Sector ETFs

Last week at that ETF conference I was made aware of someone who is working a new type of sector ETF. I won't say any more than that to preserve what I was told in confidence (really I was given almost no info on this).

I also had a chance to talk to a couple of the guys from PowerShares who told me that the Nasdaq BuyWrite ETF had been delayed (I did not know this). Only the S&P 500 BuyWrite ETF listed and so far it has very little in the way of assets. I think buywrite is a great tool to include in a diversified portfolio, maybe they need to do more to get the word out about the fund?

In one of the sessions last week I asked the panelists how they use ETFs to manage volatility and they all said they don't do that. Either I asked the question poorly or they really don't manage volatility (I suspect the former). A similar question came my way on a panel I sat on. I used the example of having owned several individual stocks for my energy sector allocation but that I worked in the WisdomTree Energy ETF (DKA) into the mix as a way to reduce volatility as the theme got longer in the tooth.

The idea of going from stocks, to ETFs and back to stocks as a means to manage through a complete stock market cycle makes a lot of sense to me.

This gets to the point of the post which is buywrite sector ETFs--for some of the sectors anyway. Buywrite is just a strategy like any other. It has pluses and minuses. The big plus is less volatile the big minus is giving away the upside beyond a certain point. It is not a strategy for all seasons but incorporated in moderation it can reduce the volatility of the portfolio.

At the beginning of or toward the middle of a stock market cycle it makes sense to take a little more risk so a sector allocation could have more common stocks and fewer ETFs and then as the cycle matures a transition to more ETFs might be the way to go. Sticking with energy, a combo of a buy write sector fund, DKA and then the smallest portion in something that is more volatile (maybe an oil sands stock for example) would bring in a lot of yield, reduce volatility some and the small portion in the (sticking with the example) oil sands could give the chance to catch some of a big bounce off the bottom in case reallocating isn't done exactly right.

Why not just sell calls against an ETF? That could be a solution to be sure but it creates a layer of complexity and record keeping that many do-it-yourselfers may not want to do. Also a fund that does buywrite does not get called away as opposed to selling the calls yourself unless you roll up the positions which is very rarely a good idea.

The likelihood that buywrite sector ETFs ever come is quite slim but the idea is intriguing and the application has utility.

If you have any interest in any sort of ETF that does not exist I would say to let the ETF providers know about it, you never know.

Opening day for baseball, the first full day, and it looks like ESPN is back showing a lot of games again.
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Sunday Morning Coffee

A reader asked for my opinion about what sectors and countries to buy when the market eventually starts a new bullish phase.

OK so this has two parts to it in terms of how I try to frame the answer.

Long time readers may recall my saying that I try to combine what I know about market history with an assessment of current events to try to make a forward looking analysis.

An assessment of current events with an eye toward reequitizing becomes difficult because it may not make sense to reequitize for a year and a lot can change between now and then.

Starting from the top down it makes sense in a new bull market to reduce the average cap size of the portfolio (I made the portfolio larger and larger cap-wise as the bull aged) because small cap usually leads off the bottom. In making the portfolio smaller you are increasing the volatility which again makes sense to do as obviously the prevailing direction of a bull market is up. All of this probably reduces the yield a little bit but in a year where the market goes up 25%, squeezing out an extra 50 beeps in yield should not be the priority.

In terms of sector the first thing that comes to mind to overweight is industrials. Globally speaking money must flow into infrastructure so I believe industrial stocks that benefit from this capital flow stand to do well.

Financials would be another area that usually does well emerging from a bear. Problems at Citi are not new. After a the famous near death blow in the early 1990s Citi went up about 2000% versus 300% (just eyeballing a chart) for the SPX into year end 2000. Citi was not my fav before this all started and probably will not be after but the point is that the financial sector (the ones that survive) will come back from this and probably outperform meaningfully for a while.

Tech should be one to overweight but if I were reequitizing right now I would be skeptical of that one but we'll see when the time comes.

Discretionary does well early cycle too. Energy is a tough call from a historical perspective as I think there are skews to each of the past episodes that make looking back especially unhelpful. Based on my perception of what is going on with supply and demand I would probably want to be overweight. Ditto materials.

Telecom equipment should do better than the ma bells of the world (and I do mean the world) but I am a little distrustful of making a big bet on that. Utilities, staples and healthcare would probably lag a little.

Most of this is based on how cycles work. I tried to add in a little current thinking in there but I think it will be a while before this matters and the manner in which the bear plays out will influence how I actually execute.

As far as countries I am not likely to make really big changes to the countries I favor. I have talked about adding China back in across the board at some point and I might add a little to a couple of the other countries I currently own. While that mind not sound like much keep in mind I have about 20% cash so at 2 or 3% per position it wouldn't take much to reequitize.

The picture is obviously from South Beach last week. That hotel is on Ocean Drive and looks out on to the beach (where I am standing) and the ocean beyond that. Unlike most of the pictures I took I don't hate this one.
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The Big Picture For The Week Of March 30, 2008

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Yikes

The news about rice prices is making the rounds and this particular link seems very depressing.

This is worth following and understanding (to the extent we can) as there are probably several investment implications.

On a different note I took quite a few pictures in Miami in order to give Joellyn some sense of what it looks like. And while I think I did that, candidly most of the picture stink.

This is one of the better ones and it stinks. Oh, well but if you've never been this give a little inkling of what some of the buildings in South Beach look like.
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More Reasons To Keep It Simple

There was an interesting article in the WSJ yesterday about a couple of funds run by John Meriwether, yes the LTCM John Meriwether.

He has a fixed income fund that instead of being levered 50 to 1 is levered about 14 to 1 (both numbers according to WSJ). There is also a macro fund that the WSJ says is down 6% through Feb and was down 5.7% in 2007.

So whatever it is that these funds are doing I doubt it is very simple but maybe they think it is simple. Yesterday in the panel I participated in we were all talking about how we each use ETFs. I mentioned that I use mostly stocks but that I use ETFs where ever I think they are the best tool to capture a theme. One of the other panelists said "we like to keep things simple" and then described his use of of ETFs. Simple is in the eye of the beholder. I think he was saying that the approach of blending individual stocks and ETFs was not simple.

Fair comment. I have responded to reader comments in a similar fashion--"that sounds complicated" I might reply. Obviously if you really understand some sort of method you probably think it is simple. So maybe the better idea is to keep it predictable?

I don't mean don't take risks but to generally quantify your risks in some sense. For example anyone overweighting broader dividend ETFs clearly has an overweight position in the financial sector. Generically speaking this doesn't have to be a bad thing. A lot of dividend ETF exposure makes you vulnerable to a down turn in the financial sector. This has mattered over the last year or so and at some point in the future won't be a big deal but now it is.

Knowing, in this example, that the financial sector is a threat, you can mitigate that risk in whatever manner is appropriate which can include selling some, hedging or holding on but mentally preparing for a downturn.

Even this doesn't work though. If you are levered up 14-1 on a fixed income program you know that if the market moves in the wrong direction of your trades there will be a blow up of some sort.

So what is the answer? Maybe the answer goes back to keep it simple. Despite my co-panelists comments I think a diversified equity portfolio that can generally stay close to the market either way is simple and manageable.
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Miami Tidbits

A few months ago I put up a chart like this and used what is on this chart the maroon line to say I thought a bear market had started.

Recently I saw where some folks felt that SPX 1350 would be an important level and I think the green line makes it clear why someone would draw that conclusion.

Monday when SPX was above 1350 for most of the day and then closed at 1349 I thought that 1350 might in fact be significant. Wednesday opened with a small gap down and SPX stayed below 1350 all day.

Maybe today it will take 1350 back or maybe 1350--or 1359 the day high on Monday-- will be a turnaround point. Who knows?

The point is that technical analysis is not the be all end all tool. It is very useful at times but I don't think any tool can work all the time. The 1350 conclusion made a lot of sense based on the chart (anyone should feel free to offer up why that is wrong) but anyone making the decision to implement based on the action on Monday (hey 1349 is close) probably regrets doing so.

I did not sit in on every session yesterday at this conference I am attending but the tone of the ones I did sit in on and the one panel I participated in seemed move away from how to actually use ETFs in portfolio construction. The focus was more on asset growth or whether ETFs will or should focus more on alpha as opposed to beta and whether that is a good thing or not. On that last point Richard Kang had some very interesting things to say.

One very neat thing is I got a chance to bend the ears of the guys who created the Market Vectors currency ETNs. I pitched my idea of creating funds that would offer access to growth in a country that was independent of the stock market. The example I always using is with a rubber or palm oil or both as a proxy for Malaysia. Another example might be timberland, sheep, cows or wool from New Zealand, I view this as a way to to invest in what is actually happening on the ground as opposed to stocks. Eh, we'll see.

There seemed to be a lot of agreement that we need more fixed income ETFs but I am not sure that means we'll see more fixed income ETFs.

As I mentioned after the Super Bowl ETF conference last year there seems to be a lot of currency interest. In addition to the Market Vectors, Barclays is due to launch 3 new currency ETNs (one based on carry trade, on emerging markets and one on Asia and the gulf) very soon too.

I went over to South Beach yesterday afternoon to see the architecture and was not disappointed. I am flying out later today and I have to say that much to my surprise I have really enjoyed the visit here except for the airport. When I landed on Tuesday it seemed like a maze with crazy long lines everywhere. Oh, well.
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Margaritaville

Since I am at an ETF conference I thought I might put up a post about ETFs.

I perceive a slowdown in the flow of new ETFs and I think a slowdown is a good thing. I think the market long ago tired of different mixes of the same cap and style indexes--the revenue shares were the most recent and hopefully fund companies will focus on more innovation from here.

Many think that actively managed ETFs will be a big deal and while I suppose that could be the case I think the fanfare will be much bigger than the utility. The trouble with actively managed funds, well there are a couple, but in this context the first one is that ETF buyers often like the idea of knowing what they own and knowing what the fund will look like in the future (the turnover in most indexes is quite low).

Knowing what a fund will hold three months from now allows for a portfolio to be constructed that looks forward. With an actively managed fund you do not know what it will look like in three months. This makes building a portfolio with active funds very difficult to do. Obviously poor management or a cold streak becomes another possible issue.

My hope is that we will see fewer new listings but that the ones that actually come (there are many funds that have been filed for ages ago that I don't think will ever actually list) will deliver something that is really new and potentially very useful for paving the way to better portfolio construction.

One example of this would be the recent SPDR Global Inflation ETF (WIP) which I wrote about for TSCM here. WIP provides access to something that really is different. Perhaps there is some future for solar ETFs or shipping ETFs but I think currency, foreign fixed income and absolute return ideas could be very useful along with some really outside the box stuff like the filed for but not yet listed carbon credit ETF/ETN (that one could be a lousy investment for all I know but learning about the carbon credit market and taken as an example for outside the box it is worthwhile).

Progress in this direction will be slow as funds, regardless of the wrapper need to be at least break even and hopefully be profitable. More assets makes or breaks funds so the gamble a company takes is not insignificant but we can hope.

The thing that I am trying to do is learn as much as possible about products that deliver some of the attributes sought from currency, foreign fixed income and absolute return regardless of the product wrapper.
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Airport Blogging

I am about to get on a plane to Miami and should be hitting the clubs in just a few hours. Although I am not sure it is possible I will be out as late as 7:45 tonight.

Anywho, I have been wrestling with a small dilemma and candidly I do not know what conclusion to draw.

Others have said this before but is the US really a capitalistic country or are we only capitalists when markets are going up.

Whatever the best description for the Bear Stearns story it is not being allowed to fail in the purest sense of the word. Whatever the Fed's role really is, JP Morgan was nudged into the deal (not that it isn't a good deal for JPM but would they have gotten involved without the Fed?). I believe that an outright failure, because of BSC's leverage would have dominoed to create problems, maybe really big problems, for other firms and by extension the US economy and maybe the global economy.

No doubt you have seen rumblings for more regulation as a result of all this which is not a shock especially considering that this is an election year.

I could be easily convinced that all of this intercession makes the short run better but I do think that it puts the future at risk. All of that free market theory you read about at some point in your past, well it holds some water. Treading on that does create a risk for long term consequences that would probably be less of a shock and more of a deterioration. I tend to think that bouncing back from a painful, but fast (fast could be two years), dislocation would be much easier than bouncing back from a ten year erosion.

What do you think? Maybe a productive discussion can break out while I'm on the plane watching Miami Vice DVDs so I'll be ready for my visit.
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Something For The Future

I have noted my belief that just about every aspect of of the way this market has rolled over into what looks like a bear market and the big picture catalysts that triggered it has been very textbook.

In that light it is possible that it could continue to be textbook throughout the process and on into the eventual real upturn.

If it does continue to play out in textbook fashion then the idea of when the time is right to take a more equitized position should be very uncomfortable--it should trigger an emotional response in people prone to emotion.

One of the things that makes a bottom a bottom is sentiment. Instead of being hopeful after a small bounce people should be very skeptical. Further there should be more talk of getting out of the stock market for good than there is now.

To really wrap your hands around this you probably need to think about what sentiment was really like during every other scary time for the market that you can remember first hand (the older you are the easier this is obviously).

Of course anything is possible. A bottom could be in, there might not be a recession and now could be the time to buy. I don't think any of that is the case but it could be.

This is the nature of feel good rallies. You wonder if this is the rally and often these moves draw people in only to endure a bit more whooshing.

Giving into emotion with a tweak is ok but big changes right here right now works against the history of how bear markets usually work. The reason I focus on this sort of thing so much is that I think knowing the nature of market cyclicals makes the job of participating in the market much easier.

If you are one to hold on no matter what then knowing how cycles work should make holding on easier emotionally. If you are one to make tactical changes then a little more understanding of cycles could provide a better framework for whatever tactical decisions you might make.

How 'bout them Davidson College Wildcats!
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Sunday Morning Coffee

There is no doubt that the declines in housing prices and stock market prices are a serious matter and that people will be impacted in various ways as a function of circumstance or because of their own actions and the potential impact on the economy at large could be unpleasant.

While I believe the above to be true it is also true that many people will not be meaningfully affected.

If you have a mortgage you can afford and you want to stay in your house it is likely that a drop in your home's value won't matter a whole lot if at all.

My wife and I recently bought a house and I can't imagine we could sell it today what we bought it for six months ago. All things considered I would of course rather that the value did not go down (I am assuming it is down some but I don't know with any certainty) but we can afford the mortgage and want to keep the house.

If three houses on your block each sold for $500,000 a year ago you might assume that is what your house is worth but if you did not try to sell you really don't know. You can only know the value of your house when you and a buyer meet on price. What your house might have been worth a year ago really means nothing.

If you own a house that you want to stay in you don't need to worry about the value today you just need to make your payment (if you have one) and fix things that need fixing.

Think about your stock portfolio now. At year end the SPX was at 1468. Let's suppose that between now and the end of the quarter SPX goes up another 100 points. If that happened the SPX would finish the quarter down 2.6%. A person whose only exposure is a 401k with a 70/30 mix would likely be down less than 2.6% for the quarter. If this same person does not follow the market at all and only checks his 401k balance once a quarter he might be totally oblivious to what a wild ride this quarter had been.

Think of all the ink spilled and TV segments over the last three months, all the big mistakes that have probably been made by people panicking and we are only a good week away from what might end up netting out as not that big of a deal.

If you have the proper asset allocation (this is crucial!) a bad year is unlikely to really have anything more than a psychological impact. All of the gloom and fear that this time could be different notwithstanding I think it is a good bet that American capitalism is not permanently broken.

You don't need to worry about stock prices you need to focus on having enough money when you need it in the future. That means a lot of saving and a couple of prudent decisions along the way.

This entire post is a matter of perception and I concede that any of it can be refuted but it is just how I view things.
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The Big Picture For The Week Of March 23, 2008

On Tuesday I am flying to Miami to speak at the World Series of ETFs East on Wednesday and Thursday.

One of the panels I am on is about how to integrate ETFs into an investment management practice. Besides the obvious of just buy them the topics will include how to research them, how to explain them to clients and what the drawbacks are.

The other, and probably more interesting, panel will be about reducing portfolio correlation with fixed income ETFs. That the global TIPS ETF just listed under ticker WIP should make the conversation all the more interesting.

There are a couple of other sessions that I plan to sit in on when I'm not out on the water in a speed boat or racing through the streets in a Ferrari (humor attempt).

The evolution of the investment products (not just ETFs) and the strategies that are now more easily accessed is a great thing for do-it-yourselfers in that very sophisticated can be constructed for individual sized investors. I've tried to delve into some portfolio ideas both here and in articles I've written for TSCM and the cool thing is that the concepts become dated very quickly as new products come out or as readers point out things I've never seen before.

This past week an email came in telling me about the Arctic Glacier Income (AGUNF.PK) which is a Canadian trust whose business is selling ice cubes and blocks. The fund recently got hit hard in the face of an ice industry collusion allegation that has also hit Reddy Ice (FRZ), ice collusion, wow.

Both are fairly recession-proof (good) paid a high dividend even before the price drops (this may or may not be good you need to look under the hood) and both are very levered (FRZ more so) which is not so great.

In general 10% yielders are risky (I have said this before as have some readers), something that yields 10% in a 5% world, generically speaking, is risky. You either know what the risk is or you don't.

There is nothing wrong with allocating a few percent to a levered, high yielding product that you feel is sound (to be clear I am offering no opinion either way on AGUNF or FRZ). A diversified portfolio should take some risks, maybe not a lot but some. A modest weight in something that blows up would be a bummer but not ruinous. Depending on the account size, 5% split between a hydro fund, one of the plane leasing companies and some other high yielding segment (assumes all three are properly researched) is far from crazy.

This turned into a bit of a ramble so I'll finish with how good the games were on Friday. Just wondering, does anyone like Billy Packer? I think Bill Raftery is much better, much funnier and seems to enjoy it much more.
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Unusual Retirement Idea

Every so often I mention my belief that successful retirement will require resourcefulness, be it multiple streams of income, a post retirement career or something else.

Here is an idea that requires only a moderate ability to think outside the lines; being a caretaker (caring for a house/property not a person) of some sort but maybe at a place smaller than The Breakers in Newport, RI (I went there on a field trip in 11th grade).

I actually know two married couples who have done this in one capacity or another and my wife just found out about an opportunity near where we live (we are not going to be the caretakers) for something similar.

The two I knew about previously had different durations but the shorter of the two was several years and the one Joellyn just heard about has visibility to last for 10-15 years for anyone so inclined.

This sort of stint can relieve a lot of pressure on your finances--not having to pay for housing, utilities and a car or insurance obviously lifts a lot of the burden off of whatever your sources of income would be. If you own a house you might be able to rent it out to cover the mortgage or if the house is paid for then renting it out would just put more in your pocket. You could also sell the house and buy something else when the caretaker gig ends but that does entail some risk.

That I know of a couple of people that have done this and am aware of another opportunity arising makes me think it may not be as uncommon as it might seem.

"Retire" at 60 and caretake until 68 might be a good way to transition and would help your portfolio.

I write about things like this (or the backhoe-ing neighbor) not because this is what you should do but hopefully it gets you to think creatively. The need to be resourceful will touch a large percentage of Americans and while no idea I have ever written about before may fit your circumstance there is probably something that does and would be a good contribution to the discussion.
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Do A Little Dance!

This market has all the action of a KC and the Sunshine Band (whoo!) concert.

They are finding quotes from people who are saying they've never seen anything like this.

Maybe that's true maybe it's not but it is unimportant.

While I discount no possibility, this sort of manic willingness to take prices big, I mean really big, in either direction is a sign of a lot of emotion which is not consistent with bear market bottoms.

I would expect there to be despair at the bottom. In March 2003 people did not believe the move, right now it seems like many people are really buying in emotionally.

I have talked repeatedly about not zeroing out of equities because just because there is no way I think the bottom is in I could be wrong and to repeat, lagging a monster rally (if that is what this turns into) is a whole lot better than missing it.
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Wha' Happened?

If you saw the movie Mighty Wind that title will make sense and the question could apply to the rally on Tuesday and the action in the entire commodity complex.

Wha' Happened?

First I will reference Tuesday's post which mentioned that Dennis Gartman talked about this on Monday on Fast Money. He looks to be correct so far but his being correct does not make you (or me) any more or less suited to make major short portfolio shifts based on the action on one day.

Let me be clear, his call looks very good right out of the chute but I think I heard him say on Monday that equities might look good, which was correct for Tuesday, but then I think I heard him express caution toward equities yesterday on the same show. That is not a shot at all but it makes the point from Tuesday, when you try to make big changes in reaction to a day or two you must be prepared to make yet more big changes a day or two later. Gartman can do it, I cannot, what about you?

Onto commodities. Is it over? Has the entire theme broken down by the side of the road like an old car driving up a mountain in the summer? You know, 'cause it overheated. If you read enough articles or watch enough stock market television you will probably be able to come up with an explanation that makes sense to you regardless of whether it is correct or not but maybe there is no real reason other than one way trades reverse course eventually regardless of the fundies or anything else.

I have been a believer in commodity exposure since before I started this site (back then there were far fewer choices) but I always repeat by belief in having moderate exposure. My thoughts about my commodity exposure is not that I am going long commodities but that I am adding in a little zig to my stock market zag (to be clear I do have long exposure, I just don't view it as a bet on commodities).

There is plenty of research that compellingly argues for 20%, give or take, in commodities and some readers subscribe to that line of thinking but I have never been comfortable with a number anywhere close to that.

In buying gold I hope I am buying a little something what will go up if there is an external event that crushes the market so in a way the price does not matter. No matter where gold is today or where it was yesterday if there is a terror attack tomorrow I think gold would go up.

Another aspect about small commodity exposure versus large is how levered you are to one theme. If you were 20% yesterday you really need to decide what you think the Wednesday sell off means and whether or not you need to do anything about it. With a 3 or 4 or 5% weighting the consequences for being wrong are much less which makes managing a portfolio much easier.

As this has played out over the last few months I have not sold any GLD, a couple of people have DBA and I sold 1/3 of that in late Feb right around $40 (I think I disclosed that in the comments of a post but am not sure) and I have also disclosed selling some Vale (RIO) at around $35 and then later at $30 (a sale for which I do not find a post for).

The sales were not about trying to make big changes or time anything but one sort of exit strategy is partial sales after a huge run. There is no right or wrong with this, something grows faster than the portfolio there is logic in reducing, something gets too frothy there is logic in reducing (or maybe selling out).

Needless to say I am thrilled about the NCAA tourney starting today. Before I started working from home I used to schedule vacation days to catch the first two days of games.
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V The Series The IPO

If you remember this show you are either a geek or a pop culture maven.

Visa's IPO couldn't have been timed any better for the sellers. The issue priced above the high end of the range which of course is positive in that it shows demand for equities might be pretty good, it is a negative in that they are bringing $17 billion in supply to counter some of that demand. For now I guess the positive outweighs the negative.

The rally yesterday was very impressive, just as impressive as the one last Tuesday. There were a couple of comments from readers (one of whom I know is bearish and one whom I suppose is bearish) that introspectively questioned their bearish bias--4% days will do that because of course they feel so good (as in feel good rallies).

There is nothing wrong if you doubt your position or feel some emotion either way. The point I try to make here is to not continually give into your emotion. The emotion isn't wrong but actions stemming from emotion might be.

One thing about the rally that nags at me is the lack of skepticism. Other than Doug Kass (who has been bearish) the other day and Tobias Levkovich (who is calling for SPX 1165 but based on what I know about him I can't imagine he will be correct) , it seems like everyone who was bullish before still is and anyone who was bearish still is. If the entire housing/credit/whatever this is event is anywhere near as important as people make it out to be I would think the bear market would have to be longer and cause a larger drop. Further I would expect that when we are at the bottom and there is a big day it would be viewed skeptically by more people.

If that is wrong, so be it.

For all the ragging on the Fed (me included) I actually think the combo of the action and the statement was a net positive (regardless of what stock prices do). They continued what has been aggressive and innovative action. They would have needed to do less had they recognized the problem earlier and started earlier but I do believe the action of the last couple of months has been aggressive.

They managed to put in a big cut, keep expectations of a future cut alive, not derail the stock market and reverse the dollar decline, even if just temporarily, against quite a few currencies. My thoughts on this are not original but this fits for now.

Part of being in the market and having opinions should be the understanding that things change eventually. Always being bullish or always being bearish makes no sense to me. I have been expecting a normal bear market, have not changed my mind, talked about feel good rallies before the bear started but an up 4% day is a good reason to explore the thought process.

A quick update on China after I posted about it last week; In that post I noted my old holding, Sinopec (SNP), was at $96 after being as high as $178. After that post SNP dropped as low as $78 intraday Monday and closed up a lot yesterday at $86.

To reiterate a point I made in the post last week. The Shanghai Composite is now down 39% from its high and still there has not been the attention paid to this that I would have expected. For now I am not a buyer but if your time horizon (emotionally speaking) is long term, buying into a market that is down 35-40% is not the worst thing in the world--this is not to say that this market can't go down another 20% however.
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BigMarketLift, BigMarketLift

Think that title sung to the tune from Madagascar.

Recession? Forget about it!

Dollar tanking? Who cares?

Bear market? Nah!

Expensive Commodities? BFD!

Housing problems? There aren't any!
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Bear Market 2, Electric Boogaloo

While the entire idea of electric boogaloo is hysterical I need to disclose that David Gaffen at MarketBeat came up with this a while ago.

Yesterday in the car I caught a Dennis Gartman segment on Fast Money. Mr. Gartman expressed some concern for parts of the commodity complex that he has favored and also posited that now might be time to take on more equity exposure. He specifically talked about having sold commodity ETFs on Monday, he mentioned JP Morgan (JPM) but I am not sure if he bought the name (if you know, feel free to leave a comment).

It seemed like he had made some meaningful changes to his portfolio based on the action on Monday.

Assuming I have that right it raises an important investor know thyself point.

Making serious changes to a portfolio based on the action occurring on a given day (or two) is probably the wrong strategy for most people (me included). Just so no one get the wrong idea I am not taking a shot at Gartman just pointing out that if you previously were not one for big changes based on what could be a change in momentum for market segments before you probably should not be one for those changes now.

If you listen to Gartman, he clearly knows what he is doing with regard to momentum, making changes, spotting trends and so forth. Other people have equal success buying on weakness and selling on strength.

Changing your stripes on a whim based on a segment on TV or from one article you read is likely a very bad idea. It is an especially a bad idea when the market is having a crisis of some sort like now.

If you are familiar with Gartman you know that the changes he made Monday (again assuming I heard correctly) could be reversed at any time based based on his interpretation of the market. Making big portfolio changes on a regular basis will work for some folks but not for others. Where does your approach fall in this discussion?

The desire to react to a compelling argument made by someone who sounds like they know their stuff is very human--we've all done it once or twice in our lifetime--and buying a stock in a moderate quantity in this context that sounds like a winner will not be the end of you by any means but the pattern of reacting excitedly on a regular basis is a potentially dangerous behavior.
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Confluence

Yumpin yiminy there is a lot going on out there.

This is a chart of USDJPY. I'm not sure how to quantify a currency collapse but how close is 22% in eight months?

Is the Fed going to orchestrate the bailout of every institution above a certain size?

Things seem to be broken all over the place but the stock and bond markets are not that bad off (yet?). Stocks are only down 17% from the high, while that is more than down a little it is far from historically noteworthy. Yields on the treasury curve are quite low but they're not at Japan-like levels.

By the way, how many people said 2008 was finally the year to buy Japan? And were these the same people who said it last year and the year before that?

The Fed is doing big and desperate now instead of doing small and gradual nine months ago. While I am not smart enough to quantify the ultimate magnitude of any of this, the blundering by the Fed seems to now be bearing some very ugly fruit.

Could a Fed induced introspective look at leverage, value at risk, risk models, inventory on and on, a year ago when there was not even the slightest inkling...well except for the failure of New Century and abnormally sloped curve... have lessened some of the blow? Maybe not though.

$2 for Bear Stearn's equity? Really? Cripes.

The Fed cut the discount rate Sunday night just as the Australian equity session was opening, two days before a meeting, man.

The frantic nature of all of this could be resulting in what will turn out to be bad decisions implemented very poorly and with more consequences coming down the road.

Whatever comes of all of this I think it will take a while before it is all sorted out. The media will continue to ask if now is the time to buy but keep in mind that this bear market could last until April, 2009 and still be considered normal.
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Sunday Morning Coffee

Saturday morning our fire department (for anyone new, I am the assistant chief of a volunteer fire department that deals with wildfires and medical calls) had its annual driving test which consists of performing a half dozen tasks in an obstacle course-like setting in one of the trucks.

The tasks include backing up between cones for 200 feet, driving through cones that get progressively narrower and serpentining backwards through a bunch of cones.

For most of the required tasks there are techniques that ensure success without having to rely solely on judgment. If you know the technique the task becomes much easier.

Now think about that in investing terms. If you know the basic building blocks the task (by task I mean navigating the market over the long term) becomes much easier.

The reader who emailed me, mentioned in this week's video, told me he spent a lot of time going through the Seeking Alpha archives and he said "I am amazed by the amount of money that could have been lost by following most recommendations." I can't vouch for the accuracy of that statement of course but if we take a step back we can put it in a little better perspective if he is in fact correct.

In a bull market stocks generally go up and in a bear market stocks generally go down. I'm not trying to be a wiseass but as a building block, fewer ideas/themes/concepts will work in a bear market. I suspect that the reader's perception of the articles would be different if he were looking back at content from 2003 (if Seeking Alpha had existed in its current format back then).
This is obviously another endorsement from me for top down management. If you can recognize market cycles and can know that extra risk will be punished at certain times and rewarded at other times you will make the task easier.

A baseball analogy; there is some sort of stat out there about how much higher everyone's batting average is when the count starts 1-0 versus 0-1. When you are down a strike the task is more difficult, when the market is in a bear phase the task is more difficult.

Different subject.

This post from Barry has some sickening numbers on the extent to which inflation might be understated and what some of the near term impact could be. As is my nature I am not interested in trying to figure out if this analysis is right or wrong but instead I would focus on if it is right what needs to be done to protect the portfolio.

Aside from obviously stocking up on more dynamite and beef jerky it probably means increasing gold, foreign currency, foreign t-bills, other commodities, absolute return and TIPS, I am probably leaving a few out.

The picture is obviously not one of our trucks but I think it is neat and sort of ties in with the post.
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The Big Picture For The Week Of March 16, 2008

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Pre Fab Houses

Ok, first things first, attribution of the photos. The trailer condo looking picture I got from Barry's site (he attributed the picture to someone named Gary) and the kit house photo I got from this article in the WSJ.

The WSJ article linked to above was about kit houses. Some of the kits can be very moderately priced and some can be very expensive. If I read the article correctly the house pictured below cost $255,000 for the kit and another $545,000 to get it built.


If you have some vacant land and you need to cut your expenses couldn't you buy three or four trailers for $10,000 each, rent a crane for a day at a few thousand per hour, place them in a way that made sense to you, spend another $10,000-$15,000 on each one to refurbish the hell out of 'em (and probably blow in some insulation) and end up with some decent digs for about $120,000?

If you had to finance the whole thing at 8% (I am assuming the rate for this sort of project would stink) your payment would be $880 per month.

Do this the right way and you'd get your own special on HGTV.

I am well aware of the WTF nature of this post, but still, I'm just saying.
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Calling All Technicians

Did $1000 for gold mean anything?

The way it hippy-hopped right over the figure today makes me think no but it doesn't really matter.

The greenback is oddly holding in a little better than I would think given the news of the day.

The market is so bi-polar that nothing should be a surprise. There is no close (up a lot or down a lot) today that would shock nor would a crash be a shock either.

No great info for you on this post, just a chance to put up a funny picture and the thought that while the news today seems big I don't, as a function of the brevity of the time line, think this is the end of the news. I am convinced there will be more.
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Is $20 Billion Enough?

Bear Stearns had about a $20 billion market cap back when it was trading at $160. Is the news today of the JP Morgan/Fed bailout liquidity helper program a part of the path to the end of Bear Stearns?

I do not know, Dick Bove just said BSC is too big to fail (not sure about that one) but it is not too big to go the way of Compaq Computer (getting absorbed into a bigger company).

Big market events like this often include enormous failures. BSC is certainly big but I am not sure if it is enormous. This being important news would be constructive as part of the ending process and while I hope it turns out to be important it might be a little early. Stay tuned!

Update Update

Actually more of a new thought. What of the put buyers who made so much news buying March expirations of $40 and even $30? The stock is printing $31 (assuming what I am looking at can keep up) as I publish the update
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Themes

If the font is too small you can hit Cntrl+ to make it larger.

I was talking to someone yesterday and the question of thematic investing came up.

Themes have come up many times on the blog as the idea plays a big role in the way I construct portfolios. Themes would appear to be a top down concept but perhaps a bottom up investor could make a case the other way.

The reason I think it fits in with top down is that most themes start from 30,000 feet. One I stumbled onto in 2004 was that anything good for oil will be good for Norway. If you think about it that is a pretty vague starting point, no less true for being vague but vague nonetheless. I would also add that it is a very simple idea as well. No one has ever been confused when I have said that.

The way a theme gets implemented may or may not be a little more complicated. I started out in 2004 with Statoil which has generally been a good hold although the last year or so it has had a little less impact on the portfolio. I have disclosed quite a few times having bought Norwegian two year sovereign debt last spring for some accounts which might have been a little more complicated and not the right type of position for every account.

As I say it might have been more complicated even then it really wasn't. Norway is a surplus country (the surpluses are still growing), GDP has been very healthy, it was pretty clear there would be plenty of rate hikes to come and if nothing else I was, and still am, convinced Norway is at a different point in its economic cycle which at a minimum creates some diversification.

This all seems like just a series of fairly obvious observations as opposed to any sort of black box study.

The forest for the trees element of the process makes the job of construction and then ongoing management much easier to do.

Infrastructure is another obvious theme. Well it is and it isn't. The money is going to be spent, it will be billions and billions, all over the world over a long period of time.

The various stocks will at times outperform and at other times lag. The chart shows Abertis (ABE.MC) the Spanish toll road company which has done better YTD than SPX and has predictably been less volatile. Foster Wheeler (FWLT) has predictably lagged SPX YTD and been more volatile so obviously for a bear market the toll road idea is better.

Not so fast my friend, I mined the data, Transurban (TCL.AX)the Australian toll road company has been about even with SPX YTD but has been more volatile while Flour Corp (FLR) has beaten SPX YTD. This hopefully makes the point that the theme might be obvious but how it is accessed may not be.

Flour's outperformance notwithstanding no matter when someone buys it they are adding volatility. The toll roads are usually less volatile but not always. Sticking with the example of how to add infrastructure (and let me be clear I don't own any of the names being tossed around in this post) attention then needs to be given to the volatility (and other) characteristics of the overall mix of the entire portfolio and how the name you are considering adding affects the rest of the portfolio.

Keeping it simple and assuming Abertis lowers vol and FWLT increases vol, based on where you think we are in the stock market cycle (talking generically not right here right now) do you want to increase or decrease the vol? If you want to decrease it and you choose Abertis you then need to decide how you feel about Spain and how Spain fits in--there are some economic parallels to the US and while Spain was doing very well a while back the risk there, like most places, has ratcheted up a bit.

Or you can just buy an ETF.

Hopefully this illustrates that the theme can be simple but accessing it may or may not be simple.
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China

If the font is too small you can enlarge it with Cntrl+.

From the standpoint of this site being about sharing process I find the current state of the China investment theme to be particularly difficult right here. As disclosed previously I had close to across the board exposure to China with Sinopec (SNP), charted in red, that I first bought in 2004. I sold the last of it last May over concern that the run would soon come to an end. I did not use a stop order because at the time the day to day movement did not, IMO, lend itself to stop orders.

The sale was good in that older clients made 2 1/2-3 times their money, the sale was so-so except I was a few months early, the sale was bad because while I sold at $103 it peaked out at $178 (point there being there are many ways to look at a sale). Sinopec closed yesterday at $96.26.

What makes it difficult is that many things related to China are down a lot; the Shanghai Composite, charted in blue, is down about 30% from its peak in October which is a lot but there doesn't seem to be any recognition of the decline and I can't recall any what's wrong with China articles or TV segments. There was virtual panic (slight exaggeration) when the US market was down 5%, China is down 30% and very few, if any, people seem to care.

Down 30% is not the worst place to initiate a position because often people start to give up at about that level which is why 30% is about the average size bear market decline in the US. But if China is down 30% and no one is even miffed, holding off seems right but that is what makes this a tough call.

Just so no one gets confused I am talking about the price of stocks not the story on the ground in China. I have been convinced for years now that China is a huge story and could easily supplant the US in being the globe's big Kahuna but none of that makes it immune from bear markets. The stock I want buy is not down anywhere near the 46% that SNP is down, but it is down noticeably and like I was saying with financials the other day I feel good about where the price will be 36 months from now but three months is tougher to see.

This hopefully shows that it is ok to not know. No one can know everything, there cannot be perpetual clarity with everything. I think I am reasonably well in touch with the theme (stocks going down, CPI going up, GDP going down, yuan going up, the magnitude of importance of the Olympics) but for now I don't feel like I have solved it just yet. This has happened with other things in the past and will happen in the future, it is normal.
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Timing The Market?

If the font is too small you can hit Cntrl+ to make it larger (this works for Firefox and IE; hat tip to an anonymous reader) Cntrl- to reduce.

I read yet another article yesterday that said the market cannot be timed. This is a good rule of thumb to be sure but is not universal and for anyone who is new it might be worth giving one example of what has been a useful tool and what I use as a tipping point in the accounts I manage.

The first chart is from the mid-1970s and the second chart is from early in this decade. The black line in both charts is the S&P 500 and the yellowish or brown line is the 200 DMA.

As you can see in both instances (and it is also true in the current market event) the 200 DMA was not breached at the top but served to avoid most of the decline if adhered to in the strictest sense (which would be all in above and all out below).

If you look at the S&P with its 200 DMA over the last few years you will see several headfakes
with this indicator where it went below the 200 DMA for a few days before going back above. This would not matter to anyone with one ETF. A fake out that results in one or two extra $10 commissions is not a big problem.

However in the real world where investors have diversified portfolios that would incur real commission expense and tax consequences all in or all out becomes impractical. But it is the evidence in the two charts (and how the current decline has played out is further support) which leads me to use this indicator for taking the type of defensive action I have mentioned numerous times before.

Changing subjects... the Fed seems to have pulled a rabbit out of its hat yesterday with the TSLF news to help lube the bond market's chassis a bit (although some question what the real catalyst was) and despite my bearish expectations I would be thrilled if the bottom was in and equity prices would stabilize with an upward bias (pretty much Emily Litella-izing yesterday's post). Bull markets make the job easier and more importantly makes it easier for clients.

You probably heard the comments from the various naysayers about the TSLF and unfortunately I probably side with them. There are still more writedowns to come, I can't see how earnings don't get further impacted, one reader forwarded a skeptical report from Merrill that cited the market is $6 trillion big and the TSLF is only $200 billion, bear markets usually turn for no reason at all not from a clear and obvious catalyst and there are probably other things too.

One other aspect about this is that the Fed is clearly willing to take action that appears to be innovative and has no qualms about doing something and then coming back very quickly with something else. While that could be a plus it leaves me thinking that the Fed is reacting to news as it hits the tape instead proactively trying to right the ship. If that is correct then I don't take much solace from a Fed that is continually a step or two behind the music.

Here's hoping I am wrong.
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The Big E!

What, you were expecting a different Big E than Elvin Hayes (number 44 in the white jersey)?

Bear Stearns (BSC) had a rough go on Monday and has had a rough few months. The stock closed at $62.30 down 11% on Monday and is down close to $100 from its high (feel free to go look for yourself as I too would be skeptical of the accuracy of that one were I reading it).

Along the way there have been some hedge fund problems associated with the company, a couple of cash infusion investments (at much higher levels) and the news yesterday was potential liquidity issues which were denied (by the former CEO).

I have no idea if they have liquidity issues or not but the market is certainly open to the possibility isn't it? For a while many have thought that Goldman Sachs (GS) will not have the same sort of trouble yet while BSC is down about 60% from its high, GS is down about 38% from its high (I should note that GS made its high on 10/31/07 while BSC's high came six months earlier).

The point is that Goldman's apparent fundamental good fortune (making some assumptions here) helped for a while (over the summer) but ultimately gave way just like the rest of the sector.

The whole way down the chatter about finding value in the sector, stocks being cheap and the great dividends have meant nothing--which is normal.

As I sort of alluded to yesterday there is an element of enticement with some of the financial stocks. First, very few big companies will fail; maybe there will be one or two. I think the idea of buying a big American bank that survives with a 6-7% yield now will look brilliant in three or four years but the dilemma is what about the next 20% and or the next 6-9 months?

The guys telling us what great values they are don't devote enough to how nasty things could get as the sector bottoms. Barron's cover story this weekend theorized about the future of Fannie or Freddie. If the equity of either one disappears it will cause a lot of damage before doing anything else.

This is really a know thyself moment. You could find the right bank that is fundamentally untouched by any of this and it still could drop 30% from here just in sympathy. Can you handle that? Is it even appropriate for you to try to handle that?

I have no idea where the bottom is but for now there is a lot about this crisis that is nowhere close to having been quantified. We should expect a big failure and no, I don't think New Century or Thornburg are anywhere near big enough to count as big.

I have been and remain underweight the sector.

I switched templates again because this one is very similar (code-wise) to the old one and so is easier for me to deal with.
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Sentiment

Both Barry and Adam touched on differing aspects of indicators that offer glimpses into market sentiment.

Reading things like put call ratios starts to get tricky if you believe this is a bear market. This is a point in the cycle where it is easy to get fooled. The market is down almost 20%, I'm sure if you looked you could find an indicator or two to tell you the market is oversold (I don't really look at oversold or over bought as it tends to be shorter term in nature that the way I invest), stocks that are down 20-30% do have some appeal and many of the historical every time the market does such and such statistics give a bullish conclusion because the market goes up almost 3/4 of the time.

The media (print and TV) seems to spend so much time exploring whether now is the bottom all the way down, is it safe to buy fill in your favorite sector and it seems that most of the experts are not worried about whether the market is in a bear phase and they have found good values and think those values should be bought now.

These sorts of things can be very compelling and enticing.

Compelling as they may be, if it is a bear market all of these things will be wrong. Bear markets last longer than five months and on average go down more than 20%, closer to 3o% actually. So anyone giving in to a compelling case for buying now is fighting a big cyclical headwind.

I would add that the suggestions of buying staples stocks is a good idea in a way but not a good idea in another way. Staples usually go down less than the broad market in a bear and that is the case now (so it is a good thing) but they still go down a lot (a bad thing), I believe the crew at Bespoke came up with a 21-22% average decline for staples in a bear. So the expectation needs to be that of hopefully going down less not staying even.

The question this begs is why not get completely out. The reason I do not get completely out is for all of my this time won't be different comments, what if it is different? What if the 1293 close on Friday is the low close? What if it is just a five month decline that is a hair less than 20%?

There is no convincing me this is the case but it could be nonetheless. As a matter of philosophy (based on reading the numbers in the Trader's Almanac) I do not want to completely miss big moves up. Going up 14% in an up 20% world, especially if I can engineer going down less during the decline, is no where near as bad as just collecting money market interest in an up 20% world.

As I say though this is a philosophical matter and some will either take that sort of miss or will take a stab at when to get back in--some will be successful with that and some will not. It's all fair game but I am trying to find the easiest path possible.
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Important Administrative Post!

I had numerous reports of pop ads that come from loading the site and/or during the process to leave a comment that I had nothing to do with that contained offensive material.

I found two different suggestions to try to deal with it. One was to run a spyware program to look for malware that could be on my computer and there was none to be found. The other suggestion was to look at the template code for something that could be in there and again I did not find anything but it is easily missed by someone with limited knowledge so I changed the template.

I am obligated to to certain ads and links that I will restore slowly over the next 24 hours into the new template.

I need your help though, if you still get the pop up please let me know. If nothing else I can move the site but that would be a big headache for everyone.
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Sunday Morning Coffee

Barron's had an article in this week's edition about the mistakes that investors makes that result in falling short of the S&P 500 or even the mutual funds they own.

This is something that has come up before, human nature is a pretty big enemy where long term success in the stock market is concerned.

The first crucial error cited is not diversifying properly. Quite simply by avoiding big bets and allocating a portion to many asset classes you won't get taken down by one bad bet and you give yourself a better chance of having something that is going up.

As you look across the entire market there are clearly some groups and individual names that are doing just fine such that you'd have no idea the market is down almost 12% YTD by looking at them.
I've got a bunch of names that are up or down 3% YTD which offsets nicely the ones down more than that YTD 12%. I've been writing about this for ages; this is not about good stock picking it is about good diversification which is a whole lot easier.

The next mistake cited is timing the market, many people try to do this and get it wrong. I do believe in using the 200 DMA, which is a timing tool, but it has given a few headfakes over the last few years which is why avoiding big bets is so important. Further I think the 200 DMA as a measure of how healthy demand is is a very simple tool that is not triggered all that often but it is the type of thing (like other timing methods) that can cause problems if used too aggressively.

As I have mentioned before if you just buy an index fund, add to it over time and just hold (assumes proper adjustments to asset allocation) it you will capture the market's long term average (save for the OER). All of the other things we try to do, trades made, studying we do, new ideas we implement all work against the fact that buying an index fund and just holding will deliver a very competitive result at the end.

However that also means enduring every bit of bear market, financial crisis, housing slump, war event that ever comes along. I do believe that active decisions can smooth out the ride against these events (you can look at the last few quarterly recaps to decide for yourself about that) and that is a big part of the content here but if you are trying to add value in this manner you should not lose site of what it means to buy an index fund and just hold it.

It's been a little warmer here the last couple of days which means we'll be seeing horny toads here soon.
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The Big Picture For The Week Of March 9, 2008

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Can It Be?

After a glitch with a studio in Prescott on Monday I am scheduled to appear on CNBC this afternoon sometime between 3:15 and 3:30 EST talking about the financial sector.

I don't believe my comments will be surprising to anyone who has read this site for a while.
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Queue The Ominous Music

Late start this morning due to an interview.

The jobs number stunk but fortunately the revisions stunk too. Jack Bouroudjian didn't seem too worried though so chances are all is honky dory (that is a sarcastic comment).

Things appear to playing out as they always do which is a positive the way I view the world. Declines in new jobs, fewer hours worked, people leaving the work force and so on are all ordinary recessionary stats.

The one really negative for me, but readers correct me if I am wrong, is based on what I see on the teevee and read in MSM is that there are very few people that take action ahead of time or more correctly have some sort of plan of how and when to take defensive action.

Things being what they are I do get interviewed every so often and I don't know what I could possibly come up with if asked what should investors do now, is it too late; that is a no win question.

If it is a no win question then it must also be a no win strategy.

Is now the time to own commodities? Should people buy gold? Should you sell financials? Should you buy healthcare? On and on.

The focus of this blog has been taking action ahead of time. If you have a diversified portfolio you already have a little gold and a little commodity exposure. These have been great holds for a long time. The question then becomes should I sell a little more or add a little more. That is an infinitely easier question to try to tackle.

If you've been lucky enough to be underweight financials through all of this then adding a little or taking a little off becomes less scary.

And so on.

Things written about here and in other places are proactive decisions and while not everything has been correct of course the decline has been less and all of the things I have written about and implemented for clients I lifted from other people--meaning it was all out there before I came along.

The bigger macro is how do you avoid big chunks of down a lot? You worry about it before it happens. I believe Mr. Kudlow could learn a thing or three about this concept.

Was Hampton Pearson wearing a purple trench coat? That is dapper.
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Anyone Know This One?

The other day I stumbled across a couple of funds that trade in Canada that on the surface are quite intriguing.

Candidly my second thought is that I am missing something here and that I should stay away.

It might be right to think of this space as one of my blindspots.

The chart is of something called the Algonquin Power and Income Fund which trades in Canada under ticker APF-UN.TO and on the pinks here with AGQNF. Algonquin has four segments; Hydro Electric 31% of 2006 revenue, Co-generation 28%, Alternative Fuels 21% and Infrastructure, which is mostly water, 20%. The 2007 annual report is not out yet but I believe the revenue mix will be noticeably different.

It pays a very large dividend of C$0.0766, which works out to C$0.92 per year which is more than a 12% yield. They do make enough to cover the dividend. In reading the 3Q 2007 report they have had some revenue issues due to having operations in the US and being domiciled in Canada (currency issues).

In greenback terms the fund made a high of $9.42 on October 17 so it is down 25%. Over the last year it is down a more reasonable 3.3%. For the period charted, which is as far as Yahoo goes back (maybe that is when the fund listed?) it is down 19%.

The lines of business they are in, the potentially non-cyclical nature of those businesses, the future need for more things like hydro electric and alternative fuels, the yield and what has been a low correlation to the S&P 500 make the concept intriguing but something seems off.

If the price could have kept up with the dividend I might feel differently. Flat with a big yield is potentially a winning combination when blended in to a diversified portfolio but so far it has been a let down on the flat part.

I have questions, I called the fund and left a voice mail for someone, said I was from theStreet.com because I would like to write an article about the fund but it has been a few days now with no call back.

If anyone knows more about the fund please leave what you know in the comments. I looked at a couple of other similar funds (more focused on the hydro electric than a diverse business) and most of those look to be worse than this one. The one that I found that has done better is Great Lakes Hydro (GLHIF.PK) which yields a less scary 7.1%. I'll try to do a little more digging on this one to see what I can see and will let you know.

From a slightly bigger macro if demand for regular stocks stays lousy for a while these funds are the sort of thing that could be a great place to hide out in until demand for equities gets healthy again. To be clear I am not suggesting these funds in any shape or form, I still have a lot more to learn about them.
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Commodities

A lot commodities got pasted yesterday but you probably know that by now.

iPath Nickel JJN down 2.96%, iShares Silver down 2.69%, PowerShares Base Metals DBB down 2.39%, DJP down 2.08%, PowerShares Ag DBA down 2.61% and a lot of the related stocks were down too.

One bad day obviously means nothing in the long term but the upward price action that we have seen of late, the this time is different mentality, the awareness of the space by people who 12 months ago never had had exposure and the intense media attention are all a rerun of the same movie.

To address one thing up front, this time might actually be different. It makes sense to me that the supply and demand equation, especially for industrial and agricultural materials, is evolving and that the types of prices we saw a year or two ago will never come back. But parabolic price rises, especially throughout an entire segment of the market, are a sign of excess and a big drop should not be a shock even if it is now different.

Let me also clarify most clients have exposure to gold, a seed stock, a diversified miner, economies that benefit from the commodity boom and one or two folks own DBA. Sentiment wise I am as on board as anyone but I have also disclosed shaving down positions in a couple of names as they have run up and would suggest that you take inventory of what your exposure is and think about the consequence to your portfolio if there is a nasty correction.

If you truly believe this time is different and we really are just a few years in to a two decade run then you have to understand that even if the ultimate run exceeds your wildest expectations it cannot be in a straight line. During the emerging market boom we have seen a handful of 25% corrections and there will probably be more.

I am not making any sort of prediction in the post nor am I doing any analysis. The point is to understand market behavior and what sentiment can do to prices on the way up and the way down. The fundamentals of commodities could be unlike any other part of the market but the behavior of people placing buy orders is not.
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OK, But

I found this article by Nouriel Roubini on the Foreign Policy website (hat tip Alphaville). It outlines why various regions in the world will feel the US' pain, especially if the recession lasts four quarters or more.

The quick take is that everywhere will be hurt but that a couple of places will, in addition to be being hurt, will also derive a touch of benefit.

A reader left a comment yesterday saying he might chuck it all and go into GLD. If you read a lot from Roubini you might be inclined to do the same.

If you have been reading this site for a while, you know where I have stood for months--normal bear market without pieces of sky hitting the ground but of course I could be wrong. If you are inclined to chuck all your equity exposure you need to explore and understand the other side of that trade, know the risk you take in doing that and have something reasonable in mind for how you make up for normal equity market growth.

Sticking with the normal cycle idea (which the risk faced by the chuck it all idea), if this turns out to be normal it is very likely that the first year off the bottom will be huge, like 2003. How many people do you suppose finally gave in in 2002 and did not catch 2003? There is no way to know but we can know that a lot of people did sell in 2002 as it was the worst of the three year decline. This decade has had a lot of down followed by many years now of up but anyone completely missing 2003 (or a large chunk of it) has likely missed too much of what little up (in percentage terms) there has been.

This is how people come to lag the markets in all those studies we see quoted. When the bottom comes and the market turns it is likely to be a big bounce. This has held up historically in all manner of declines (long bear markets or nasty V shaped events). The way this decade is shaping up missing 2003 could be the difference between being even on the decade or down a lot. Likewise anyone missing 1975 (up 31%) made the 1970s much worse than it needed to be and anyone missing 1934 (up 40%) made the 1930s worse than it needed to be.

Anyone reading this site for a while knows I am all for defense and underweight but the risk of zero weight and missing the best year of a decade can be very bad. The market averages 10% (or whatever the exact figure) by going up 40%, down 40% and everything in between. I can't stress enough that missing one of the big years in a decade can leave you so far behind as to alter your financial future.

Lagging an up 40% year however is a horse of a different color.

This is not a bet I would make and anyone entertaining that sort of a bet needs to understand the consequence of missing a reentry.
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Venting?

More than a couple of times recently, readers have left comments that they close out in such a way that they let us know they are just venting.

That people need to vent and choose to do on this blog does not bother me personally but in the context of what I write about and the things I try to convey it's a little disappointing. The market action is unfriendly, has been unfriendly for quite a few months now and more importantly might become yet more unfriendly if history is any guide.

So either I can get ready for more venting but of course that does you no good or you can get ready for market turbulence.

As all of this has been unfolding I have, in addition to the blog posts, sent out the occasional email to my colleagues to then forward on to clients trying, ahead of time, to express how bear markets usually work, what to expect and so forth in order be out in front of any reactions.

Part of smoothing out the ride, the way I look at it, besides within the portfolio, is to try to prevent big emotional reactions. Just like with the blog I sent these emails before things got ugly and while things have been ugly.

Based on feedback from my colleagues, I believe the communication has been effective in helping clients deal better with what has been going on.

The point of writing this is that, as I tried to convey, mentally preparing for a market downturn can be an effective way to avoid getting emotional and succumbing to that emotion with panicked trading.

To be clear staying unemotional is no guarantee that your plan for defense (if you have one) will be exactly right, or that your timing back in will be right either but underlying this is that bear markets come along every once in a while and then they give way to a new bull. If nothing else time will bail you out. On this go around it might be a normal amount of time (this is my opinion) or it may take longer but bear markets end.

Navigating any market environment is a serious of decisions. Some will be correct and others will be incorrect. Just as it is impossible to be right every time it must also be that being wrong every time is impossible too. Knowing ahead of time that you will get some right and some wrong might also offer the chance for less emotion.
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Sunday Morning Coffee

A reader asked for my take on the difference between owning currencies, gold and the gold miners. The reader notes that they seem to be similar in some aspects but different in others.

I'm not sure there is a single all-encompassing answer to this, just opinion.

From the top down they provide similar protection to a diversified portfolio during periods slow decline or deterioration in the US.

I made a comment in this week's video that if you think Michael Panzer will end up being correct you probably should buy a lot of gold and foreign currency as the dollar would likely decline a lot from here against both. To be clear I do not draw the same conclusion that he does.

However I am not so sure that in the face of a terror attack the dollar would decline. The dollar used to be a flight to safety destination as it was in 2001 and during other quick and scary events. The money that would come into dollars would then go in to US treasuries. Gold also has history of going up in the face of real fear like that.

Over the last couple of years I have been less interested in the gold mining stocks compared to just using GLD (which I own for most clients). I made a switch from Anglo Gold (AU) into GLD a couple of years ago and am unlikely to go back to a miner anytime soon. Here I am differentiating between a gold miner versus a broad diversified miner of which I have two in my ownership universe or a narrow miner of something other than gold of which I have one or two on my radar but do not own.

Over the last year the metal has outperformed the Market Vectors Mining ETF (GDX) and Newmont Mining (NEM) but most of that has come in the last three months. It seems to me that at times the metal leads but that the miners also lead some of the time too. One theory you've probably seen is that the ease of trading GLD means the miners will now always lag the metal. I wouldn't bank on that one but if there is ever a terror event again or something else that causes that sort of fear it seems more obvious to me that GLD would be better than the miners.

Foreign currency exposure is not really (or should this be not yet) protection against panic save for the Swiss franc perhaps. I view currency exposure as a way to diversify cash and protect against deterioration not terror.

I have felt for a while that the dollar is on a slow path to having to share the role of world reserve currency and that it will eventually cede that role to something else (here is a link to a post on this subject I wrote three years ago). I don't know how long this will take or which currency will supplant the greenback but nothing in the last couple of years has changed my thinking.

If that pans out then some moderate exposure to foreign currency (or very short term debt) should make sense.

The picture is from the trail through the mountains just above downtown Juneau.
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The Big Picture For The Week Of March 2, 2008

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