Claymore MacroShares

You may have seen the interview this morning with Robert Shiller and Sam Masucci about the new oil related shares. I found the interview and this article to be very confusing.

From the a picture is worth 1000 words file, I offer this chart. Clearly the Up Shares (UCR) and the Down Shares (DCR) are intended to move inversely of each other.

I think UCR moves with oil and DCR moves inversely to oil, both on a one to one basis.

The two funds will pay interest by virtue of capturing the energy effect in the derivatives market thereby having money left over for short term treasuries.

Conceptually there is probably utility with these but I need to look further to learn the ins and outs. If you know something please leave a comment.
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A Call To Arms!

Roubinians of the world unite, the Chicago number came in below 50, oil is above $63 and my neighbor is hoarding water and powdered food.

Well that last one is not true.

It is fascinating how the data points seem to alternate between good and bad, although I think the tilt has been toward negative data. My brother commented that Nouriel and Barry have been way off with the timing of their predictions.

So here is a theory or maybe more of a rhetorical question. That the super tanker that is the US economy is taking longer to turn than normal (not sure that it is turning slower than normal but work with me here) does that mean that whenever the next recession does come it will be longer in duration than normal?

Discuss.
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Czech Koruna

Jyske Bank had a research piece on their site yesterday suggesting use of the Czech koruna as a funding currency for carry trades instead of the Swiss franc.

They see visibility for the Swissi to go higher, not what you want a funding currency to do, because growth in Switzerland has been picking up and the SNB (the central bank) has been raising rates, albeit slowly.

They like the koruna as a short because rates are very low, 2.50% for its repo rate, and they feel political deadlock will cause further weakness in the koruna. Well maybe, but the Czech National Bank forecasts inflation between 2.8% and 4.2% so I'm not sure how long rates will stay this low.

The reason I bring this up is that I view various carry trade dynamics as expression of the market's willingness to take on risk. While this is not a trade too many of us have access to, shorting the currency of an emerging (or maybe frontier) market is far from riskless. While I don't know, I can't imagine Jyske is the only bank willing to short the koruna.

This chart compares the kiwi to the yen; the last three months have been good to the carry trade. While this pair might be the poster child for the carry there are several other pairs to look at too. The higher yielders include the Hungarian forint, Icelandic krona, the Aussie, Turkish lira, Brazilian real and the South African rand. The low yielders obviously are the yen and the swissi.

The market's willingness to take risk can be used as an indicator or a contrarian indicator, how you might use it probably depends on whether you are more of a Roubinian or Kudlowite.
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Energy

Energy stocks have had a nice lift in the last couple of days, naturally a lot of folks have come out calling for $68 or some other bigger figure than we have now.

To me that is just noise that may or may not help your portfolio in the short run. I have not reduced energy since the spring but I did do a dollar for dollar swap out of a stock into an ETF.

I continue to view energy as a big macro theme. As such there has been and should continue to be a lot of short term action in and around the big macro element. If you read this site during the decline you might recall I was not worried, I made comments like "it is no shock that I will lag when energy gets crushed." I haven't tried to game this and now that energy is doing well I see the portfolio doing a little better.

This ties into a sort of predictability that I want to embed in my portfolio. I want it to behave in the manner I expect. If you think tech, as an example only, is the right place to be and you go 20% tech you know that when tech does poorly so will your account.

This sort of predictability makes the task of participating in the market much easier.
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Tuesday Tidbits

I'm sure there are more support lines violated than the two I drew on this chart. I still think some portion of this gets corrected but over the next few years there is a good chance that the dollar loses some permanent ground against other currencies.

It makes sense for you to spend some time now looking at what has done well through this period so you can learn more about what to own if the above thought turns out to be correct.

Here's a new blog to tell you about, it's called World Beta. It is very new, started this month and is written by someone named Mebane Faber, relative of Dr. Marc or reporter David? I don't know.

The site seems primarily devoted to posts about portfolio construction with ETFs along with dissection of portfolio research. The content has a lot of meat on the bone so you need to roll up your sleeves.

In case you missed it PowerShares is listing another batch of ETFs, only five this go around.

• PowerShares Financial Preferred Portfolio (PGF)
• PowerShares Dynamic Large Cap (PJF)
  
• PowerShares Dynamic Mid Cap (PJG)
  
• PowerShares Dynamic Small Cap (PJM)
  
• PowerShares Value Line Industry Rotation (PYH)
  

The preferred fund is unique for an ETF but there are CEFs that invest in preferreds. The three dynamic funds are obviously variations on existing themes and Claymore has an ETF that it calls Sector rotation.

Did you see the David Tice interview this morning? To paraphrase a Seinfeld episode; you know, just managing a bearish fund doesn't have to mean you need to always be bearish.

I have seen and read enough Doug Kass interviews to know there are always stocks to short regardless of what the market is doing. This morning Tice said he can't make a bullish case for stocks as he was calling for a 40% decline. I don't understand this. His opinion can be irrelevant. He's got a fund to sell. His fund is a tool for people that want some downside protection. It seems like he is always calling for a HUGE correction. I'm not sure how anyone can always think the market will can only go in one direction.
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Interesting Nugget

Bernanke just said the cost of capital remains low. For those folks that like to dissect every word and think that every single part of his speeches have meaning, that could be a biggie.
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Dividends and Demographics

A reader asked me to comment on this article on MarketWatch. The article profiles commentary from Richard Band from Profitable Investing which appears to be a newsletter.

The two big points made were;

• The retirement of 76 million baby boomers is the most important demographic trend of our lifetime; a seismic shift
• Dividend-paying stocks will outperform growth stocks for the rest of your investing life

So baby boomers eh? I can't vouch for the 76 million number but I'll take his word. The baby boomers shift in to retirement causing the second point to occur is important and will move all sorts of things related to consumption trends, healthcare needs, ascendancy of some geographic regions and just about anything else you can think of; I'll agree with that.

However I would think trends that effect 800 million to 1 billion people might be much, much more important; here I am talking about China and India. If you add up the populations of some of the N-11 you get another half a billion people that will gravitate to the same types of trends but maybe on a slightly different time table. In the spirit of Nigel Tufnel; 2.5 billion is more than 76 million.

This is not to say that investing around boomer trends won't be the right thing to do and won't be successful but don't lose sight of other big trends going on in the world.

As to the second point about dividend stocks outperforming growth; hasn't that always been the case over long periods of time? Value (implying stocks that pay dividends) beats growth more often than not. The point made in the article is that boomers will seek out dividends to contribute their income stream which makes sense and I am a believer in dividends to be sure but I would file Mr. Band's comments along these lines under this is how the market usually works.

There is one thing that I think is important to add here; the retirement of the boomers followed by their entitlement payments stands to be a colossal problem. There is too much spin and data mining for me to know when social security will really start to crap out but we have a big problem there. Then don't we have a bigger problem with Medicare at some point for these folks?

These things should be very troubling for all of and offer several very scary outcomes. For now though this is all far enough down the road that the US capital markets can go through at least a couple of complete cycles before this starts to cause visible damage. I'll cover this in depth during the 2020 presidential election season (humor attempt).

For people younger than 50, which includes me, I would suggest saving as much as possible, live below your means, open an HSA account but don't tap it to pay medical bills, make your car last for at least ten years and see to it that your portfolio is globally oriented.

The point is not to scare anyone or be a fear monger. This is something that could hurt us in the future. If this does not pan out negatively well, no problem but we need to learn and study what can go wrong not what can go right.
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Swedish Krona Update

I have been writing for months in my belief in Sweden as an investment destination. Most clients own one Swedish stock and the Swedish krona ETF (FXS), I have disclosed this before.

I bought in to FXS in early July in the 138's. My general expectation for FXS was that it would not do much most of the time but that every once in a while it would help reduce volatility in the portfolio. That has been the case for the last few days and the chart posted here shows a narrow range for most of the time followed by a small but noticeable breakout.

For all I know FXS will go back into that channel but during the down draft so far the fund has acted as hoped for-it has reduced volatility of the portfolio. There have been some negative comments left by readers along the way on these but I think there is value in allocating a small portion to these types of products; be it ETFs, OEFs, actual currency or anything else that offers the effect.

I have been consistent on these will continue to be so but I would not be surprised to see better mousetraps come along.
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Technical Analysis

This chart plots the US dollar against several major currencies and as you can see, ahem, the dollar looks like it is going lower against all of them.

Over the last few years there have been a few spikes like the one that started last week. More often than not these admittedly big moves draw a lot of folks to jump on the bandwagon and then the move retraces somewhat.

This is not so much a prediction but a reminder that this movie may not be much different than other movies.

I do think the dollar will drift lower over the next couple of years but 2% moves in just one day are tough to hold on to with out some correction.
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Zero Coupon Bonds

A reader left a question asking for my opinion about zero coupon bonds and whether now is a good time to buy 30 year zeroes.

I am generally favorably disposed to how they work but they are a nuisance in taxable accounts. You can click here if you are unfamiliar with what these are.

Zeroes are a great tool at the right time and a horrible tool at the wrong time, especially 30 year. Zeroes are extremely volatile when rates start moving. It would be very easy to buy in at the wrong time and be down 20% before you know it.

Long term rates are very low right now. There is more room for them on the upside than there is on the downside. I think this is especially true given that the curve is inverted such that long rates are very low by historical standards and short term rates are kind of middling by historical standards.

If 30 year zeroes ever had an implied yield of 10% again (from this point on I will just say yield and not implied yield) I would consider loading the boat for a lot of clients. Here is the idea. Zeroes yielding 10% maturing in 30 years might cost $0.15 for a dollar face value (making that number up, this is just an example). One thought for a $100,000 portfolio is to buy $100,000 face value for, in my made up example, $15,000. Then invest the remaining $85,000 in a normal manner in the stock market. Another thought is to invest some larger portion of the portfolio in the same zeroes; we are talking 10% after all, and the rest in equities.

The bigger macro is that stocks average about 10% per year. If that can be had risk free (not volatility free) in a treasury product...well, hello.

So the question becomes at what yield for a zero does this compel you? I'm not sure at what level I find it compelling but 4.5% for 30 years or 4.75% for 20 years ain't it.

The way cycles work there are good times and bad times for certain products. When it is the wrong time for a product the best thing is to just wait. I think this is the wrong time for zeroes.
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Currency Effect Example

Last April I got caught up in some of the excitement about consolidation in global stock exchanges and bought a few shares of OMX Group, the Swedish stock exchange that also owns a bunch of other exchanges in the region and also has some whiz-bang technology.

I bought OMX on April 11 at 149 kroners which worked out, at the time, to $19.60 per share. I sold it on Friday at SEK 131.75 which looks like an 11% loss but when factoring in the currency move the loss shrinks considerably. In dollars I sold at $19.25, a loss of $0.35 or 2%. Along the way I took in a $0.34 dividend so I just about broke even.

As the chart shows via the blue line; the dollar depreciated by about 10% against the Swedish kroner during the time I held the stock. Visibility for a strong kroner, which I wrote about several times on the blog, contributed to my decision to buy the stock and it was the currency that bailed out a bad stock trade.

If you compare a chart of any locally traded shares with that of the shares in US dollars along with the currency you will see that any difference between the two will be attributable to movement in the currency.

The point here is that owning foreign stocks can help your portfolio if the dollar decline continues. If you can pick a stock or an indexed product that doesn't drop 11% in local terms, well, all the better.
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Rhetorical Question

Barron's has a special interview with three hedge fund managers. One prediction that came up was that leveraged buyouts will continue. The inverted yield curve means intermediate money is cheap. Does the shape of the curve continue to facilitate cheap borrowing, muting the impact of the 937 previous rate hikes and force the Fed to hike further to quell excesses?

I don't actually think the Fed will hike more. The probability of the above scenario is quite low, IMO.
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The Big Picture For The Week Of November 26, 2006

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Just Got Back From The 3 AM Sale!

Well no, that's not true. I will be hunkering down until the close and then watching some football without going shopping.

The US session is only three and a half hours today. It is only three or four hours every day in the Philippines; fun fact.

Even with every living American going to two malls today the US dollar is getting hit yet again. EURUSD has gone through 1.30, the Swissi is back below 1.21, over night the Aussie was $0.78 and the dollar has even been getting weaker against the Hungarian forint. Remember Hungary? The big cheese there lied about the country's growth rate and their currency is up on the dollar.

These big moves like we've had over the last few days happen every so often and usually we see a lot of people come out after a big move calling for a much larger move in the same direction. It is usually at that point that the dollar then heads back the other way. We'll see if it holds up this time.

If the dollar is down, gold must be up and it is, rather quietly. Not much has been happening with gold so it seems but actually gold has had a decent rally and is getting close to $640. It is up close to 10% since late September. This is a good example of why you can't give up on every theme that may not be working.

It looks like the ten year is yielding 4.54% this morning, wow. I have not been on board with any justification for why this inverted curve is different from past inversions. If somehow this inversion is different, there is no recession and no normal sized bear market decline I will be thrilled.

For the record we have done most of our holiday shopping already but I still need to shop for my wife.
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Turkey Tidbits

European stock markets are generally lower today.

It looks like the dollar is getting hit gain based on the quotes I see on Yahoo Finance except against the kiwi.

Hedge fund manager Hugh Hendry from Eclectica was on Squawk Box Europe and had an interesting comment. He said a soft landing is perfection. He doesn't see a lot of perfection in his life. He said a lot of people are betting on a soft landing which is to say a lot of people are betting on perfection. I should note that Hugh generally comes of as bearish where the US is concerned.

There was a reader question about how much of an ETF's move is from the underlying index vs. trading in the ETF itself. Because of the ability to create more shares the tail should never wag the dog. I don't discount the possibility that every great once in a while it could happen but as a practical matter no. The most popular ETFs are tied to very liquid indices with active futures markets that really do away with the effect the reader asks about. The smaller ETFs have such small dollar volume that it does not become an issue there either.

I should note that Jim Cramer has written and or spoke on this quite a bit in the past. Basically he takes the other side of this debate. The dollars involved in the entire ETF industry just don't back up the contention that this is an issue. On any given trade sure but as a real market moving issue; no.
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Let's Light This Candle

Why wasn't the next commercial Mr. P at Stewart's party?

Hat tip Trader-X.
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Good Stuff From Barry

The Big Picture: 917 trading days since down 2% day
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A George Divided.....

I love that bit from Seinfeld when George talks about the world of independent George colliding with the world of relationship George. Our Thanksgiving will be a colliding of worlds as some of my family will be joining my in-laws for dinner.
Speaking of sick and unhealthy this chart shows the Kiwi's strength against the US dollar. New Zealand has some big problems yet it's up huge against the greenback.

The US dollar is getting pounded today almost across the board. There are a couple of things going on, maybe the biggest being the revised GDP numbers coming out of Washington.

Intuitively holiday volume is exaggerating the moves but CNBC Europe just had Steve Barrow from Bear Stearns in London saying too big a move may draw in more participants, maybe he means stop orders at key technical levels.

I tend to think that some portion of the move this week unwinds next week if not sooner but maybe this can serve as a nudging of recent trading ranges.
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Readers; Let Your Voice Be Heard!

A couple of weeks from now I am going to a conference in Phoenix (I'm just going for part of one day but the whole thing lasts what I think is three days) about index investing. Things being what they are I have arranged (hope it does not fall through) to meet with a person of importance at one ETF provider and might be able to make contact with someone similar at a different ETF provider (still waiting to hear back).

I am starting work on a list of questions. This is a chance for you to speak up. What questions would you want to ask? I am thinking I want to ask about possible new funds. I think the possibility of a new fund idea becomes more compelling if I can say what about X and oh by the way 100 readers emailed me about the same idea.

You can either leave a comment on this post or email me at the address on my blogger profile page which you can link to up above. I may not be able to reply to every email but I will put up a synopsis of sorts of the questions I can gather before I go.
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Yet More Tidbits

There is an article from IBD on Yahoo Finance about the new ETFs. There are some cautionary quotes from a couple of investment managers. Here's one; The WisdomTree approach seems to be "in style" now, but that could change in a couple of years.

I think this misses a big big point about how ETFs tie into a portfolio. An ETF captures some sort of effect. That effect is either in favor now or it is not. It makes no sense, for example to have your entire portfolio in five different mid-cap growth ETFs. Having one might make sense. Chances are if you do have one it is the one you think is the best one for that effect. It being the best one does change when the group rotates out of favor. As having nothing but mid-cap growth ETFs is not a good idea neither is having only dividend weighted ETFs.

However you assemble your portfolio you would logically own what you think is the best vehicle for each part of the market. If you are diversified you should expect some things to be doing well and some things not doing so well. Your success depends on the blend of strong and weak performers.

The other day I put up a post in response to a reader question about what parts of the market might weather a US collapse better than others. In that post I specifically mentioned US stocks with high dividends might not offer much shelter. That post was picked up by Seeking Alpha (I linked to the SA version for this purpose) and drew a comment from Seeking Alpha contributor Geoff Considine that said he thinks KO would be an example of a good place to hide because it has a high yield and by his work a 0.36 correlation to the S&P 500-so he is taking the other side of my point, fair enough, this makes for a good debate.

I am a fan of looking at correlations to assemble portfolios but I think it is easy to get too wrapped up in the data. Sometimes a real world check is better than data.

This chart compares KO to the S&P 500 from July 1, 2000 to December 31, 2002. You can see for yourself how KO did. To repeat a thought from before, how much solace is a 3% dividend (or whatever KO paid back then) in the face of a 25% decline?

The context of the original question was trying to avoid a collapse, I don't think this holds up but you should decide for yourself. You can link through to the SA post to read Geoff's full question and then his reply to my reply and even read his article he referenced in both of his comments if you are so inclined; I did not read his article.
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Tuesday Tidbits

There is a good article from Bloomberg about whether investors are better off with active or passive management in emerging markets with iShares MSCI Emerging Markets Fund (EEM) being the proxy for passive management. The general take away is that passive is better than active but that seems like the type of thing where the data could be mined either way.

As a recurring theme I think a combo of different things is the best way to go. Broad-based exposure is probably right for a big chunk of a do-it-yourselfer's emerging market exposure. However I would not rule out a narrow idea or two; either an individual stock or a fund of some sort that is single country or regional.

If a do-it-yourselfer allocates 6% to emerging markets it does not seem like a stretch that this person could pick one narrower idea to study, learn and then buy.

For a while I have been writing that I thought that in the next few years Vietnam and Pakistan would be lifted into a similar echelon as the BRIC countries. Turns out some other folks have had similar thoughts according to this article from New Zealand. Goldman Sachs JB Were in Australia has a term called N-11 which stands for the next eleven after the four BRICs. The N-11 countries are Mexico, Korea, Bangladesh, Egypt, Indonesia, Iran, Nigeria, Pakistan, the Philippines, Turkey and Vietnam.

That group of countries represents opinion from JB Were. It is not clear to me that these are necessarily the best eleven in sum but this ties in with some of the recent posts about frontier investing. As it is with investment products so it is with these economies; they continue to evolve socially and as investment destinations. I think it is worthwhile to devote time to these types of places.

One reader left a comment about too many of the new ETFs being for commodities and emerging markets. I am not sure whether this is correct or not but either way it is true that brokerage firms and the like to tend to create more products geared to a certain part of the market closer to a top than a bottom.

The thing I would say about this is that just because there are several funds to invest in alternative energy type stocks does not mean you increase your position beyond what you currently own, if you own any and BTW I do not.

If you allocate 5% to commodities; five new products give you more choices for your 5%. The investment companies might be trying to time something but you don't have to.
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Deep Thoughts...

Well there is no Jack Handey here and maybe not much depth either.

Could ten be the new twelve? In the last few years 12 seems like it has been a number of significance for the VIX index. As I write this, VIX is printing below 10. While I am not sure what to make of this, if you look at this long-term chart, VIX itself seems no less volatile it just seems to be moving in shallower waters.

EOP and PD are big fishes in their respective ponds. Less supply of stock in these two areas is a positive. Both sub-sectors could still decline but less supply is a tailwind.

A few weeks ago in one of the video posts I made a reference to a website called Crowder Investments. They have some sort of short term trading model and the results posted looked good. The context of my comments were to say I had no specific interest in what Crowder was doing, and still don't, but that the broader notion of allocating a small portion, very small, of a diversified portfolio to something very aggressive has some merit.

A reader left a comment with a couple of details about some sort of problem he is having with Crowder. I'm sure the reader has his side of the issue, Mr. Crowder probably has his side and no doubt the reality is in the middle. The reader asks for input from any other readers who know about Crowder's service and what their experience has been.

As a matter of personal philosophy paying for a newsletter for specific short term trades (equities or options) does not seem ideal. Not that these folks can't teach us a lot but I think I'd rather pay to learn about process that get a bunch of picks. This is not a dis on newsletter writers, many of whom have amazing results, but more about my own comfort level.
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Great Read From Our Kiwi Friend

NakedShorts: Making a list. Over 300? Looks right.

Everything you wanted to know about what's in the hopper now.
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REIT O'Rama

By now you know that Equity Office Property (EOP) is getting taken out. A lot of REITs are lifting in response. There had been chatter that this was a possibility, it has created some heightened excitement and now we will probably see a lot of Are-REITs-Right-For-You type articles.

My position on REITs has been same for a long time. Most clients own Equity Residential (EQR), EOP's cousin, which I first disclosed about a year and a half ago. A few clients less tolerant of stock market volatility own a second REIT.

Sometimes I see or hear commentary that lumps REITs in with the homebuilder stocks. This chart of EQR (as a proxy) compared to the Homebuilder SPDR (XHB) shows a very low and often negative correlation between the two.

I have never thought there was much of a fundamental connection but you can judge for yourself.

In addition to what I think is a fundamental difference there is also a difference in sentiment. Hot money seems to love to chase the homebuilders while REITs attract more staid capital. REITs, kind of like the Canadian income trusts, can create a false sense of security. REITs have utility and have a place in a diversified portfolio but too much of anything is not a good idea. REITs had a rough run during the bubble years and they will have rough runs in the future.

Should you have exposure? Probably, but 20%? Not for me.
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China ETFs

I have been writing about China as an important investment destination since I started the blog. Any posts along these lines in the past have been focused on a longer term view in terms of many years. The simplest description of this theme is that China will be much more economically relevant in coming years. This has been occurring steadily and I believe will continue for years to come. Anyone may or may not be able to guess what more economically relevant will look like but that is what's happening.

There are two ETFs that I am aware of; iShares FTSE/Xinhua China 25 Index Fund (FXI) and the PowerShares Golden Dragon Halter USX China Portfolio (PGJ).

Obviously Golden Dragon has lagged FXI badly. There has been some attention paid to the odd mix of stocks held in PGJ. I have previously disclosed owning FXI personally (for a little over a year now) and that quite simply I preferred it to the PowerShares product because there were fewer moving parts. With these kinds of emerging markets and I'll throw in the frontier markets while I'm at it I want exposure to the big phone company, the big bank, the big oil company, the big food company, the big...eh well you get the idea.

The PowerShares fund has some weird stuff including a biotech stock and a ring-tone company. I haven't really analyzed PGJ since it first listed beyond knowing its holdings are more complex. WisdomTree has filed for the WisdomTree China Total Dividend Fund which could turn out to be a better mousetrap. I think PowerShares has single country funds in the works based on Robert Arnott's fundamental indexing; maybe they will bring another China fund there. StateStreet just listed a couple of Japan ETFs; maybe they will come with a China fund too.

Any of these could be better than FXI. Normally I might say it doesn't matter what you own because even if you pick poorly you can capture some magnitude of a big move. Well either PGJ is the exception that proves the rule or it shows that top down management is not infallible.

On a different note I am very excited about the Maui Invitational that gets underway in a few hours. My friend Russell asked me if I was going this year. Well maybe next year but Joellyn has said we are not going to Hawaii to sit in a gym and watch basketball. She does have a point.
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Holy Cow!

Freeport McMoRan is buying Phelps Dodge.
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Various What Nots And Such

At the end of this week's Up and Down Wall Street column there is a snippet from Alan Newman from CrossCurrents with a theory that the market has gotten a boost this year from the issuance of ETFs. According to the column "net issuance of ETF shares has totaled more than $34 billion thus far in 2006." Newman says that the new ETFs need to buy stock for the funds when they are issued which "is one of the things that has helped kite stock prices."

OK, $34 billion, that's the figure? It seems to me that the NYSE and the Nasdaq each average about 1.6 billion shares per day, anyone with the actual figures can leave a comment. Anyone know the typical share price of a stock on the NYSE or the Nasdaq? Me neither but it probably is more than $10. At $10 I think that puts the dollar value of shares traded on a typical day, between the two markets, at $32 billion or 94% of Mr. Newman's $34 billion in new ETF money. Even if my figuring is off by 100% working against my point we are talking about dollar volume averaging two and a half days of trading. I must be missing something.

Gene Epstein has an article in Barron's that opines that the dollar will get stronger not weaker. He cites research about rising rates combined with the argument that too much global trade occurs in dollars which makes a decline work against the interest of too many parties.

The argument obviously has merit. I took the tone of the article to be longer than a year-end call. The thing to watch for in this case would be business now being conducted in dollars rotating to something else. The euro is an obvious candidate. Norway has made some overtures to having an oil bourse that trades oil in euros. We read about all sorts of smaller countries diversifying some portion of their dollar reserves, it seems like China is considering buying fewer dollars at some point in the future (note I am not talking about them selling what they own, I have never thought that). None of these by themselves would take the dollar down but a trend to more and more of this type of action around the globe would become a problem.

I use ETFconnect.com almost every day, the information helps me with both my jobs. The site has one quirk I have never understood why the site blurs the distinction between closed end funds and exchange traded funds; Exchange-Traded Closed-End Funds.

Hey, its ETFconnect if they want to label them this way fine. People like me, though, need to know the difference which brings me to this amusing nugget from The Motley Fool. They have written a bunch of articles that each profile one ETF in an effort to pick the best one for 2007. One of the ETFs highlighted is the Hambrecht and Quist Life Sciences (HQL). Two of the merits cited are that the HQL ETF trades at a 7% discount and it pays an annual 8% dividend.

Oh, boy.

First, FWIW, the H&Q website makes no reference to ETFs; the fund is a closed end fund per its news releases. It would appear that the author does not know the difference. The dividend is actually capital gains which he says once but uses the term dividend at least twice. ETFs don't trade at big discounts.

The fund has done well, paid out capital gains quite consistently and for all I know might be a great way to invest in biotech but I was amused by the writer's ignorance on the vehicles. I actually emailed the author who replied courteously with a definition and link from ETFconnect. After reading his email, I am convinced he does understand there is a difference.

As for those gains paid out, if I were interested in buying the fund I might want to find out if it paying out gains accrued before or if it consistently can trade profitably to pay gains. If these are gains from years back do they run out soon? Would the fund then make no payouts or return capital to maintain the payout? The fund may have one more gain to pay or 100 more, but I would want to know. BTW, ETFconnect lists the distributions as dividends but I looked at two news releases and the 2005 tax info which labeled the payouts as captial gains.

This article, which I am intentionally not linking to, belies the fact a lot of people writing about investment products don't really understand investment products. In addition to most of what I have read from Motley Fool I would also lump in Morningstar. No doubt I am being overly critical andI have made my share of goofs too but I think you should be somewhat skeptical about what you read including my stuff. You can absolutely learn from these articles but they are not anywhere close to the last thing you should read before buying something.
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The Big Picture For The Week Of November 19, 2006

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Links and Thoughts

I stole this from Adam who might have stolen it from Barry? I don't know but a list of links like this is certainly not an idea I thought of.

The NYMEX (NMX) IPO is obviously white hot but I find it interesting how everyone is on the same side of this trade, so it seems. I am not trying to make a prediction but with all of the exchange IPOs in the last few years and the can do no wrong attitude I wonder if they can keep going?

I wrote a few days ago about the health of the high yielding currencies as a sign of a willingness to speculate. Now there is commentary here and there about this starting to unwind. You can check this out from Dr. Roubini and from Danske Bank. Dankse Bank has been particularly negative on Iceland for a while but this PDF is interesting. If demand for the carry unwinds a little with taking down stock markets it could be viewed similarly to an increase in VIX.

Bill Cara got his hands on Morgan Stanley's ETF report and uploaded it here. Some of the data will be stale but the report absolutely has utility.

I had a reader email that notes comparing your portfolio returns to the "market" when chances are you own bonds in addition to stocks may not be the right measure of performance. Great point. This ties in with something reader RW has been saying for months which is that do-it-yourselfers don't need to worry about benchmarking returns. I agree with RW to a point. Hopefully if you are your own PM you have some sort of financial plan and you know what your portfolio needs to do. If you are coming short of your plan and the market repeatedly something may need to change. But if you get 7%, your plan needs 5% and the stock market gets 10% I would say no worries.

In case you missed it StateStreet listed two new Japan ETFs.
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Shameless?

I don't think I am too much of a shameless self promoter, fair enough if you disagree, but today's Wallstrip interview, which you can click on just to the right of this post and down a little, is well worth the time.
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What To Do?

A reader asks for my opinion about how to protect against a collapse in the US. He asks if currencies or foreign stocks would help. Before I answer this, let me be clear I am not in the collapse-is-coming crowd.

I think it depends on the nature of the collapse. If the US economy simply rolled over because of all of the things that are known and have been worried about for ages I think diversified basket of foreign currencies would work. There are the ETFs that I have written about, I also believe it is possible to have an account at Everbank with different currencies in it; here I am not talking about the CD's but just holding currency in an account. If anyone knows about this please leave a comment.

Various commodities should do well also. Here the usual suspects like gold, silver, maybe some industrial metals that China steel needs and probably agricultural commodities too. I am sorry to report that the 29 commodity ETFs listed in London in September will not be available to trade in the US, so says Schwab. There are a couple of broad based products here to trade that will have to suffice for now.

Foreign equities may not do well in a broad sense. The US markets wag an awful lot of global dog. There are several types of countries that might be able to do well. The first type might be a country like Australia. It has a low correlation to the US market and held up very well during the blow up of a few years ago. There are other commodity countries too like Norway, New Zealand and a few places in South America but I would not be too gung ho on Canada in this regard.

I also think some "in their own world" countries might do well too like Turkey, Russia, China, India, and Iceland. Here the thought is that there are some countries where the internal story is such that there is not much reliance on the US for these stories to continue evolving.

In a similar vein I think certain frontier investment destinations could keep chugging right along with or without the US.

There are certain themes that could prevail, here the water theme comes to mind. Now I may or may not be right about water prevailing but there would be special themes that would work out.

Staples stocks or certain healthcare stocks should do better overall be would probably not be completely immune to a big decline.

If you think foreign stocks would be a good place to hide out, OK but watch out for iShares EAFE (EFA). It is heavy in Japan and the UK which would not be places I would bet on in light of a true collapse.

Domestic bonds might not be so great, I would think US rates would go up a lot in the face of an economic collapse.

One last point on this; there are often a lot of comments in this context about owning dividend paying stocks. Be careful with that one. I think it is too broad a statement. Yes high dividends bring something to the table but stocks of companies that pay dividends can still decline. During the US blowup of a few years ago the financial sector had a couple of different times where it fell 20%-25% very quickly. I mention the financial sector because it makes up 36% of iShares Select Dividend (DVY) (client holding), in fact most of the domestic dividend ETFs are heavy in financials and I would not expect that sector to be a great place to hide in the event of a collapse.

I would also be careful, in this context, with Powershares International Dividend Achievers (PID) (client holding). When PID first listed it had 20% invested in Canada including 13% in Canadian banks. Eyeballing the PID page it appears to be not quite as heavy in Canada but it still owns close to 10% in Canadian banks (under the sector header NA). Again this is about my opinion that in a US collapse Canada would not be spared. I'm a big fan of Canadian banks ex-collapse, I own one personally and for clients but I would expect it to get hit in the context of this question.

As an FYI most of the broad based WisdomTree funds are heavy in financials but they do not invest in Canada which might make them an alternative to PID in light of a collapse.

If the collapse came because of a terror attack on some unprecedented scale I would expect the dollar to go up along with bonds, gold and the Swiss franc.
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Pelosi Hoyer as House Leader

Democrats defy Pelosi, elect Hoyer House leader - Yahoo! News

It didn't sink in until a few minutes ago, Pelosi got dissed on the hill, wow.

According to the article linked above it wasn't even close.
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Dollar Crisis?

The Thursday Daily Pfennig has some limited comments about Paul Volker assigning a 75% probability to a dollar crisis in the next couple of years and to hear Chuck Butler (author of the Pfennig) tell it, Robert Rubin doesn't disagree.

Whatever the truth of that story this is something to monitor. I am not really a big believer in doom and collapses but I think it is worthwhile to understand what can hurt the markets we invest in. The threats to the dollar have to do with various imbalances, dependence on the kindness of strangers with regard to our bonds and so on.

I am in the weaker dollar camp, not collapse just weaker. In general too much study on all the wonderful things that can go right may not be very productive. Things' going right doesn't hurt your portfolio. My sentiment has been much more bearish than my positioning through this rally as an indication of what I am trying to convey here.
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What Are Appropriate Returns?

A reader asks;

A consistent theme of your work is the desirability of accepting slightly less than market returns in return for reduced risk. But the market perform very well over rolling 10 yrs., and superbly over rolling 20 yrs. So, why settle for below-average returns, especially for well-diversified, long-term, do-it-yourself accounts, when volatility is actually working for you...The one answer I can come up with is the need to tailor the account to the investor's risk tolerance, but that's really a personality consideration, not an investment issue.

Actually the point of the posts that are long these lines are to get readers to explore the notion. This is not a topic explored elsewhere very often (I don't think, anyway). Not everyone needs 12% growth. Some folks only need, say, 7%. There is an argument to be made for not taking the risk to get more return than your financial plan calls for. Further there are people that simply cannot tolerate normal stock market volatility. We have clients that fit this description some of whom can afford a low tolerance and some who cannot.

The reader's thought in the context of 20 year time periods is correct. I have seen data that says the market is higher in 15 years rolling time periods something like 92% of the time. This all speaks to something I have touched on previously; there is a mathematical argument to be made for 100% equities all the time. As a practical matter I have only met a few people that can think of their stock market portfolio in terms of that many years.

I made a reference in passing the other day to behavioral finance and the pain of losses having more emotional impact than the joy of gains; supposedly it is twice the impact.

The bottom line, I think, for this question is that for the reader's comments to be 100% right 100% of the time would require completely emotionless robotic like approach to stock market investing for both do-it-yourselfers and clients of a money manager. I know from the correction in the spring, more specifically some of the comments left on the blog, zero emotion is far and few between.

My exploration of this topic has come at time when the market has been doing very well and emotions are generally running low. IMO, this is the time to think about this sort of low impact concept. During the decline of last spring I devoted more posts to how markets do correct and the notion that that time period was teaching people whether they had too much in certain parts of the market.

My own opinion is that if you sweat normal declines in such a way as to lose sleep you need to make changes. I can guarantee there will be a 20% decline in our lifetime again, probably a 30% decline for that matter, both are in the market's historical fat tail. At some point after that decline, regardless of whenever it comes, the market will go back up and make a new high.

Here I am being neither bullish nor bearish, I am just saying that markets, in the future, will be similar as they were in the past. Not exact but similar.

Rationally, there is no reason to fear a portfolio decline today if your time horizon is in fact 20 years from now yet people do. Some introspection now while things are peachy could spare grief the next time there is a bear market.
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The Wrath Of Kang!

The title is just a humor attempt and this picture seemed like a better choice than one from the movie; there was no wrath, just some good questions from Seeking Alpha contributor Richard Kang about the cornucopia of new ETFs listed or in the pipeline.

He asks for my opinion about WisdomTree method of dividend weighting compared to PowerShares RAFI funds which scores companies buy sales, income, book value and dividends. I just did a write up for TSCM about the Rydex equal weight sector ETFs. In the course of writing that article I saw that most of the RAFI sector funds look a lot like the Sector SPDRs in terms of weighting a $200 or $300 billion at 20% of the fund, or thereabouts. These lopsided funds are quickly fading as being the best choice.

The WisdomTree funds that are out so far offer a type of differentiation that I find useful in conjunction with other stocks and ETFs I use. If they are coming out with domestic sector funds, as appears to be the case, well I am initially skeptical that they can be different, but of course I will check them out. Whereas when I first heard about their foreign sector dividend ETFs I was immediately interested and sure enough I have used one of them in broad fashion for our clients.

Richard notes that both dividend weighting and RAFI weighting both lagged the SPX during the late 1990's.

I don't know that as fact but I will take Richard's word and say that intuitively I believe he is correct about that. The building of the bubble may not be the best time period to benchmark against. In all of my articles for TSCM about various products that aren't heavy in mega caps I caution that toward the end of most cycles it is the mega caps the lead. I heard something on CNBC about only 30% of SPX components beat SPX during the bubble years. This is only true for a short time during cycles so I put less weight on the importance of this tidbit.

Lastly he asks for my two cents on the increasing number of funds that do some sort of fundamental indexing.

I say bring it on. More choice is a win for investors. If a do-it-yourselfer needs an ETF for energy and financials they have maybe ten funds to look at for each. It does not seem like a stretch to think a Vanguard fund could be best for one sector while an iShares product is best for the other one. I have a couple ETFs for some clients that I will be swapping out of in favor of newer ones that do something similar but, IMO, better.

This is something I have written about for two years now; there will be better mousetraps. We have seen that recently and I think the statement is still true looking forward.
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Fed Comments? Stop Order?

I do not know whether the rally today is the Fed, some sort of short being stopped out or something else but if there is no real reason for the rally you should not be surprised to see it unwind tomorrow.

Don't take this as talking my book, believe me I will be thrilled if the market goes higher and stays higher, thrilled.

Rationally speaking I can't imagine cycles have been repealed but shorter term the trends have been favorable overall regardless of today or tomorrow. I hope it sticks, I'm just not sure it can.
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Invest Like A Turtle?

I stumbled across a blog called Money Turtle. It is written by an anonymous GenXer in Boston and focuses, he says, on life sciences investing. It seems to me that he covers more ground than that however. His posts seem short (in a good way), easy to read and impart a knowledge of the subject. You can decide for yourself whether the site offers an utility or not.

The reason for the post is how brilliant the blog's name is, I assume it is a play on the tortoise and the hare. We all know that slow and steady won that race. I think slow and steady wins the investment race too, assuming you have saved properly.

This speaks to the idea of capturing most of the market with less volatility that I have written about previously and which I think is very important. While I am not a behavioral finance expert there are many studies that show the pain from losses has greater impact than the joy of gains. This makes a compelling case for less volatility in your portfolio.

When I think of investing like a turtle I think of dividends. If it were possible to get a 6% yield with only 3%-4% of price appreciation in most years I think I might take it (here I am talking about my own portfolio). While is not a realistic combo it makes the point and I do think 3%-4% in yield is close to happening with some of the 5% yielders out there or on the way.

Two years from now I think it will be possible to build a diversified portfolio of a dozen ETFs with a lot of yield and a standard deviation of maybe 2/3 of the broad market to create the turtle effect I am talking about. Further, investors who are so inclined could then layer in a few narrow themes (stocks, funds, whatever) to add a little more growth potential.

I think this is huge for do-it-yourselfers I just hope there are more than a couple of people exploring this.
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Well, It Doesn't Hurt

You may have seen this already as I seem to be find articles on this all over the place but a report from the UN ranked the best places in the world to live. Norway is number one followed by Iceland, Australia, Ireland and Sweden.

All five are investment destinations I have written about on this site. If you are curious, the US came in number eight.

It is tough to say concretely that there is a correlation between a high ranking and investment returns but as it says in the title of this post it sure doesn't hurt.

I was surprised that New Zealand was only 20th, I would have expected it to be higher.
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WisdomTree A GoGo

WisdomTree filed for another 31 ETFs (hat tip Tom Lydon and a nod to Richard Kang) and some of them appear to be very interesting, at first glance and so far a glance is all we have.

• WisdomTree Communications Sector Funds
• WisdomTree Financial Sector Fund
• WisdomTree REIT Sector Fund
• WisdomTree Utilities Sector Fund
• WisdomTree International Real Estate Sector Fund
• WisdomTree Total Earnings Fund
• WisdomTree Large Cap Sector Fund
• WisdomTree Midcap Earnings Fund
• WisdomTree Smallcap Earnings Fund
• WisdomTree Earnings Top100 Fund
• WisdomTree Low P/E Fund
• WisdomTree Asia Emerging Markets Total Dividend Fund
• WisdomTree Asia Emerging Markets High-Yielding Equity Fund
• WisdomTree Emerging Markets Total Dividend Fund
• WisdomTree Emerging Markets High-Yielding Equity Fund
• WisdomTree Emerging Markets Dividend Top 100 Fund
• WisdomTree Latin America Total Dividend Fund
• WisdomTree Australia Total Dividend Fund
• WisdomTree Canada Total Dividend Fund
• WisdomTree China Total Dividend Fund
• WisdomTree France Total Dividend Fund
• WisdomTree Germany Total Dividend Fund
• WisdomTree Hong Kong Total Dividend Fund
• WisdomTree India Total Dividend Fund
• WisdomTree Malaysia Total Dividend Fund
• WisdomTree South Africa Total Dividend Fund
• WisdomTree Singapore Total Dividend Fund
• WisdomTree South Korea Total Dividend Fund
• WisdomTree Taiwan Total Dividend Fund
• WisdomTree United Kingdom Total Dividend Fund
• WisdomTree United Kingdom High-Yielding Equity Fund

Some of the country funds could be very interesting. In most countries there are only a few ADRs to trade compared to what is at home in the local market. For example according to ADR.com there are no NYSE ADRs for Malaysia. iShares Malaysia (EWM) yields 3.43%. It seems to me that there are probably some high yielding stocks in Malaysia that might make WisdomTree's dividend fund at least worth looking at. Malaysia, after all, has a current account surplus, low interest rates and a strong currency. All good stuff from a top down perspective. Malaysia may or may not be a country you want to own, I don't know if I want to own it either but there are some good bones and the WisdomTree Fund could be better than EWM or the Malaysia Fund (MF).

Ditto Singapore.

Obviously I am going to be interested in the Australia fund; hopefully it is not too heavy in Telstra (TLS). The three emerging market funds could be strong competitors for EEM and ADRE (client and personal holding). I will be curious to see if the sector funds (which I presume are domestic) bring anything new. They appear to not be dividend weighted but weighted with some other fundamental criteria. If true this is new for them, if successful this could open other doors for them.

China and India could be popular and they also pave the way, maybe, for Russia, Brazil and maybe a few more destinations not yet covered.

We all have to stay tuned.
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Gimme More Risk, Gotta Have It!

As a follow up to a couple of recent posts about increased appetite for risk is this chart from Jyske Bank.

The currencies here cover a lot of emerging market real estate. A lot of money flowed into higher risk currencies last month.

Interesting stuff.
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Reader Tidbits

A couple of comments came in about the Fidelity Nordic Region Fund (FNORX). According to reader comments that fund has 50% in Sweden, 25% in Norway, 14% in Finland, 6% in Denmark and 1% in Switzerland. Another reader noted that the fund has a 0.61% correlation to the S&P 500 and a beta of 1.22. FWIW, PortfolioScience has the correlation at 0.489.

As you can see on the chart the fund has lagged EWD and EFA over the last twelve months but outperformed SPY.

A reader named Mojave left something interesting about credit default swaps which are essentially protection against bond defaults, kind of like put options. A few weeks ago there was an article in Barron's about using the ratio of the credit default index to VIX as a measure of complacency. I could not find the index on any of the normal charting sites but Mojave got them added to StockCharts.com. The North American ticker is $DJCDXNI and the ticker for the emerging market version is $DJCDXEM.

This is new to me, you can read more about it here, but I take the chart to imply fear about debt has gone up this month relative to the concern for equities. This after fear in the stock market went up a lot vs. bonds in October.

Anyone with more on this feel free to weigh in.
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Follow On To Foreign

The recent post on foreign investing drew some good comments and questions.

A reader asked what I thought was superior to EFA; he said he was hiding out in EFA, EEM and iShares Canada. First, I was probably too brief on this point. For people that are inclined to put the time in, which is not easy or right for everyone, I think the foreign portion of a portfolio can be assembled to yield much more than EFA and offer lower correlation, EFA has a 0.81 correlation to SPY. Personal and client holding iShares Australia (EWA), a theme I have been writing about forever, has a 0.48 correlation to SPY. Long time readers know I am a fan of Ireland as an investment destination. There is a CEF for Ireland with ticker IRL (no position) has a 0.25 correlation to SPY. I have liked Norway for a while and although there is no fund (that I am aware of) I have disclosed owning Statoil (STO) personally and for clients, STO has a 0.43% correlation to SPY. One more example; I have been writing about Sweden a lot this year, iShares Sweden (EWD), no position, has a 0.68 correlation to SPY. EWD's correlation is higher than the others but still lower than EFA.

Only STO is lagging EFA, it was way ahead earlier in the year as you might expect and now trails by a hair, although maybe not after accounting for the dividend.

I didn't even mention any of the broad-based WisdomTree funds (no positions in the broad-based ones) which I think will be better performers than EFA for investors that would rather not take single country risk. These folks might also want to consider an actively managed OEF instead of EFA.

TomK thinks EFA is a good hold. It obviously is a popular offering; I just think there is better diversification to be had.

One reader thinks exploring correlation is useful (agreed) and asks where this can be found. I use PortfolioScience.com which costs about $20 per month. The information is good but the actual site is very temperamental. A couple of readers left a link that Charles Kirk found from the SPDR people that I have not looked at yet which is free, as I understand it.

In the post in question I said that I found the quote in Barron's about no more 15% in any sector, including foreign, to be peculiar. A reader left a comment saying they agree with the quote to an extent. He believes that treating foreign as sector is correct but does not think 15% is enough in foreign. I can't say he is wrong of course but I view it differently. For example when I look at how I want to capture a sector I look for what I think is the best way to do it. Here I am talking sectors that make up the S&P 500. With energy, for example, there are various countries that I think are better for clients than the US. With staples I view Diageo (DEO) as a great way to capture staples and the UK. The point is that I think it makes more sense to integrate foreign into the sectors and not view as a stand alone. I think that when viewed as stand alone, the chance of lopsided sector weightings increases.

Another reader thinks most of an investor's assets should be in foreign stocks because of the state of the US economy. He says that for every good domestic stock there is a good foreign stock to match, he cites Total (TOT) instead of Chevron. Well, maybe. Here again, what is the best way to capture different parts of the market? What is best today may not be best in the future. I would tell this person to be cognizant of this point.
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Old Time Hockey?

Our Arizona Sundogs put on quite a show in their franchise home opener as you can see here. Unfortunately they got waxed 6-0. The game was fun, the action was good and there were a couple of fumbles along the way that you might expect from a new minor league hockey team. We will definitely go to more games.

On to market related stuff. There was an article in Barron's last Tuesday that quoted several different money managers opining about how much foreign exposure they have now or how much they plan to have in the future.

One advisor was quoted saying "her firm will not allocate more than 15% of a client's portfolio to one sector, including international, as a way to control risk." This seems like a peculiar comment to me. I count 22 single country ETFs from iShares. Of the 22, twelve have a correlation of less than 0.60 to the S&P 500. I would say that risk control is the result of how a portfolio's components are blended not whether a specific holding is volatile or not. Of the 20 single country funds that existed from 1/1/2001-12/31/2002, nine outperformed the SPX, this during a particularly bad run for the US market. Of those nine, seven outperformed dramatically.

The manner in which this person is quoted (here I am saying the above quote could be out of context) makes it seem like she really does not understand foreign investing or diversification. Assuming the quote was wrong and she does know, you will no doubt encounter people that you maybe looking to have help you that don't know.

Here I think the onus is on you. It is not that difficult to learn the big macro for some other countries and to also learn generally how volatile those markets, what makes them tick, how they correlate to the US market and how they could incorporate into a portfolio.

If your plan is to manage your own portfolio I think you need to be willing to explore and learn about this sort of thing. I don't think you can just count on hiding out in iShares EAFE (EFA) either. It looks like it listed in summer 2001. From its inception until 12/31/2002 it dropped by the same amount as the S&P 500.

EFA has never been my first choice for foreign diversification. I own it for a couple of accounts where circumstantially it is what fits but there are countless alternatives that are superior.

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The Big Picture For The Week Of November 12, 2006

As you watch please replace the word pretending with the word assuming. I don't like my use of that word but did not want to do the video again and upload again. Thank you.
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Sports Palooza

Congrats to Rutgers last night beating Louisville which could create a difficult national championship picture but Rutgers still has some tough games left including West Virginia.

It looks like the Arizona Diamondbacks are changing their uniforms for next season. Hopefully this leads to better personnel decisions. I'm quite certain there is a high correlation between the two.

The biggest news of all is that we here in Prescott now have our own professional team; The Arizona Sundogs, a minor league affiliate of the Phoenix Coyotes. Tonight is the team's home opener against the Youngstown SteelHounds and Mrs. Random Roger and I are going to the game. She is, ahem, thrilled.

On the Sundogs website is a poll question about who will be the Sundog's biggest rival. My vote is for the Odessa Jackalopes.
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Chinese Diversification

There was an article last night on Bloomberg about the Aussie going up against the dollar because of rumors that China "may switch out of U.S. dollars to diversify its more than $1 trillion in foreign-exchange reserves."

I have never been a believer that China will sell enough dollars to move the market meaningfully and I'm still not but I have expressed concern about the possibility that China buys fewer dollars in the future. The above article theorizes that China would buy more Aussie dollars for several reasons including the fact that it buys a lot of natural resources from Australia.

This is one reason that I have been a believer in the Australia theme for a while and have had client money invested there as well.

There have been stories of other smaller countries selling down their dollar exposure in favor of a more diversified currency reserve. Those countries are small enough that they can sell without much impact. China cannot sell without impact unless they do it v e r y s l o w l y. China owns so many dollars that selling enough to move the market is not in their interests. Of course fear of what they might do could move markets.

But they may buy less in the future. This seems much more plausible to me. Either way this is important to monitor. I would expect Australian investments to do well, Chinese investment should do well for US based investors and other big G-10 currencies should also do well. If China does buy fewer dollars they are going to buy other currencies. Investments from those countries could do well in dollar terms.

Don't lose touch with one.
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Safe Stocks?

There is an article in Journal called Safe Stocks which is a Smart Money (Magazine?) stock screen. The screen is looking for low beta stocks that zig when the market zags.

Among the stocks listed are Zimmer Holdings (ZMH) and WellPoint (WLP). There is a table of stocks and according to that table the beta for Zimmer is zero and for WellPoint it is 0.1, again according to the table in the article.

I specifically did not want to look elsewhere for corroboration. This is more of a sniff test than number crunch. Look at the chart here and forget the table in the article. Do you think these stocks reduce volatility?

The point here is that even if the data from the table in the article is correct, your eyes may tell you something different.
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$2 Trillion?

While I can't vouch for this, Chuck Butler, writer of the Daily Pfennig, says that China's currency reserves will reach $2 trillion by 2010. You probably know they just passed $1 trillion recently. Chucks comment about $2 trillion was the first estimate along these lines I've seen.

I do not know if this will prove to be correct but that is a big big number.
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Equal Weight

Rydex issued nine sector ETFs that are equal weighted. This differs from the other sector ETFs that weigh by market cap or some fundamental screen. The result of market cap weighting or most fundamental weighting is that the largest stocks have the heaviest exposure, even in the fundamental funds. For example Exxon Mobil makes up 23% of the RAFI Energy ETF (PRFE), GE is 20% of the RAFI Industrial ETF (PRFN) although I will say that the RAFI Financial ETF (PRFF) is not lopsided in this manner.

The equal weight funds offer access to sectors in a way that should be different than what exists now. I wrote an article for TheStreet.com that you can read here without a subscription that goes into more detail about the composition method.

I think these funds are a great addition to the do-it-yourselfers' arsenal. By offering sector access without mega cap lopsidedness investors can change they way they construct different sectors within their portfolios. Sticking with energy; Exxon Mobil badly lagged sector the vast majority of the recent/current bull market. During the last three months though it has significantly outperformed. Mega caps tend to lag for most of the stock market cycle. An investor not wanting single stock risk could buy the equal weight ETF and then later in the cycle either rotate into a cap weighted ETF or just buy a few shares of Exxon, either one brings the same effect but there is less tax consequence from keeping the same ETF and then adding or subtracting one stock.

Further I think the equal weight ETFs could also complement the use of a sub-sector ETF or two along with a stock from a part of the sector that is not otherwise ETF-able. There may also be a way to work in the WisdomTree foreign ETF too.

I am convinced that the utility of new products that come to market in combination with some of the old standbys will give the chance for better diversity with little or no single stock risk.
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Recent Trade

Go to the Bench for Oil Substitute

Earlier this week I swapped out of BP and into WisdomTree International Energy Fund (DKA). This was something I had been thinking about doing for a couple of weeks. BP has been struggling for several reasons. I think for the short term, 6-9 months, BP may not be able to outperform the sector.

If this turns out to be correct, taking the singe stock risk is not ideal. If this turns out to be incorrect and BP goes up a lot I would expect DKA to benefit as BP is weighted at 9% of the fund.

To be clear I expect the two to correlate very closely. If things get worse for BP clients will miss a portion of that lag.
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Morningstar Votes for Mutual Funds

Morningstar Votes for Mutual Funds

Jen Ryan from TheStreet.com has a great article up that takes on Morningstar's apparent bias against ETFs that quotes several people including one slow witted blogger.

Morningstar of course denies it is biased against ETFs, they say they are not conflicted and that they just call them like they see them.

I have been critical of Morningstar many times here and once or twice for RealMoney.com. But let's take them at their word for a moment; straight shooting un conflicted opinion. OK well then this is an admission that they have no ability or interest in forward looking analysis.

As the article points out their ratings are based on past performance. UC Riverside Professor Barry Misha commented that you can't blame an ETF if it does well or not.

Think about that, how many times was last year's worse performing sector or country or something else this year's best performer.

Also taking Morningstar at their word they make no effort to explore how a narrow ETF might fit in to a diversified portfolio.

Clearly you will not need the vast majority of ETFs that exist but that does not mean they don't merit unbiased study which Morningstar seems unwilling to do.
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Inhibitions By The Wayside?

You may recall that the emerging market (and other markets) correction from last spring started in part due to the unwinding of the carry trade. The poster child for this risk aversion trade was the Icelandic krona.

In the last three months it seems like the carry trade has come back better than ever, the anti-risk aversion trade.

This chart shows various high yielding currencies against the yen for the last three months. The kiwi is up more than 10%, the Aussie is up just under 5% and the Hungarian forint is up 6%. Not so much Australia but New Zealand and Hungary are facing some big obstacles. Relative to the world currency trading the risk taken for the extra yield seems to be quite high. And last spring market participants were falling over themselves to unwind these trades. For now they clearly have confidence that the high yielders won't decline, that is they are willing to maintain more risk than they did last spring. Put differently this could be construed as letting their guard down and being optimistic about the near term.

This could be the market correctly saying all systems go for global markets or it can be taken as a contrarian indicator that now is the time to cut back risk. You can decide for yourself. Clearly the market is not as afraid as it was a few months ago.

The point of this post is that the goings on in the currency markets can help assess the market's perception of risk similar to the VIX index but with more of a global flavor.
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Election

You may recall Emily Litella misunderstanding that there would be an election.

You have probably also heard that the election results may not all be in right away. I don't think too many people envision a post 2000 election rerun, but it may be worth taking a look back at the market action then and think about what might happen now.

In 2000 Election Day was November 7. The S&P 500 closed that day at 1431 down about a point. On the 8th, when there was no winner the market fell to 1409, about 1.5% drop. The market bottomed on Dec 20 at 1264, an 11.67% decline before starting to work its way higher. On November 9 of that year the market fell 2.5%, yikes!

An uncertain election result was a new thing for the market when it happened in 2000. If there is some period of uncertainty this time around with who holds congress or the senate it makes sense to think there could be some negative market reaction but since we just had something similar six years ago with a presidential election I do no think it makes sense to fear a decline of the same magnitude.

The market fears the unfamiliar. The last time around there was squabbling and two months of uncertainty, we know what that feels like, the impact will be less, if it even happens.
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Forsyth On Indexing

Randall Forsyth had an interesting comment about indexing versus active management in his daily Up and down Wall Street column on Friday.

Index funds have a place in a portfolio, providing a core position at a rock-bottom cost. But providing true diversification and extra returns requires straying well a ways from that benchmark.

The above quote was in the context of interviewing David Winter of the Wintergreen Fund (WGRNX). He used to work at the Mutual Series of funds and has had his own shop for a while. He is on the Connie Mack show on PBS every so often.

If you are managing your own portfolio you may not be inclined to own and follow 45 stocks. I do think that a lot do-it-yourselfers can index a big chunk of their portfolio and then follow ten or maybe a dozen narrower holdings that can, depending on the investor's leanings, increase or decrease volatility or provide exposure to some themes not captured through indexing.

Exposure to single countries is one that is tough to capture through "normal" indexing but can be a way to get some genuine zig-zag compared to domestic holding. I've written more than a few times about water and oil sands as themes that are important to me, chances are there are other non-single country themes that are important to you. A theme like this, assuming it is one you believe in, has the chance a lot of growth that could come regardless of what the market is doing.

ETFs, where they exist, allow investors to simply learn the fundamentals of the theme whereas picking an individual stock requires knowing the theme and the stock. This is absolutely doable but it is obviously at least twice the work. I would say first to focus on the theme and then figure out the best way to invest in it. There may not be a fund or other product; a common stock may be the only way to go.

It is not vital that you own the single best performing thing to capture the effect. For example, I don't think there is an ethanol fund but the pure play stocks (just picking a fad here that I have no exposure to) are very volatile. The theme might be right for you but the stocks may be a little too hot to handle for some folks. If there were an ETF it would capture most of the effect with probably less white knuckle.

The theme is more important than the pick, so says top down theory.

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Marvin Appel

CNBC just interviewed Marvin Appel. He has a book out called Investing With Exchange Traded Funds Made Easy. As best as I can tell the basic strategy is 25% in bonds, 25% in REITs, 25% in large, smal-cap, value & growth (some combination?) and 25% in International, S&P 500 or cash(one of the three?).

For purposes of the post the strategy does not matter and I am neither endorsing nor trashing the idea. This is a very simple strategy that I am sure has compelling results. The point of this post is that to take on a strategy like this is to take a long term view of your portfolio which is something I think is very important.

Like with all methods I am sure there are periods going forward where this will lag and other periods where it will do very well. I specifically did not want to analyze it in this manner. If you can embrace a long term view, first I think you will have a much better experience in terms of emotion, you have to realize and accept that there will be periods where you beat and other periods where you lag the market. Chasing heat during the lags is when people get themselves in trouble.
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Text Book

This chart is from the info page for the First Trust Aberdeen Emerging Opportunity Fund (FEO). This is a fairly new CEF that invests in some combination of emerging market stocks and bonds.

There is no information about holdings on the page (or at least I couldn't find any). The point of this post is not about the fund, but the action on the chart.

It captures the premium that closed end funds have when they are issued and the inevitable erosion of that premium in the subsequent weeks and months.

This neither makes CEFs good or bad but is simply one of the mechanics of the product.

On a related note a reader asked what I think about CEFs that use leverage. That's a very broad question. One leveraged fund may be very skilled at knowing when to increase or decrease leverage while another fund may have no skill or make no effort in this regard.

Leverage obviously increases risk. I am not a huge fan but throwing a well run leveraged fund into the mix has its place. The thing to focus in is how the fund uses leverage, how much leverage the fund uses and if you own several leveraged funds, how exposed you are to that leverage.

Too many people don't learn how leveraged they are in these until it is too late.
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The Good Doctor And Other Tidbits

This table comes from John Hussman. It captures the percentage move higher during past bull markets. It also captures the net gain of the full cycle.

The take away is that a lot is lost when the bull phase ends and the bear market starts. Regardless of whether you tend to be a Kudlow-ite or a Roubini-an a complete cycle includes bull and bear phases and betting that cycles have been repealed is a bad idea.

The Daytrade Team has a funny post up about how the human brain works that could be a nice diversion to your day.

For an even bigger diversion try this site, don't worry its G-rated.
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Starting From Scratch

There was a question about frontier investing that got me to thinking that an example of how to start researching one of the countries could be worthwhile. One of the countries mentioned in the Barron's article was Zambia. To be crystal clear I have no intention of investing money there personally or for clients, this is just an example. Frontier investing has merit, I have small exposure to another frontier country, this is just a primer on how to get started. I'll also add that for me the usual catalyst for me to learn about a new country will be something positive and compelling I might read somewhere, but that was not the case with Zambia.

A good starting point is the Wikipedia page for the country, and there is one for Zambia. This page tells us the inflation was 18% last year, GDP grew at 5.1%, 85% of the work force works in agriculture, they export copper and cobalt, they import almost every thing else. There are big issues with life expectancy, health, poverty and so on. There would not seem to be room for things to get too much worse (but I obviously can't predict something like this) and a lot of room for things to improve. To be clear, social and economic improvement may not come in this century if ever.

Next stop; the central bank web site. Like the sites of most central banks there is an English version. This will give more up to date data than the Wikipedia page. It looks like five year government debt yields 13% and six month T-bills yield 9.5%.

After that you can go to ADR.com and see if there are any stocks, I found one, Zambia Copper Investments. Yahoo Finance knows the symbol as ZMBBY, but Schwab has it as ZMBBF. The company has a website and its annual report is in PDF format. The company is tiny, its primary listing is in South Africa, the numbers are not very inspiring but the stock has correlated closely to BHP Billiton which I find interesting.

For a lot more risk you had the same return. This only makes sense if you think Zambia, and by extension Zambia Copper as a proxy, will go through a big transformation.

Since Zambia Copper appears to be the only stock for now you can do an Internet search where you will find plenty of hits. I would also suggest a Technorati search as well which seems to reveal an investment in Zambia by Chinese concerns. This makes some sense as 13% of Zambia's exports (according to the Wikipedia page), think copper, are to China.

I also want to be in touch with the currency of a country if possible and BigCharts does have data on the Zambian kwacha. The last year has certainly been a wild ride for the kwacha. I would not expect this to change too much in the near future.

So at this point what have we got? Really a vague familiarity with the country and the stock. If you read some of the various search hits and combed through the central bank you will know a little more. Now comes some follow up reading, maybe adding a term or two to your news feed and maybe every few months learn more about the destination and the stock.

There is no real hurry. If Zambia or any other frontier country is going to become the next China it will take years and years and you will not be late even if you spend half a decade learning the story.

This kind of work may not be for you, after all even if you fall in love with a frontier market, how much will you invest in one?
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Time For A Second Cup

One reader asked for my two cents on the homebuilder stocks noting that Cramer is bullish. I don't know first hand what Cramer's opinion is. I have written a few times about this group. This is and has been a blind spot for me. I do not quite understand how there can be unlimited demand for new houses. Every investor has blind spots-this is one of mine.

That being said, at a minimum there is plenty of debate about magnitude of the current economic slowing underway. If you acknowledge there is a debate about slowing, that would seem to create a big head wind for the group.

Another reader is in a dilemma about how much cash to have on hand. He believes that he will be able to buy things he likes at better prices. He could be right but no one can know obviously. The answer is subjective but there is a difference between raising some cash and missing the market. The reader mentions high yielding stocks and the like as a means of taking down the volatility. When I implement a new account clients often ask about how to get started, what if the market drops quickly? If you buy ten different stocks today, one from each sector, chances are a few of the entry points will look great, some will look lousy and some won't matter. Further it is very unlikely that you could guess ahead of time which would be which.

Trying to get too aggressive with cash (like 50% or more) is going to be really wrong that vast majority of the time.

Another reader asks for specific answers about how to invest in frontier markets. I linked to a Barron's article that had some OEFs that provide some exposure. There are some closed end fund-like products that trade in London, in US dollars, that invest in some of these countries. TrustNet is a site that is a good resource for these funds.

The same reader also notes that he can understand anyone being frustrated because I have been too negative this year and by my own admission am having a bad year. Hmm not exactly right. Too negative this summer; yes. Bad year; not quite. I had a big spread over the benchmark that evaporated to now being about even. As RW graciously noted that's not bad. Equaling the market, getting a big call wrong, with a lot of cash is not a bad year. I was on my way to a much better year to be sure but an incorrect decision does not necessarily mean the year is bad.
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