, when there is a bear market it would outperform by a mile.

There are a lot of ifs to the idea. While I have not yet looked for other things that behave similarly to MERFX, taking that fund a proxy for the idea there is no way to do any forward looking analysis on it. "Yeah I think that they will keep doing their thing the same way" is about all you can say or "I think the fund will be different two years from now." Neither one makes sense to me but that's about it for analysis.

One candidate for inclusion into this idea would be if something could actually mimic the CBOE Buy-Write Index. I plugged in just about every covered call CEF into PortfolioScience to try to find one that correlates highly to BXM and none of them do. Even the fund called S&P 500 Covered Call Fund (BEP) falls short with a correlation of only 0.459. With all the ETFs what about one that mimics one of the buy write indices? I believe in the concept and for now I think CEFs are the best way to capture it but I would not hesitate to swap for an ETF that could successfully mimic a buy write index.

This was the best chart I could find to compare BXM and SPX. It clearly is no MERFX but it is a noticeably smoother ride than the S&P 500.

With these two examples and any others that might come up I am not talking about fixed income products. The idea still centers around growth, boring sleep at night growth but growth nonetheless.

Clearly this will miss a lot of things and it does not strike me as the best possible way to manage your portfolio but if you do not already have an element or two if this, which I do, in your portfolio it probably makes sense to spend some time with this and learn a little more.
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Hedge Fund Stuff

Before I get into this, a quick public service announcement; I responded to a medical call tonight and let me just say if you do an activity that might need a helmet with a faceguard...wear a helmet with a faceguard.

With the Amaranth blowup there have been and will be articles questioning whether people need hedge funds or not, questioning the purpose, calling them out for the blight that they are, you know, that sort of thing.

First a word about Amaranth. As best as I can tell being wrong about the trade did not blow up the fund. It was the misuse of leverage. Too much leverage seems to be at the root of most of the problems that arise, here I am excluding fraud.

The fact is that hedge funds do provide liquidity to certain markets and when coordinated properly, here I am thinking Swensen at Yale or El-Erian at Harvard (or Jack Meyer before him), they do serve a purpose and are appropriate. Of course this probably is of little importance to your portfolio.

The point of this will not be whether you should or should not buy into a hedge fund or build your own but more of an exploration of a couple products that make hedge fund strategies easily available.

Merger arbitrage is a strategy most people are familiar with. There are several OEFs that invest in the strategy, the best known of the bunch might be the Merger Fund (MERFX).

This chart compares the fund in red, to the S&P 500 in green and its fund category. By and large it offers a pretty smooth ride and seems to have captured most of the market's move.

The correlation to the S&P 500 is 0.519, the standard deviation is 2.6 and the beta is 0.12 (all according to PortfolioScience.com). Regardless of what they are doing in the fund and how much (or how little) you are interested in the strategy, the results are compelling and doesn't seem to be inappropriately crazy.

A similar strategy might be long short funds that do pairs trading. I think all of the sector ETFs create the chance to go long a stock and short a sector ETF. If you can pick a stock that outperforms its sector (this may not be easy), maybe with an above sector dividend yield, that has a high correlation to its sector and the result exceeds the current risk free rate of return it might be worth considering for someone that can spend a lot of time monitoring their portfolio.

As an example, National City Corp (NCC) yields 4.3% and has a 0.705 correlation to iShares Financials (IYF), I should note it has lagged the ETF but this is just an example. Going long NCC and short IYF in equal dollar amounts nets you a dividend of 2.49%. If NCC goes up 15% and IYF goes up 12% simplistically speaking you net 3% for a total return 5.49%. If your stock pick ends up lagging or the financials decline you have mitigated some of your risk.

The new single commodity ETFs that I wrote about a couple of weeks ago create all sorts of strategic opportunities, ditto the existing and any new currency ETFs.

To reiterate, the point of this post is not to encourage anyone to do any of these trades. Various ETFs, OEFs, CEFs (which I did not get into here) open the door to many interesting possibilities. At some point if someone pitches a fund to you or you think about buying into one it is possible you can recreate the same effect yourself or, by virtue of having thought about some of the types of trades mentioned here, make a more informed decision.
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The Big Picture For The Week Of September 24, 2006

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Market Backs Away

So the market made a run to the May high and might be failing, although a day and a half may be too little time to draw a conclusion.

This is something I have been writing about for a while. I did not invent this notion it was more of a school of thought that made sense to me at the start of the summer. It seemed like more people were publicly bearish in June and more people were publicly bullish all through August and September, no shock.

There are, and have been, serious issues confronting higher stock prices. In the last couple of days it seems like these have come to the fore a little bit and the yield curve inversion has been getting larger. So either stocks are taking a breather or rolling over. Being consistent, I think a rolling over is more likely but we will see.

Being consistent is an important thing in managing money, yours or someone else's. From the start of the summer I have been consistent about wanting to maintain a slightly more defensive position than normal. At the outset I said that I did not expect to capture all of a move higher while positioned that way and despite a lament or two along the way I have stuck to my knitting as the things that concerned me seem to have deteriorated a tad more, not doomsday just a little worse.

The big concept to tie into this post is that investing requires patience as measured by longer time frames than just days.
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Mega Cap Leadership?

Michael Kahn, in his regular Barron's column, talked about where the various major indices stand in relation to their highs of the year along with his opinion, technically, on each of them.

He made an interesting point out a recent shift in leadership to larger companies and drew what I thought was a good conclusion to pass along here.

He is focused on the S&P 100 (OEX), the biggest of the big, as the canary in the coal mine for the market. He says "If the steadiest and strongest index runs into problems, then the rest better watch out."

There is an ETF that mimics the OEX that trades under ticker OEF. I thought that to illustrate the point, using the Rydex Russell Top 50 (XLG) might capture this point a little better.

This chart compares XLG to SPY for the last six months. A similar chart comparing OEF and SPY shows a flat line which is corroborated by a 0.982 correlation, per Portfolioscience.com. XLG has a slightly lower correlation to SPY than OEF at 0.935. As read I Michael's column, a rolling over of the biggest of the big would spell trouble, this chart just looks at it a little differently.

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New ETFs From Powe....I Mean Clay...I mean iShares

This has been some week for new ETFs, howyadoin?

iShares listed five new global sector ETFs. iShares has five others so I guess the rounds it out.

The five are;

iShares S&P Global Materials (MXI) which is 76% foreign and oddly seem to have two different listings (different countries it seems) of BHP Billiton totaling 7.8% of the fund.

iShares S&P Global Consumer Discretionary (RXI) which is 50% foreign and is heavy in auto stocks.

iShares S&P Global Consumer Staples (KXI) which is 44% foreign and looks, at first glance, like it will pay a pretty good dividend.

iShares S&P Global Industrial (EXI) which is 43% foreign and may be worth considering if for nothing else its relatively small weight to General Electric (GE) at 15.66%.

iShares S&P Global Utilities (JXI) which is 60% foreign.

I will look at these closer. I have used the other iShares Global ETFs in accounts where ETFs are the best tool, have wanted these five to come for a while and hopefully after further review I can find a use for them but I will study that later.
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Cause For Concern?

I for one continue to be concerned about the yield curve. I saw visibility for inversion going back a long way and we have been living with more than a slight inversion for a long stretch now. The ten year is yielding 4.66%, the 30 year is at 4.78% and you know the Fed Funds are at 5.25%.

The historical implication is that this will cause a recession. It works most of the time and this go around will either fall into line or not but I think at least it should be a concern. Some are saying that this is the bond market building in a slow down and that Fed Funds will be lowered soon to adhere to what the market is saying.

I don't think there is any way (excluding external shocks) that the Fed will lower rates this year or in the first quarter on next year. I am not trying to predict when they will cut I am just saying it won't be soon.

The lower rates could push back whatever the fallout might be in the housing market which would be a plus but being dismissive of the potential for recession is a mistake, IMO.
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New ETFs From Powe....I Mean Claymore

If you did not see the in depth 30 second segment on CNBC you may have missed this news.

The five ETFs are the Claymore Zacks Yield Hog (CVY), the Claymore Zacks Sector Rotation (XRO), Claymore Sabrient Insider (NFO), Claymore Sabrient Stealth and Claymore BRIQ ETF (EEB). As a side note they Claymore listed essentially the same BRIQ ETF in Toronto under ticker CBQ in the last couple of weeks.

I will be doing a write up on CVY for TheStreet.com on Tuesday (it will be available for free). These ETFs have been in the pipeline for a while and I have touched on these briefly in the past. The potential problem I see in utilizing some of these fund like Stealth, Insider and Sector Rotation is difficulty in managing the capsize, style and sector weighting. The back tested performance has been very good to be clear and while relying on back testing is not ideal, good results certainly are better than nothing. Of course if the results stunk there'd be no fund.

If you have interest in picking a strategy, similar to a stock screen, to include in a diversified portfolio you need to check the balance of your fund in the context of your portfolio a little more often than most folks, again if staying diversified is a priority.
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Water Off A Duck's Back

That is how the market appears to be taking the coup in Thailand. This chart shows the Thai baht getting hit as before the coup it took about 37.25 baht to buy a dollar. Then it took as many as 37.9 baht to buy a dollar and now it is back to around 37.4.

As recently as January it took 41 baht to buy a dollar. It turns out that over the last 60 years Thailand has had about as many coups as the US government has had presidential elections. Well that is an exaggeration but in Thai history coups seem to be an accepted way to change government.

The stock market, the SET index bottomed out at its open with a 4% decline but closed the session down 0.6%, in the immediate aftermath of a coup, 0.6%? Fascinating.

I have written a few times in the past about how markets tend to snap back quickly (this is subjective of course) from scary external events. It took six weeks for the US to snap back from the September 11 attacks for example.

It is possible it took less than six hours for the SET to snap back. While there could be more selling to come the very muted reaction provides a good example of how the market does not fear what it knows and for Thailand, it knows coups.
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New Sector ETFs

The gang over at PowerShares rolled out a bunch of sector ETFs based on Robert Arnott's method of fundamental weighting. I am sure some people will immediately will say we have enough sector ETFs, and maybe we do, but from where I sit if only one or two of them provide a better way to access a sector and the rest turn out to be duds that is OK.

Quite a few of the PowerShares product line does well, performance-wise, and draws a lot of volume. Their success allows them to venture further out and try new ideas. I saw Robert Arnott speak at the NYSE last December and I asked about this methodology being applied to foreign countries he said yes and also various sector which we are seeing today.

The new ETFs are;

PowerShares FTSE RAFI Basic Materials (PRFM)
Consumer Goods (PRFG)
Consumer Services (PRFS)
Energy (PRFE)
Financial (PRFF)
Healthcare (PRFH)
Industrial (PRFN)
Telecom (PRFQ)
Utilities (PRFU)
Small-Mid 1500 (PRFZ)

Obviously that last one is not a sector fund.

I will study all of these in the next few weeks but looking at one random fund I picked the Industrial fund. According to the info sheet General Electric is the largest component at 21%. Yikes. GE is the largest holding in every industrial ETF. It makes up 18.5% of the Industrial Sector SPDR (XLI), 19.5% on Vanguard Industrial ETF (VIS) and 19.8% of iShares Industrial (IYJ).

I'll look at these closer but I will say that I am surprised at the lack of differentiation between PRFN and the others.
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Bumpy Ride

Emerging markets are going through a couple of huge market-moving events right now.

In Hungary, it turns out that Prime Minister Gyurscany lied about the health of the economy in trying to get reelected. This has resulted in demonstrations in the streets including, according to one story I read, a takeover of state-run television!

Thailand is currently enduring a coup. A coup?!

Prime Minister Thaksin has been controversial for a several years, and it looks like it has reached a boiling point.

I write a lot about investing in emerging markets, and I have unyielding faith that the asset class belongs in a diversified portfolio, but moderation is very important and something I have tried to convey here.

I had countless comments and emails from readers with 20%-30% in emerging markets last winter before the spring correction. I urged those people to cut back, but who knows if they did.

IMO, equal weight is about 7%, and for some folks, that is too much, which is OK. The current events of this week will not be the last disruptions in your lifetime for these markets.

Be exposed, yes, but also be prudent.

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The Most Dangerous Metal?

So said Nicole Elliott from Mizuho in her usual appearance on European Closing Bell.

This is pretty much how she drew the chart and said she thinks it is going lower before doing anything else.

I have not said much about Silver or the Silver ETF (SLV). I have been clear that I think the market is tougher to assess and more volatile than gold. I do know the market is smaller for silver.

According to Portfolioscience.com the standard deviation for GLD is 22.89 and it is 40.20 for SLV.

In trying to find a good way to take on some commodity exposure SLV has more octane than I want to deal with. 
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A Tad Under The Weather

That's me so this will be short.

On the last video post and a few times during the summer I said that a lot of smart people were concerned about a lower high ending this run for the market.

While I don't know that this is what is happening right now it looks like the market is struggling with that May high. For all I know the market could rocket higher but clearly the resistance at 1325 matters to some degree. We'll know whether it matters a lot or a little soon enough.

In my haze I think I heard Steve Leisman say that we now have definitive proof that the housing bubble has burst. Whatever is going on with housing, risky loans et al I doubt it will be as all encompassing the internet bubble which really was a bubble that wiped out many many people. Anyone with too much house faces the risk of a wipe out at any time but I think that whatever might be coming will have less impact across society than the net bubble.
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FTSE/CNBC Global 300 Index

If you read Barry Ritholtz you know that this index exists but finding information is not that easy. I found this PDF on the FTSE site.

Like a lot of global mega cap-tilted indices it is about 50% US (52.03% to be precise). The UK and Japan are the other two big countries at 11.97% and 7.39% respectively; I am surprised Japan is not a little heavier weighted in the index. France is the only other country above 5% at 6.28%.

There are some interesting countries like Norway, Greece and Argentina included but they are so small that I don't think they can have any impact.

Over on Barry's site there are some comments that make fun of this along the lines of they will make an ETF out of this and it will be a dud. I am aware two ETFs the mimic similar indices; the iShares S&P Global 100 (IOO) and the streetTRACKs Global Titans (DGT). IOO and DGT are almost identical and any investment product that might come from the CNBC index will fall right in line.

You might find some commentary saying that these global mega cap funds are duds. More likely is that it has been a while since mega caps provided any long-lasting and substantial leadership. At some point mega caps will lead the market leaving other once hot segments for dead.
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Amaranth

You probably caught the news that a hedge fund called Amaranth got caught on the wrong side of a natural gas traded and that the loss YTD for their two main funds may be as large as 35%.

I do not know how important this story really is but I do think the episode is very constructive for anyone trying to manage their own portfolio. Earlier this year during the emerging market selloff there were a few comments left by people with, as it turned out, too much emerging market exposure.

I imagine this selloff in materials and energy has taught a few people they had too much exposed to those sectors. I have continually preached moderation in portfolio construction this current and now very popular idea that oil and gold will keep going down might be an example of the concept.

Materials, of which the mining stocks are a part, only comprise 3% of the S&P 500. Materials make up a similar percentage of most other broad benchmarks. I think 20% in gold stocks a huge bet. If an investor merely doubled up on materials and his picks doubled in value he would have added six percentage points of return to his portfolio which I think is substantial. If from there he sold nothing and those same picks are down 1/3 from there high he has only taken a 4% hit to his portfolio and is probably still close to the market for the year.

For anyone that now finds themselves with a lot of commodity holdings and lagging the market badly I think you need to consider changing how you do things.

This will no doubt fall on some deaf years as many people like the idea of chasing big returns but where possible I do what I can to smooth out the bumps that come along the way and one way to that is not go 20% into a narrow, volatile theme.
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Sweden

The Swedish election took place and the more conservative party won which sets the stage for lower taxes and the trimming of the extent to which Sweden is a welfare state.

I have disclosed having exposure to Sweden in the past for clients with long term holding Volvo (VOLV) and more recently having added the Swedish krona currency ETF (FXS) as well.

While I have no exposure to iShares Sweden (EWD) I have written about that ETF two times for TheStreet.com (here and here) and I wrote about FXS one time.

This chart shows the extent to which EWD has out performed SPY year to date. While I doubt it is the case for the run up in March and April, the run this summer was due, I believe, in part to the expectation the more business friendly candidate would win the election.

Now that the expected has happened I would not be shocked to see Sweden take a bit of a break. Long time reader, Tom in Indy asked what the down side to Sweden is. This could be one negative. While I have no plans to try to trade around this notion a pause makes sense.

Another thing that makes sense to me is that any change that might come will not transform the country into some sort of libertarian state with no tax and no government. A more realistic expectation would be a few small incremental steps.

One of the reasons I have been inclined to own Sweden is that is that GDP growth is outpacing the Eurozone and Sweden has a much lower unemployment rate. A few months ago when I touched on this point a reader left several links including this one that question the validity of the numbers. I don't think the market believes the numbers are bogus but if you have an interest in Sweden it is worth know that this argument exists.

For now the immediate reaction is that the krona is higher against the euro and the Norwegian krone (this is a popular currency pair), has given up its gain against the US dollar and the stock market is up 0.29%.
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Items

The Consumer

Rudolph-Riad Younes made an interesting comment in his Barron's interview about home equity borrowers in the US.

Wages + Home Equity Borrowing = Living Standard

In the context of discussing why there has not been much wage pressure in the US he said consumers have been taking out their equity to fund the gap thus averting wage pressure. That will change if/when "that sort of financing dries up for the consumer."

While this makes sense and seems intuitive I hadn't thought of it this bluntly. I am not trying to make a prediction from this but I think is worth passing along.

VIX ETF

In response to my off hand remark about a VIX ETF a comment was left asking how to invest in VIX given that there is no ETF. There is a futures market on the CBOE that I have not studied. There is an options market for VIX that is tradeable through any brokerage firm. The volume is decent and their is plenty of open interest in a lot of strikes. These can be difficult to trade however due to some strategic limits.

You know that VIX has generally been low for a long time, save for a few spikes. From 11.76, Friday's close, who is going to buy any puts? Selling puts seems sort of attractive but the only buyers (the use of the word only is hyperbolic) would be people putting on some sort of multi-legged combination. Generally there is more volume and open interest in calls than puts.
Using options risks worthless expiration. An ETF would avoid that issue, albeit more expensively. There are people that know a lot more about this than I do, maybe Adam Warner will find this post and weigh in?
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The Big Picture For The Week Of September 17, 2006

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The Fed Can't Cut Rates

Here's a theory.

Some out there think the Fed may cut rates fairly soon. I don't think so. Not that I am having an original thought but if the Fed cuts too soon it undermines their credibility and would likely cause some amount of panic selling in the dollar. Not to say that the dollar would not recover in this scenario but this absolutely something the Fed wants and needs to avoid.

Ron Insana started to go down this road yesterday saying something about an average of nine months between when hikes end and cuts begin. While I will take his word for that number I think a cut this year, save for a terror attack or other systemic shock, is off the table.

There has not been enough time for all of the rate hikes to work in to the economy. They had something in mind with regard to inflation as they were hiking and so some sort of scary number in the next couple of months should not be a shock if it comes.
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Labels

Where possible I try to avoid bull and bear market labels (admittedly they are easy words to use) but we had a good example this morning of why the terms mean very little.

There was chatter on CNBC about the Transports having topped out at 5000, going down to 4000 which is a 20% decline, a bear market but now it has gained almost half of that back.

The peak was in May and then it got close again in July. Clearly the ride down from July 5 to about August 10 was brutal but even if there is a text book definition somewhere that actually says 20% equals a bear market I don't think a bad month is something to be feared. Bad months happen all the time.

The sector is at a point now where we can see all sorts of things converging on the chart so the next few days could be interesting.

The decline from earlier in the summer makes some sense in the context of transports being so vital to an expanding economy. If there is a slowdown or recession in the cards transports would be especially hit (this is not a bold call, just a normal reaction to a recession).
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Sweet Fancy Moses

That was my reaction when I found this article from Index Universe via Seeking Alpha. ProShares has filed to launch 66 new ETFs.

ProShares (part of ProFunds) has filed for a double long, short and double short for the following;

Russell 2000
S&P Small Cap 600

S&P/Citigroup 500 Growth
S&P/Citigroup 500 Value
S&P MidCap 400/Citigroup Growth
S&P MidCap 400/Citigroup Value
S&P SmallCap 600/Citigroup Growth
S&P SmallCap 600/Citigroup Value

Dow Jones U.S. Basic Materials
Dow Jones U.S. Biotechnology
Dow Jones U.S. Consumer Goods
Dow Jones U.S. Consumer Services
Dow Jones U.S. Financials
Dow Jones U.S. Health Care
Dow Jones U.S. Industrials
Dow Jones U.S. Oil & Gas
Dow Jones U.S. Precious Metals
Dow Jones U.S. Real Estate
Dow Jones U.S. Semiconductors
Dow Jones U.S. Technology
Dow Jones U.S. Telecommunications
Dow Jones U.S. Utilities

If these get approved will you need them? Will anyone need them? With a long list like this there will be funds that do attract a lot of interest and ones that don't. This is far from insight but just the nature of things in ETF land.

I hope they get approved. I like the idea of being able access more parts of the market in different ways without having to pick stocks. Long time readers will know I use common stocks the vast majority of the time (despite all the writing I do about ETFs). More specifically I will use whatever tool I think best captures the effect right now. Most of the time I conclude that is a stock but not always.

I concede there is very little chance I will ever need double short semiconductors but who knows what the market will bring three years from now. This list, if approved, simply creates more choice which I view as positive.

While we are at it, anyone working on a VIX ETF or any foreign short, double short or double long ETFs?
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Global Tidbits

The Swiss National Bank (SNB) raised rates by 25 basis points.

In New Zealand, Bernanke equivalent Alan Bollard indicated that their overnight rate may need to be raised in the future.

Inflation in Poland is only 1.4%.

The Daily Pfennig noted that the Ukraine has rotated some of its reserves out of dollar and into euros. The Pfennig rightly notes that the numbers are small but this is yet another country demanding fewer dollars.

The Sedlabanki (Central Bank in Iceland) raised its over night rate to 14%.

The point of these items is just to promote awareness. I believe in staying in touch with what is going on elsewhere.

About Iceland, after being headline news for a while things have calmed down. The krona has been strong for the last few months.

I first wrote about Iceland as an investment destination a year ago March and have been invested there personally since February.

My timing was not as bad as it seems (part of it was out of my hands as it took months to get an account open) as the market went up a lot right when I got in. It then went down a lot but with all the excitement the ETF I own is down 1.8%. When the currency is factored in I am down about another 9% but I have half the account earning interest which has averaged 10% since I have had the account which helps absorb the currency decline.

When I made the decision to invest in Iceland (note that clients do not have exposure due to the volatility) I felt it would be a very long term proposition, similar to Vietnam which a couple of clients are exposed to. When it was really hitting the fan in Iceland during the spring I was not concerned in the least. This is about mind set and nothing else. I could end up being dead wrong about Iceland but I won't know right or wrong for several years.

I can tell you that having been there, things appear to be booming. The drive in from the airport is littered with cranes. In walking around there are a lot of young people driving BMWs, Mercedes and Range Rovers. Also some of the off the record comments from my interview with Glitnir CEO Bjarni Armannsson left me with the impression that there are more good things to come in Iceland. Here I am isolating anecdotal bits of information that you might not read about elsewhere.

All of this guarantees nothing and no doubt there are intelligent points to take the other side of every bullish point I could make but I believe in what is going on there. Also I have less than 4% of my portfolio exposed. Iceland won't go to zero but if it cuts in half I won't be damaged.
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I Don't Think So

An analyst from BB&T Capital Markets was on CNBC a few minutes ago and I think he had a tough time because it looked like he was working very hard not to make Mark Haines look silly.

The analyst covers mostly drug stores and super markets. The lead in to the interview was how strong these stocks have been this summer. The stocks on the graphic that he covers were Fred's (FRED), Kroger (KR), Safeway (SWY), Longs Drugs (LDG), Sysco (SYY), United Natural Foods (UNFI) and Walgreen (WAG) which is a client holding.

It was these stocks that were discussed in the interview. Mark jumped in by asking if you believe the market is a discounting mechanism then these stocks are telling us the consumer is just fine. The guest analyst was stymied. He steered the conversation to restaurant stocks and more specifically restaurant suppliers. He noted the suppliers have been beaten up lately.

The consumer may be fine but drawing this conclusion by looking at staple stocks makes no sense. Staples tend to provide leadership as the stock market starts to discount (to use Mark's word) slower growth or recession. Sales of prescriptions and relish are not a way to measure the health of consumer spending.
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Weightings

Tom McManus was on CNBC earlier today and the discussion drfited to what would be an appropriate weight for commodities in a diversified portfolio.

I have written more times than I can count about my belief that commodities are a crucial element to being diversified. I have heard in various interviews that anywhere from 5-15% should be in commodities. I have never been a proponent of a double digit weighting.

Right now just about everyone has the gold ETF (GLD) at a 2-3% weight and some clients own a big, foreign, diversified miner at 2% and that is it for direct exposure. I do think of Plum Creek (PCL), which I have disclosed owning previously) as being different and PortfolioScience backs me up saying that its correlation to GLD is 0.057 and although I don't own it anywhere, PCL's correlation to the DB Commodity ETF is also quite low at 0.026.

Kind of in the commodity arena is the Australian bank I own for clients but its correlation to GLD is 0.359 and a few people own CVRD (RIO) and a Chilean bank which correlate to GLD at 0.429 and 0.187 respectively.

I don't view the above as particularly heavy but you may view it otherwise, I should add that no client has all of the above.

I find that there is a lot of extreme positioning and commentary available out there and while I find utility in reading the arguments made, I don't find much utility in the positioning.

All of the commodity naysayers will tell you that commodities are volatile and difficult to time well. Hello, they are right! The volatility (this is a euphemism for decline) of late is exactly what they mean. My first post on gold two years ago said that stocks tend to zig when gold zags. This summer captures it perfectly.

On more than one occasion, I have said here that I do not want gold to ever be the best performing thing I own because chances are things look rough elsewhere.

Another thing I have preached is that not everything should going up at the same time. If so, you are not that diversified. Lately gold and oil have declined but a lot of other things have been working. While it is true I have lagged this summer the fact is some things are up a lot, look at Walgreen and Target.

The action recounted in this post is the playing out of almost every theory I subscribe to. Despite getting a couple of big things wrong client accounts are going up. I still think it turns but even if I stay wrong the impact for clients is much less than had I been only 30% invested.

Good stuff!
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Four Things

ETFs

A former colleague of mine sent me the link to this Morningstar article by Dan Colluton. The basic premise expressed is that ETFs may not be all they are cracked up to be because the managers aren't on record for owning shares of their funds. Mr. Colluton believes that this can be useful indicator for how much the managers "really believe in the funds they run."

He goes one to say this does matter because "the interests of managers who are compensated based on how well they run their funds, and who have significant sums of their own money invested in their portfolios, are more aligned with their shareholders."

Wow.

This seems so upside down I don't know where to begin or end. So is he saying iShares Korea (EWY) is the correct investment for anyone involved in managing it? It seems like an awful lot of all ETFs specialize in a sector or a single country.

If you look at the Morningstar ETF Report page you will see the most recent report was on the iShares Global Energy Fund (IXC). It turns out they think most investors should avoid the fund. Right before the report on IXC they did one on the Vanguard Energy ETF (VDE) and what do you know the risks out weigh the rewards. The report right before VDE was on the Utility Sector SPDR (XLU); surely not three for three! Hmm lessee, it says "We'd steer clear of this ETF."

I scrolled down to find a country fund and the most recent report I found (I may have missed one on the list) was from December on PowerShares Halter China Index (PGJ) and you won't believe this "We're wary of being tied to single-country funds due to their volatility, which is of even greater concern in emerging markets. Most would be better off with a diversified emerging-markets fund."

I think I am seeing a pattern here. So Morningstar thinks the funds should be avoided but Morningstar thinks the employees should buy the fund?

The ETF companies picked on the most in the article are iShares and StateStreet. I use more ETFs from iShares than I do from StateStreet but both are index fund providers. The work involved is making sure the math is right (hyperbole). This is not to minimize the importance of the funds or the people that work there but running an index is not about adding value as implied in the article it is about mimicking. You mimic with computers not an investment committee sitting around a big old money table debating sector and style rotation. Further I might suppose that the actual work of implementing and maintaining the fund is done by younger computer science grads.

The people we see interviewed from these companies are usually from marketing and so not really stock market people in the way that someone running an open end fund is a market person. For now, any actively managed ETFs are not really that active, they are stock screens. Here again someone clicks somewhere to rerun the screen then it boils down the software working properly.

I can't believe this was published but that's just me.

Marc Faber

Dr. Faber was on Asian Squawk Box on Wednesday morning for three very long segments. Generally he did not strike me as so bearish, relative to what I usually see him say or read of him in print. He does expect a recession in the US in late 2007 (per the interview) but he thinks the US market could go up to a higher diving board. He would avoid energy, miners and emerging markets for now but I took these more as trading calls. He said that technically the Nasdaq 100 looks to be the best trade in the US right now.

Comment Reply

A reader asked about the proposed PowerShares Dollar Bull ETF and the bear version. The funds will allow you to essentially go long or go short the US dollar index with an ETF. The reader wanted to know if I might prefer these over the single currency ETFs.

The make up of the dollar index is 57% euro, 13% yen, British pound 11%, loonie 9%, Swedish krona 4% and Swissi 3% (all numbers rounded down). Certainly I don't see the need to own FXE and PowerShares dollar bear fund. The starting point here, I think is that for some folks there is no appropriate currency product. That being disclaimed here is the comparison I see. Today you may think that in the financial sector this is a good time to not pick a stock but instead own an ETF. At some point in the future you may shift to thinking a few stocks instead of the ETF are the way to go. Even further down the road some sort of combo of stocks and an ETF is right.
This is not either or. If the funds list they will provide a different tool for a particular market. I can't imagine these could be permanently superior or inferior.

Video

It seemed like the response to the YouTube video post was positive. I will try to stop fidgeting but it is harder than it looks (at least for me) but this is a work in progress so I think they can get better. Shrink Rap's idea about doing it once a week on the weekend is a good one maybe that is what I'll do but we'll see. It is fun and the only hassle was it took a long time to upload. We'll see.
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Something New

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Gold Is Down

Gold has sold off lately. Now that it is down CNBC has brought out some analysts to tell us why it will keep going down and perhaps it will but I think it is worth knowing that the 4th quarter tends to be a time when gold rallies. Many attribute this to seasonal holiday demand from Asia.

This chart of the GLD ETF, which is a client holding, goes back three years, the left half of the chart is actually gold itself as GLD did not start trading until November 18, 2004. The seasonal effect is captured here.

In 4q 2003 gold went up roughly 13%, 2004 it went up 8.5% although it peaked with an 11.4% gain on December 3 of that year, and in 2005 it had 10.4% gain but peaked with a 13.68% gain on December 12.

Obviously there is no way to know with a certainty that history will repeat but if you are listening to people that say it will go down you may want to explore this seasonal factor a little more.

I am not really in the $1000 gold camp. In the past I have written $750-$800 as a ceiling but that seems a little high for now.

For what it is worth gold has been in a range of sorts that seems to be holding today right at the 200 day moving average. I think a $550 floor and a $700 ceiling, assuming no external shocks, may hold. If this notion holds any water, a price below $60 for the ETF for a long term hold thought of as a tool for diversification may be a good entry point for people that have no exposure.
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If Everyone Thinks It So

It can't be right.

This is the general tone of several comments from long time reader George. As I read it, he is basically saying that too many people have been on the same side of the emerging market and commodity trade. He goes on to say that you should invest in other areas that people are not talking about.

He is right, both emerging markets, as measured by iShares Emerging Market (EEM), and commodities measured by just about anything you want to look at have not done well lately.

However if you want to be diversified you need emerging market and commodity exposure. Maybe now you should have less than you did before but that is not the point here. Emerging markets and commodities provided a lot of leadership, now they aren't but they will again. By have zero exposure you are betting that you will be able to be right about when they lead again.

A portfolio that relies on being that right about timing each part of the market is a path of much resistance and not a bet I am willing to make with client money.

Being diversified means owning every sector, foreign stocks, commodities and REITs. You add value by overweighting and underweighting various parts of the market and hopefully being correct more often than you re wrong. By being diversified you expose yourself to less severe consequences when you are wrong

This brings up an important issue for trying to manage your portfolio. At any given point some part of the market is the best performer and some part is the worst. The following quarter the best and the worst could switch for what may seem like no reason at all. Are you willing to bet your own money you can consistently get these calls right?

The extreme allocation is much tougher to swallow when you are wrong.
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Big News! Seeking Alpha On Yahoo Finance

Starting today Yahoo Finance will be carrying content from Seeking Alpha, a site I have contributing to for almost two years.

This has several implications. First I believe it is another validation of some of the content available in the blogosphere. From the start I have been saying the blogosphere would evolve to take in more people, more outlets and more sophisticated content.

Posts from Seeking Alpha will show up as headlines on Yahoo Finance by stock ticker.

Another big implication, I believe, will be to draw in many more readers than currently seek out blogs for information. This will create a couple of clear and obvious benefits. First will be more great questions and comments. The comments left here have increased of late and provide for some excellent back and forth on subjects in ways I may not have otherwise thought to write about. More evolution along these lines makes the experience better for readers and bloggers alike.

Further this will draw new entrants into the blogosphere. Think about your favorite blogs. How many are only a year old? There will be new blogs that come that will be must reads for all of us.
That I have been and continue to be involved with this is a real thrill. Aside from my having fun with the site it is very satisfying to be able help people be a little more knowledgeable with their own portfolios.

This news, I think, speaks to David Jackson's commitment to seek out quality content and his commitment to helping the blogosphere become more relevant. Congratulations to David and the entire team at Seeking Alpha!
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The Future Of Domestic Investing

I made a comment in passing over the weekend about the market averaging 10% (or something close to it) per year.

Well get ready because that may be over, at least where the US is concerned. An assumption I have been working with for a while is that US based investors may need to broaden their horizons to average 10% per year. John Hussman had a comment this morning about the move from the 2002 has been smaller than normal and we have gone a very long time without a 10% correction, something Barry has been writing about for a while as well.

This is not a scary thing or meant to be a negative. From my viewpoint it is quite exciting. The world is evolving and so are the capital markets. If the US' role in the world economic order becomes a little less important over the next five or ten years this means other markets will become more important, that is capital would flow to these new future global leaders.

One of the reasons I love what I do so much is that it is always evolving. It is perpetually challenging. I can appreciate that challenging may not be what you want where your financial future is concerned but that is not the world we live in.

I think success in the future will require understanding different countries better than you do now. Also we will need to have a better understanding of market and economic cycles, the flow of capital and the really big themes which I think includes China, water, energy and currency as an asset class.

Adjusting to this means being able to focus on the big picture and not what the market is doing this week.
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Bizzaro Market

Just about everything is going down today. Over the last few days commodities and equities have generally headed lower. Usually this is not how it works. On days like these my tilt toward commodities and foreign stocks means the portfolios I manage will lag.

While I would rather not lag this is part of having opinions and being invested. Themes like foreign, some (but not a lot as I have written over and over) mining exposure, water and energy are long term in nature. The decision to be heavy in yield, to have reduced industrial exposure a few months ago and hang in with staples are shorter term and more subject to change.

I had mentioned a few times about oil testing $65 or maybe $60 and that if that happened, energy stocks would feel it. Well that is happening now. As a decline or test or re-pricing seemed to be a very logical possibility I am not shocked to see it come (not that I ever predicted a date for this) and so my emotions are in check.

There has been a lot of selling. Some portion of what has been sold will be bought back, that's how it works. Perhaps even more will be bought than was sold. If the end of hurricane season (or whatever this is) has changed your opinion about the long term dynamics of supply and demand you should probably sell. More likely the selling (in the commodity and the stock sector) is short term money reacting and rotating. Now and many times in the future your portfolio will be held hostage to short term reactions, this goes with the territory.
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This Is Going To Be A Long Day

I remember needing a break from the never ending reality of 9/11. It is only 6am (Arizona time) and I need a break. I had no friends or family directly impacted. I have been to ground zero twice.

I'll use this post to catch up on a lot of reader questions/comments.

The three utilities I was referring to the other day were Consolidated Edison (ED), Ameren (AEE) and Hawaiian Electric (HE). The are others besides these, that I own for clients, that don't move a lot and pay a high yield. You need to do your own homework.

One reader asked how I think a semi aggressive person should be positioned with cash and whether I think there will be a buying opportunity and if so what to buy. The question feels shorter term in nature than what I focus on. If I had to guess, which is what this is, I would think anything that has been hit lately is likely to snap back and anything hated has a chance turn around. This is more of a this is how the market works type of comment than a trading call. I just don't spend time trying to figure out what heat to chase.

One comment sought clarification on my notion of just staying close to the market as a goal even if that meant being down 14% when the market is down 21%. This is a complex idea and I apologize if it sounds like I am saying two different things but there is a lot to this. From the really big picture I believe it is true that if all you do is stay close (good and bad) and you have saved enough, which is the most important thing, you have given yourself a great chance of having enough money for when you need it. The market averages 10% a year taking in good, bad and ugly.

While being down 14% vs. the market being down 21% does not sound so great for your emotions right now, the fact is that one or two of those in your investing lifetime will add a lot to your average annual return. Embracing this requires that you can focus on the time horizon of your assets not a given six or twelve month period. There will be bear markets and otherwise down years in your future. Riding them all the way down is not the worst possible thing in the world that can happen to you. If you are lucky enough to miss a chunk of one or two of them I think the impact, long term, can be dramatic.

One reader asked what the carry trade is and whether the coming DBV ETF will fit into my portfolio or not. In the purest sense the carry trade is borrowing money in yen for the low interest rate, converting to US dollars, buying US treasuries for their higher yield and profiting from the interest rate spread. The carry trade has evolved to include other funding currencies besides the yen and different high yielding destinations besides the US. It can be that shorting one currency and going long another can be thought as a carry trade as well.

I'm not sure that I will use DBV. When I first wrote about it I noted that currencies where rates are rising, even if they are not high, also tend to do well and that seems more compelling to me. I own the Swedish Currency ETF and one of the reasons is that rates have been increased several times but are still low.

One reader views high yielding stocks as proxy for bonds. I do not. High yielding stocks, generally, are a great way to bring down beta but they are stocks and if things ever hit the fan in the stock market (terror, crash, whatever) you may not be too happy with the bond proxy idea.

Long time reader Retired in Prescott asked about my background and my firm. I don't delve too much into this because I don't want the blog to be viewed as a marketing piece. He asks if I am a CFP. No. CFP is for planners not portfolio managers. Obviously a PM can be a CFP but CFP is training for things like estate issues, corporate retirement plans and so on, none of which has anything to do with managing money. Our clients span the spectrum in terms of wealth and whether they are still accumulating or living off of their money and won't make anymore.

If he means resume info, I have been in the business since 1984 (which includes jobs in college). I have worked as a file clerk, cold calling broker, an institutional equity trader and a portfolio manager.

He goes on to ask if I specialize in any particular type of portfolio management. Yes, I prefer when stocks go up. Sorry I couldn't resist. If I specialize, and I don't know if that is the right word, the extent to which I add foreign stocks, blend different types of tools and expect that there will be periods I lag (and am upfront about it) might be unique. I'm not taking anyone to the hole on these points but from what I read these points seem unique.

I do try to structure each portfolio to be consistent with the client's ability to withstand volatility. For example every client has some emerging market exposure. But the client's needs and tolerances decide how I access emerging markets and what tools I use for that client. At one end of the spectrum a client might have 2% in the ADRE ETF and at the other end a client might have 2% each in Sinopec (SNP), the Vietnam Opportunity Fund (VTOPF) and CVRD (RIO).
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Five Years

There are a lot of media outlets marking the five year anniversary of the September 11 attacks. Barron's had an article by Michael Santoli that was a great read about the evolution of things, markets and otherwise, since 9/11.

The article specifically touched on whether fear is priced in differently today than before 9/11 because of the increased prices and interest in commodities, the explosive growth of the credit default swaps market, the popularity of hedge funds and he even ties in the real estate boom as being a by-product of investors looking for other assets to own, obviously low interest rates contributed to the housing boom as well.

Michael sort of addresses what strikes me as obvious, and something I have been thinking about for quite a while which is markets have become more efficient as investors are a little more respectful of bear markets for equities and that they no longer view trading stocks as a way to get rich quick.

One nugget from the article was that in April 2000 assets at Charles Schwab were $775 billion with 386,000 trades per day. Today Schwab as $1.3 trillion in assets but only 245,000 trades per day. Less people view trading stocks as a means to get rich quick (repeated from above purposely).

The portfolios I manage are structured to take in various types of assets with different correlations. There are now many more investors doing something similar. I personally know a lot more about foreign markets, commodities and currencies than I did ten years ago as the bubble was starting to ramp up, how about you?

We all know that the VIX index has been lower than normal, relative to its own history, for the last few years. Complacency is often cited as the reason and that could be why but perhaps a part of it is a greater understanding of risk and inter-market relationships by more participants. The growth in interest of derivatives speaks to a greater desire have some protection against terror or war or anything else.

Derivatives are a double edged sword and no doubt some fund or trading desk will blow itself up getting caught with too much of the wrong product on the wrong side of the market. In May I participated in an back and forth about derivatives in the WSJ Online with Michael Panzner. Michael felt/feels that that a major blow up, caused by too many derivatives is looming and inevitable, I do not. As I said someone will blow themselves up but the point of the debate with Michael is whether this poses a systemic threat.

Used correctly, and this obviously is the biggest variable, derivatives are a tool to manage risk. If the increase in derivatives is more about risk management than anything else, it is possible that there will be muted ups and downs in stocks like we have had for the last couple of years.

It's just a theory.
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The Big Picture For The Week Of September 10, 2006

It is raining like crazy here on the mountain today. I can't remember such a wet summer here as this one.

There are a bunch of comments from the last couple of days to catch up on. One reader left a comment about starting to shift more to fixed income as a function of retiring. This is tricky. I have touched on this in the past and I always get comments disagreeing. If you are 60 years old and think 90 is a realistic possibility (here, note that most people live longer than their parents and medical innovation is accelerating) being too conservative will yield the same result as being too aggressive; your money won't last as long as you need it to.

The price of a postage stamp mimics inflation over a period of years. The Elvis stamp from 1993 cost $0.29; thirteen years later a stamp costs $0.39 which is 34% increase. In 2020 your expenses might be 35% more than they are today. Your portfolio needs to keep up with that.

I believe the Elvis stamp came out in February, 1993. On February 28, 1993 the S&P 500 closed at 443.38. Today it is at 1298.92 which is almost a triple. These are numbers. In my experience with conveying this to people, this will click right away or it won't click at all.

One reader asked how I find correlation of different assets. There is a site called PortfolioScience.com that I use. It costs about $20 per month. The site is quirky though. It does not work well with FireFox, I often need to load a page twice and it times out very frequently like your bank's website might do but the info is very useful.

One reader mentioned he owns Duke Power and wanted my opinion on a best of breed utility sector ETF. Well, here's the thing; Duke is heavily weighted in four different utility ETFs I looked at. The only one I found that doesn't have a lot of Duke is from PowerShares (PUI) but the yield looks like it will come in very low and it may own Duke in the future so I'm not sure what to tell you. I have four individual utility stocks in my ownership universe; three of them are very docile and yield close to 5%. There are more than three utilities that match this description if that is what you are looking for.

One reader left a comment that an unnamed blog mentioned a fund that allows investors to participate in (as I read the comment) the yen carry trade. If that reader is reading this please leave the fund name, the blog name or both. The idea here is not so much that I think I need to own the fund (if it is that type of fund) but more about learning about something that sounds innovative. There are people that poo-poo every new thing that comes along ("you don't need it") which seems completely upside down. Investing will evolve along with the markets. If one out ten new things that come along is right for you and will help you get better results (nominally or risk adjusted) then learning about the other nine you won't ever use is worth the effort. Here I am assuming most folks reading a site like this one are more interested in their investments than picking four OEFs to rebalance once a year.
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Kiplinger's

In their October issue, the folks at Kiplinger's have an article about blogs. The box to the left is what they say about me, thanks guys.

Other blogs mentioned include Seeking Alpha and The Kirk Report. Kudos and snaps to everyone on the list but a lot of the names listed are ones that come up elsewhere as well.

While it is flattering to be included I think there is plenty of room for other blogs to join the fray. Again, readers will vote with their clicks.

I'll try to post a more thorough state of the blogosphere post next week.
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Add Peru To The List

The Central Bank in Peru voted yesterday to maintain it's overnight rate at 4.5%. Peru? Turns out their inflation rate is below 2%.

The list of countries with rates lower than the US is very interesting to me. I would advise anyone to learn this stuff and be aware of global interest rates and actions of the various central banks. Every central bank I have ever looked for has a web site and you can find a link to an English version.

If you buy into future increased globalization, regardless of the impact you expect it to have on the US, this type of information will become more important to your portfolio.
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NYSE

If you had not heard, the NYSE put out a report entitled What You Should Know About Exchange Traded Funds (link is to a PDF). You probably should read the report, it is short, and you probably should know the things the report covers but it strikes me a a couple of years, or more, late.

I would be shocked if you found something new in it. There are plenty of investors that know very little but I think at this point the people that don't know about them would be very unlikely to visit the NYSE site for anything.

People involved enough with their investments to seek out a stock market blog will find very little utility in the report.

With the number of ETF providers growing it is surprising that there still is not better media coverage yet.

To this point CNBC just ran a segment about whether there are too many ETFs citing that the O-Strip ETF (OOO) is closing due to a lack of demand. While we should not be shocked the segment had almost no meat on the bone it does show that MSM has shockingly little understanding. When they do have someone on who does get it, like today, they don't know what questions to ask. It is kind of weird, seriously. Take Erin's question today about which ETFs are the most popular. Most popular? Are you kidding?

ETFs are simply tools for accessing parts of the market. Sometimes a given ETF is the best way to capture the market and many times it is not. It is only logical that some products will fail and some will succeed.

Too many ETFs chasing too few assets (as mentioned in today's interview) is an issue on the horizon but I view it as too many ETFs chasing the same part of the market. One example would be broad based dividend ETFs. Yes they all have different methodologies but the results are not that different. That one could fail for lack of interest should not be a surprise nor be a deathblow to the company. StateStreet has a diverse product line and one of them didn't work. No big deal there will be other funds that close. This is how new things evolve.
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New Blog

When I find a new (to me) blog that I think has something to say I like to pass it on. Part of the blogosphere is growth and the addition of new content providers. I feel no threat or sense of competition, not sure if other bloggers do. Most blogs are giving away the milk. Readers will vote with their clicks.

The new blog is Investing From The Right. It is written by "T" who has left some great comments on this site which is why I think there is a chance that his blog will have something to say. Clearly he has been around the block and the perspective of experience should be very valuable and enhance the content but you can decide for yourself.

I would also say don't let the political bias sway you either way. I know someone who is so liberal that he modifies his behavior to avoid being exposed to thinking from the other side. This makes no sense to me. Personally I want to hear both extremes (although I don't really find T to be that extreme, remember I live on a mountain in rural Arizona) of any issue to help me make up my mind.

Check him out and let him know what you think.
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Follow Up Questions

I had a couple of comments left on my post this morning.

One reader asked why I thought interest rates would go up in the scenario laid out in the post. If there is less demand for dollars the market will demand greater compensation (in the form of higher rates) for holding a currency that turns out to be less important than it once was. Hopefully no one took my comment about deficits to mean I think they are unimportant, they are important and potentially market moving in a substantial way including interest rates.

The bigger idea is if the dollar shares its role as reserve currency it will be competing for capital in a way that it does not do today. The competition puts upward pressure on rates. If there is not enough compensation to hold dollars foreign investors will not hold dollars but our debt situation is such that we need them to hold dollars. That last sentence is much gloomier than I view this but that is the bottom line to it.

The other comment brought up whether oil might be priced in something other than dollars but the reader does not make the connection that this would be bad for the dollar (if I read the question correctly).

Oil, gold, copper and just about everything else trades in US dollars. This creates a constant demand for dollars creating a certain level of importance. Any trading that occurs for these products in another currency is less demand for dollars. Less demand is behind the entire theme of the post.
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Global Rates

No doubt you are aware the US Fed funds rate is currently 5.25%. You may be surprised to know the overnight rates from some countries.

South Korea left rates unchanged today at 4.5%

Malaysia approximately 3.55%

Poland 4.00%

Chile 5.25%

OK, Chile isn't lower than the US but would you have thought it would be the same? There is nothing unprecedented about this but it is interesting to me that money can be cheaper in some emerging markets.

Currently there is an ambiguity as to what will happen in the US with rates. The Fed has had the market on pins and needles for the last the last couple of months as the hike/pause/done debate has continued. It may be correct to take the view that the Fed really does not know what it will do.

Are there market implications? I'm sure there are. My own take on this is big, slow moving macro stuff. This is something I have touched on a few times since the start of this site. I think the US as sole world reserve country is coming to an end. The US will be one of a couple (or maybe a few) reserve-type countries.

Despite the concerns about our deficits and various other problems, a toppling of the US is unlikely, in my opinion. The world has too big of a vested stake in the US for something catastrophic unwinding over the course of a decade or so.

I think a likely outcome is higher, not crippling, interest rates, a somewhat, but not dramatically, weaker currency and milder economic cycles. I would expect the impact on the stock market would be average annual growth that is lower than what we think of as normal. This does not preclude the occasional big year in either direction but investors, I think, will need to be a little more resourceful to get that average 10%-ish they are used to.

I would not view this as bad or good, assuming for a second I turn out to be close to right. Markets do what they do and success hinders on seeing changes and then reallocating accordingly.
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Oil Chart

I have been honing my technical analysis skills and the chart for oil, as depicted here, looks to be headed lower.

This is a humor attempt.

While I would probably not be the one to call a top in oil I have repeatedly tried to convey the oil could go down at any time and that oil stocks would look ugly when it happened.

Recently I opined that oil would be unlikely to spend any serious time below $65, I may have the chance to be proven wrong on this.

The hurricane season is turning out to be less of a worry than originally feared, which is not much of a shock. Israel has faded some as an immediate worry and supply is perceived to be healthy for now.

This just in; oil is volatile. I have been clear in that my interest in oil is more of a big, long term, gradual increase in demand coming from China, India and others. Fair enough if you do not buy into my logic here but for folks that do own oil stocks for this reason, declines like this will go with the territory.

This does not mean you should be static either. I was very public as to the timing of reducing oil exposure back in April. While it is too early to know now, if this decline turns into a panic (this would obviously be a matter of perception) it may be time to add a bit more.
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