A few weeks ago I posted concern that if the yen were to strengthen in a meaningful way it could cause problems of some magnitude as the cheap, cheap money in Japan greases a lot of different wheels.
Turns out Dr. Brett did the heavy lifting to quantify yen's impact. A strong yen, as Brett qualifies it, has lead to an average S&P 500 decline of 40 basis points. You need to read his post to get the full context.
I doubt a hike to 50 basis points in Japan will destroy the carry trade and cause any LTCM-like blowups but it could be a trigger point for something normal in the way of a correction. If not, great, but this bears watching as the yen has strengthened in the last few days.
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17 comments:
Roger, here's an article that puts my head in a spin. by John Serrapere
2006: Two worlds, in a year of many crosscurrents. Updating the portfolio for the uncertainty of 2007.
Read the full article here.
http://www.indexuniverse.com/index.php?section=67&id=1830
If I can interest you in scanning it, it hits a theme that I sense you support...have a portfolio that may not beat but does temper losses. Ok, I want that to compliment my more aggrssive portfolio, but is the approach in this article more complex than necessary? Are there some big bets in the article's defensive 2007 portfolio that contradicts a more conservative stance? As much as I want to protect myself from big drawdowns, can these hedge diy portfolios be any better than allocations to cash or bonds? They lure me into wrapping my head around them, but all I get is the feeling that I don't get it, that I'm going down a rabbit hole, and that this approach is better left to the hard to find qualified pros. Maybe it's all part of a learning curve or maybe it's all part of putting the KISS method on its head. As you can see, I need financial behavior counseling.
Anon,
Go to this website:
http://www.quantext.com/subpage.html
and first read the article titled The 'No Direction' Portfolio
All of the other articles are very well written as well. State of the art analysis. Probably will give you more ideas as to how to neutralize a potentially lousy market environment.
Investing is truly a big numbers game.
Most of the individuals involved in the carry trade are trading swaps or can hedge quickly. I don't see an LTCM type move. But, a 1998 type move has potential. When the yen carry unraveled back then, there wasn't much backlash at the time. The markets sustained the move fairly well. Again, it's a matter of who is putting the trade on.
I'm not too crazy about the S&P correlation. That doesn't sound good.
Roger...
I just read the piece. The heavy lifting was about as heavy as a coffee mug. Bret only went back about three years. The yen has been largely rangebound throughout that time. Perhaps if he went back to 1980, there'd be a far different outlook. I tried to post something to him, but I don't have a blogger account.
David, I would ask if you think it is possible for the relationship of the yen and SPX to ebb and flowin term of importance? Could it be that it was less important before and more important now or vice versa?
OT, RE: No Direction portfolio,
Thanks for the link. Nicely written.
I'm a relative strength investor. Perhaps I am perverting the intention of the above article but for me the hook is to accumulate a list of equities with low beta and low r2 as a separate group to apply relative strength, and then to allocate a given percentage of my overall portfolio to this asset class. A macro picture emerging is that cap and style top down dissection needs to be augmented with a low beta, low r2 (high quality defensive stocks) group. Is there an etf that already captures this parameter but goes under the name of a dividend etf? Stocks, alone and more closelyfit the criteria, may be more productive. I "feel" like I'm getting back to the keep it simple.
Roger, I would like to contact you regarding posting some of your commentary on our site. Please contact me at contact(at)theeasternphoenix.com
Thanks
Off topic but I've discovered an ETF tax problem:
Roger, I’ve identified a flaw in the way certain ETFs are managed with respect to their being recognized as paying out qualified dividends.
I have contacted Vanguard - where my brokerage account is - as well as the source of many of my ETFs and they continue to dance around the issue.
According to a recent letter I received from Vanguard ( I would have posted on this at the Diehard site but they want five bucks to “set up my account”) all of the qualified dividends paid from securities in my Vanguard brokerage account can be reclassified as non-qualified if Vanguard or their agent “loans” them out to short sellers. While this only applies to "margin" accounts (that's what I ended up with for no good reason.) I have already requested they change my account to a "Cash" account but the problem only begins there.
While this only applies to Vanguard’s margin account, this got me thinking; are all dividends held in any trust (ETF) structure subject to this restriction?
According to this link, they are.
“…Payments received in lieu of dividends when shares are loaned out (this may occur when shares are held in an account with a margin agreement)…”
http://www.pgaol.msu.edu/taxation
_of_qualified_dividends.html
Furthermore Tom Lauricella’s article in today’s Wall Street Journal - pp. C1 states that not only does Barclays loan out shares (making the dividend payments ineligible for qualified treatment) but so does my beloved Vangaurd. As I stated earlier, multiple requests over the last year-plus on why I don't get anywhere near 100% qualified treatment on my dividends results in Vanguard responses that they don’t understand my question.
Take VWO. In 2005 the qualified portion was 80%, and even lower this year. This is a structural problem as well as a marketing and tax problem and I and all ETF uses are paying more in taxes because of it.
my understanding about margin accounts is that they have to have a debit balance in order for shares to be lent out.
as far as the bigger issue i have to say I had not thought about that before. The only ETF in my taxable account is a currency ETF so I can't check my 1099 but I would ask other readers to look at their paperwork and please comment.
Roger, what's your opinion of the
currency allocation in Powershars's
new ETF's (dollar down/up)?
Jay Charles
40 basis point? i sneeze and the spy changes by more than 40 basis point. While the carry trade is a serious issue, i do not believe that Brett's analysis is very relevant here.
as for the dividends. this is not particular to ETFs. If your broker loans shares you own for short sale then whom ever owns the share when the stock goes ex-dividend gets the dividend. The original owner is also entitled to the same amount, thus the short seller pays the original owner the dividend amount. The transaction is handled by the broker behind the scenes.
if i recall correctly, some broker firms -- Ameritrade seems to come to mind but i have not checked -- actually pay the original owner an amount they calculate to offset the tax consequences. I received literature to that effect from various brokers after the qualified dividend law went into effect.
Also, the margin account is relevant to the short seller. In other words, the short seller needs a margin account to short stocks. But the account loaning the stocks does not need to be a margin account, i do not believe. So your switching to cash account may not make a difference.
I cannot speak on behalf of Vanguard, but i believe the issue you refer to has more to do with how a dividend becomes qualified and less with short sales. Not all dividends are qualified dividends. The stocks has to be in the account for 60 days. So, while you may own the ETF for over 60 days, the ETF itself may not own all of its stocks long enough to qualify the dividends.
Also, REITs owned by the ETF pay non-qualified dividends. Some dividends are classified as return of capital and thus are not qualified.
Some foreign dividends do not qualify and/or have foreign tax withholdings.
A lot of these things take a while to calculate -- for example what percentage is return of capital -- and are not known till after the end of the year.
In short (no pun intended), you have stumbled upon an accounting headache and not a tax problem.
http://www.schwab.com/cms/P-270109.1/margin_borrowing.pdf?cmsid=P-270109&refid=P-841208&refpid=P-841204
Scwab policy above
http://www.nyse.com/pdfs/MarginCustomersKnowYourShareholderRights.pdf
NYSE informed investor
Hopefully the links show in the contracted blogger comment line. The above may highlight at least one broker's policy and the NYSE informed investor information.
Roger, Sami, Leisa thanks but...
...for foreign shares, there are very few REIT constructs - pass-throughs - outside the US or Canada.; certainly not twenty or thirty percent of any of the MSCI indices.
I'm a buy-and-hold so the 60-day wash rule doesn't effect me. Inside an ETF there's not nearly enough activity to warrant a 20-30% reduction in the qualified dividends due to the 60-day wash rules either.
Vanguard told me that changing to a Cash account would allow me to get qualified dividends on the dividends paid out of the ETF to me - I've got the e-document, but that still doesn't cover the dividends inside of the ETF trust structure. There's a difference. See the WSJ article by Lauricella.
It's not really an accounting headache for me; the broker reports the qualified portion and the dividend on your 1099, but for Vanguard ETFs only 70-80% of the total dividends are qualified. It may be a lot of checking for them for each firm due to the retained earnings rules associate with qualified dividends. But few US companies pay out dividends that are not qualified, aside from REITs, but they don’t make up enough of the indices. However what would make it complicated are any short sales a broker agent does make, since each of those payments covering dividends FROM the shorts tracked and tagged as non-qualified.
Furthermore, capital gains distributions – or any return of capital - are separate and also taxed at only 15% if they're long-term which is the case for most distributions I've received from ETFs.
This is a problem, since ETFs dividends are less tax efficient than owning the component securities when your agent loans them out to shorts.
As long as we are on asset allocation, I will recommend fellow readers to lookup Kirk Report. Recently Kirk has collected the widest range of model asset allocations and portfolios I ever seen on the web. A must read.
The issue of how ETF's are treated for tax purposes remains murky IMO -- it is not even clear to me if all ETF's will be 'created equal' in this matter -- and I have yet to receive the letter promised by Deutch Bank regarding the status of dividends in their commodity ETFs and whether or not the grantor trust structure allows all or a portion of dividends therefrom to be treated as ROC.
TANSTAAFL: I have no problem with the possibility that the relatively low cost ratios and convenience of ETF's may have as much to do with (possibly unrevealed) benefits they confer to the sell-side -- to those who originate, manage, transact or manipulate them -- as benefits they confer to us on the buy-side who merely wish to hold them but the putative and frequently lauded transparency of ETFs could certainly be further improved.
PS: I concur with the recommendation regarding The Kirk Report's overview of 'lazy portfolios' at http://tinyurl.com/2o2lad -- it's useful to see these model allocation strategies in one place -- currently the Q&A addressing these is for members only (password req) but Kirk may release that at some later date (or not); I believe he has done so in the past with other Q&A's.
RW: How to subscribe to Kirk Report? Donate is the ticket? Are you a member? Looks promising. Thanks.
Anon 9:18, most things at the Kirk report are free, he'll even send you the report by email if you request it. He does accept donations to support this work but only those who make a donation of $50 or more have access to his trading portfolio, private trading notes, and research. Most of the work is focused on shorter term trading.
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