Mid Morning

Seeking Alpha re-ran this morning's post and a reader left a good question on the SA version. He asked whether international utilities, specifically captured via WisdomTree International Utilities (DBU), are better for reducing correlation than a broader foreign product.

Well the numbers are in and the reader is correct. According to PortfolioScience.com iShares EAFE (EFA) has a 0.84 correlation to the S&P 500 while DBU has 0.56 correlation. I would note that DBU, although dividend weighted hasn't actually paid much of a dividend which is frustrating.

Regardless of the dividend DBU (which I own for a few clients) has done well, has outperformed both EFA and SPY and does have a low correlation.

The biggest risk, IMO anyway, would be if interest rates which are generally low start to go up. A rule of thumb is that rates moving up are bad for utilities as fixed income (talking further out on the curve) competes for some of the money that goes into utilities.

I think higher rates further out on the curve would be a positive for equities as that might signal a return to normal but it sets up utilities to, at a minimum, lag a little.
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Alternative Asset Classes Defined?

Yesterday I asked what would you include in alternative assets? What would you like to see that does not already exist in the way of accessible alternative assets?

A few people offered some thoughts and there was some half-kidding about baseball cards including a great one-liner about mothers throwing the cards away which sort of happened to me. You'll notice this card is an error but the corrected card with him on the Rangers was the rarer card, go figure.

I think getting too hung up on definitions is the wrong approach. I would say to focus more on the result a particular thing delivers and how it gets the result. It is this line of thinking that may have prompted a couple of folks to say I may be too vague about this.

First I would say things like wine and art and even my 1971 Roberto Clemente card (I have a collection of like 20 baseball cards) are not really investments easily accessed by a lot of people. I am not saying you can't make money in these things, and I think there is an Art Fund of some sort that exists in Europe but to the extent these are investments is beyond the scope of this site.

A couple of weeks ago I wrote about Dexion Absolute for TSCM which is a publicly traded fund of hedge funds that is listed in the UK under ticker DAB.L but is available in the US with ticker DAXLF.

If you look at a two year chart (hopefully that link works properly) compared to the S&P 500 there is plenty of zig versus SPX' zag. Maybe there is enough for you or maybe not but there is clearly some zig. If you find some sort of long/short product, regardless of what it trades, that consistently delivers an non-correlative result it would likely fit my definition of alternative assets.

The few that I use, so stressing moderation, generally deliver an non-correlative result. Obviously you can drill (or bog?) down in more detail but at some point it becomes counter productive (subjective opinion).

If you think about all the types of products that you know of in this realm like commodity, currency, strategic, toll roads (do these count?) and I'll include hydro funds (I do not own any of these), I can tell you there are plenty more out there that you have never heard of (I seem to find a new one every few days). The chance to find and learn about these is vast. No one will likely be an expert in all of these things. Even if you can come up with a dozen different categories of what you term at alternative it is doubtful you need more than two or three in your portfolio and even that may be too many.

If you are going to swim in this pool I would suggest being cognizant of the issue of hedging an equity portfolio with a few alternative ideas versus hedging a portfolio of alternative strategies with a few equities.

I'll finish with alternative ideas I'd like to see or see more of. For a while XShares had been on file for the AirShares EU Carbon Allowances Fund. I don't know whether this fund will ever come but something that accessed the carbon credit market is bound to come, the growth in this market would seem to be substantial and I think the correlation to US equities would be very low.

The concept behind the Macquarie Pastoral Fund is very interesting to me (livestock and farmland down under). This particular product is not exchange traded so I am going to pass but I believe if it is successful (it is a little over one year old I believe) there will be similar products that do list on an exchange somewhere.

I like the idea of products tied to economic indicators but the correlation to stocks of this sort of thing is probably high but some sort of product tied to GDP growth of a basket of emerging markets or frontier markets would be very interesting.

From the first few posts on this site in 2004 I talked about the extent to which investment products will evolve to offer the chance for much more sophistication to do-it-yourselfers (this has always been obvious) and I think the pace of this will accelerate. Just because there might be several hundred alternative (assume vague definition) products doesn't mean you need more than two in an attempt to reduce your correlation a little.
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Mid Morning

Earlier CNBC had John Duffy from JP Morgan on who among other things made the point that if you missed the best five days of this year you missed out on 12% of upside. This bit of logic comes up every so often and I think it is wildly flawed.

Forgetting about predicting anything for the moment if the market peaks on a certain day then drops 28% (normal bear market decline) over the following 12 months (within the range of normal bear market duration) then the most important thing would be being completely out even if along the way in that 12 month 28% decline there were four different days where the market was up more than 5%.

These sorts of best days worst days commentaries come along every so often but they make too many assumption and leave out too many details. If you are one to try to make defensive allocations when you think the market will struggle you should remember that there will be feel good rallies along the way.

Duffy did have one interesting thing to say about a general target allocation they use for clients which is 40% equities, 35% cash and fixed income and 25% alternative assets. This fits in line with some of the posts here of late.

What do you think of the 25% into alternative assets? What would you include in alternative assets? What would you like to see that does not already exist in the way of accessible alternative assets?
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Interesting Reader Question

A Mr. Richard Feder from Fort Lee, NJ left a comment asking how a lazy ETF portfolio I wrote about for TSCM in April, 2007 has done. The nature of compliance and this being my blog means I can't really say it was up or down X%.

For anyone who cares I can give some info that would allow for figuring out how it has done but I also had what I think it a more interesting bigger picture reaffirmation.

So this article was published on April 9, 2007. If the portfolio would have been implemented with $100,000 on that date it would have owned;

• 409 WisdomTree Earnings ETF (EXT)
• 236 Rydex SCV (RZV)
• 228 WT Asia Ex Japan Hi Yield (DNH) some clients own this one
• 153 Claymore BRIC (EEB)
• 45 iShares Global Energy (IXC) some clients own this one
• 265 PowerShares Water (PHO) a lot of clients own this one
• 75 SPDR Foreign REIT (RWX)
• 193 PowerShares Gold (DGL)
• 856 PowerShares Prefered Stock (PGF)
• 195 Advent Claymore Convert (AVK) a CEF and some clients own this one
• 63 Rydex Aussie Dollar (FXA) some clients own this one

Anyone so inclined can do the work to see how this did (please do not post the result in the comments, I would have to delete it). What I was trying to do was simply assemble a portfolio that did not use the most popular ETFs of the day. One administrative note is that in figuring the share amounts I used Yahoo's adjusted closing prices which are supposed to account for dividends so I am relying on Yahoo having good data.

On April 9, 2007 the S&P 500 closed at 1444.61 and yesterday it closed at 1396.37. On a price basis SPX was down 3.33%. If you add in roughly 2% for SPX' dividend (anyone inclined to leave the exact trailing div should feel free) means the total return for SPX would have been a drop of 1.33%.

Candidly I did not remember the article before the reader asked, the portfolio was never rebalanced (I don't know if I would have rebalanced nor do I know if rebalancing would have helped or hurt returns).

I was really struck by the extent to which so many of the components were either up a lot or down a lot. In a down 3% world, seven of the eleven components moved by more than 10%. If you actually do the math to see how this thing did you'll notice the result was far from dramatic which makes a very important point.

It does not matter what the portfolio components are doing (assuming they are adequate proxies for what they are intended), the thing that matters is what they bring to the overall portfolio. If you have a bunch of things that are up or down 20%, and are each good proxies, and the portfolio nets out to do exactly what you hope it will do then I would say you are in great shape.

I would add that anyone who cares to figure the result might be missing the bigger point of the article which is that tools like ETFs can be used to create a pretty specific effect, nowhere near as narrow as using individual stocks though.

The drawback of these types of portfolios is that I think value can be added by making decisions about all the sectors, selecting countries and several other factors. The broader a portfolio goes the further it moves from being able to add that sort of value. I know from past posts and reader feedback that some feel these sorts of decisions are beyond them and some feel at home with this; eye of the beholder sort of thing.

If you are going to use ETFs to build a portfolio (or as one reader said he puts almost all of it in ETFs but owns a few stocks with an explore portion) I would urge you to try explore everything that is out there and to stay current with new products that come out. While staying current is getting more difficult to do it is worthwhile.
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Philosophy

I believe it was noted late 20th century philosopher George Louis Costanza who said "Jimmy Crackcorn and I don't care."

I find myself not caring about all of the ink that has been devoted to blaming Alan Greenspan for the mess we are now in.

It's not about agreeing or disagreeing but more about this is where we are now, how long before things fix themselves (some would say they already are starting to fix themselves) and are we at a point where we should still be thinking more about defense and protection or about being fully invested.

We can learn and benefit in future cycles from what happened on this go around. I wrote an awful lot about the abnormally sloped yield curve as an indication for trouble coming. For me and anyone else familiar with the yield curve we can learn that it works as an indicator of trouble coming (but does not allow for quantifying the trouble). For people not previously familiar they have learned about something that will matter again in the future.

The value of knowing why and who is to blame will be of interest to many people but is unlikely to make you a more knowledgeable investor.

So if the debate (if it even is a debate) about blaming Greenspan is a waste of time then why write to say it is a waste of time? As you study and manage your portfolio it is easy to get side tracked or distracted by things that have no baring on whether or not you will have enough money when you need it.

Changing subjects I made a small goof in this weekend's video. I mentioned having found a new (to me) way to access timber, I didn't. I found Cross Timber Royalty Trust (CRT) which despite the name appears to be an oil and gas partnership not anything related to timber. My bad.

One last point about all the Yale/build your own global macro fund theme from this past weekend that seems obvious to me but maybe is a discussion point which is that this concept will be the next evolutionary step in lazy portfolios. Instead of allocating 60% to equities over five funds, 30% to bonds with two funds and 10% to some sort of REIT/commodity combo maybe the evolution is 40% in equities, 20% in fixed income, 10% absolute return, 10% currency, 10% in real assets and 10% in a catch-all combo that includes things like a hydroelectric fund, a meat fund, a carbon credit ETN or a private equity something or other.

What say you?
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Sunday Morning Coffee

I wanted to follow up a little on yesterday's video to raise a point that there was not time for.

There is tremendous long run utility in deconstructing different types of portfolios than what you currently have implemented.

For as long as we all have anything to manage we can count on every aspect of the industry evolving. The extent to which ETFs have proliferated makes the case.

Presumably whatever you are doing now is what you think is the best way to go for your situation. As time goes by you will learn more, your situation will change (some changes are predicable and some are not) and the investment industry will always create products--some of which will be very useful.

If all of that is true about you steering your own ship it must also be true of investors you think are smart and whom you listen to when they speak or write.

Changing subjects; Barron's had an article calling a bottom in the dollar, the article focused mainly on the euro.

This is a potentially very complex issue. I've been on the weaker dollar bandwagon for several years now but the magnitude has exceeded my expectations. Looking forward I expect the dollar will generally not be strong but I would expect there to be years like 2005 where the dollar does go up.

The reason to phrase it as the dollar won't be strong is because it is down a lot, can only go so far and what I think is missing is any fundamental catalyst for a higher dollar. Of course any tradeable thing can go up for no reason at all.

The Barron's piece tied in visibility for ECB rate cuts combined with a steady (after this week) Fed creating a closing of the interest rate differential. So people have been talking about this for a while, it's either priced in or it's not.

If the dollar does go up against the euro because of central bank action then it would probably make sense to diversify into currency products that do not have euro exposure. Besides the obvious ETFs and ETNs the PowerShares Dollar Down (UDN) would probably be a bad bet because it tracks the inverse of the dollar index which is 57% euro.

In a dollar up against the euro world I think currency diversification could still be had in surplus countries, countries still raising rates and emerging market currencies that will have huge growth regardless of what happens in the US (Egypt seems interesting, strong versus the dollar, one year t-bills in the sevens, GDP in the sixes, inflation is hot just above 10% no way to easily access the Egyptian pound that I am aware of).

We just completed a big (not that big) fenced in area off the deck we built last summer so the dogs would have a little more room to roam. The picture is of Roscoe on his first run through. We need to wait a few weeks for the wood to dry out before we can stain it.
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The Big Picture For The Week Of April 27, 2008

The Yale info is from Bespoke.
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Mid Morning-Special Chacha Boochie Edition

Two CNBC references in one day.

Yesterday Walt Mossberg was on talking about a service called Chacha which, as I understood it, allows you to call in (assumes you are away from an internet device) and ask them to search for information you need. Then they will search for you and then text you the info.

They have employees who do the searching and texting from their homes.

This concept sounds familiar to me, I'm not sure if I heard about this company before or someone else doing the same thing.

I think this sort of thing ties in with the ongoing retirement thread about needing to think outside the lines about working in retirement. As a society more of us are making our living on the internet (including me). This trend is not going to reverse. In the future there will be more work like this available. True it won't be lucrative for the workers and there are probably other things about to criticize too.

Any time I talk about working a part time job (like operating the backhoe, driving the airport shuttle, working a few hours at your gym--all part time endeavors) in retirement people rightfully bring up the fact that for many people physical limitations will get curtail the ability to do these things. This is of course valid but a Chacha type of job goes a long way to mitigating the issue (said the guy who works on the couch in his PJs with a laptop).

Obviously the pay for this sort of thing would be low but I think the mind set needs to be that if you need $4000-$5000 per month in today's dollars to live on in retirement, can you cover 10-15% of that with some sort of part time work? If that work can be done from home then you could possibly do it for more years than being a tour guide of some sort.

Relieving some of the burden from your portfolio with this sort of thing can only be a positive.
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Hot Mess

If you're married and you have cable TV you know who this little dude is and that one of his phrases is hot mess. CNBC used this term to describe what is going on with Starbucks (SBUX).

I had owned this stock for quite a while before selling it last summer in the $26's. Like many of the stocks I end up being wrong about the sale could have been better but it could have been much worse too.

In the time I held the stock I mentioned it several times in interviews as I believe (note the present tense) that people love the product, are willing to wait in line for it and that the company has created a destination that people want to go to.

I further believe that the stickiness of those attributes would allow it to weather an economic downturn better than other discretionary stocks.

It sounds good but somewhere in there the idea is wrong. This post is not about Starbucks. This post is about building a reasonable case around owning a stock, giving that case a chance to work, recognizing when you are wrong and taking action. I don't think why is as important as simply realizing when you are wrong, although it would be nice to know why.

During that CNBC segment they had an analyst on who they said has been bullish and still is bullish on the name. For all I know yesterday might be the bottom but that is not the point. The analyst laid out a case for owning the stock. Any bull case for Starbucks of late has been a forest for the trees thing.

Maybe the stock should have gone up but it has not and that is what matters. You will encounter this exact same thing with other stocks. If you come to realize you are wrong about a stock just sell it.

One more point to close out on would be just because a stock is down doesn't mean you are wrong. The financial sector, as measured by XLF, is down 30% from its 52 week high. If you have a financial stock that is down 25%, chances are you are not wrong. By the same token the staples sector, as measured by XLP, is down 5% from its high. If you have a staples stock that is down 15% you might be wrong.
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China Update

Last week I mentioned that China was down a lot and I questioned whether it might make sense to dip a toe back in.

After a couple more down days it has had a couple of very big up days. The move is being attributed to a decrease in a tax that was recently increased to stem stock market speculation.

The government's involvement on both sides belies the relative newness of stock market investing for the country. It seems to me that with newness comes the potential for mistakes. Mistakes of this sort don't necessarily make China any more or less an attractive destination but I do believe creates a visibility for bigger booms and busts to continue into the future.

This all might flow into an idea I have expressed before that maybe buy and hold should be replaced with buy and hope to hold. If you bought just about any Chinese stock in 2004 or 2005 you have made a lot of money. If you still have that same stock you are probably down quite a ways from its peak. Perhaps this is a lesson for the future. There is nothing wrong with taking a little off the table in a stock (or narrow based fund) if it doubles much faster than the market.
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Commodities

You probably caught the news that the global rice shortage has kicked it up a notch and is starting to impact retail outlets in northern California (Costco and Sam's Club I believe).

The price action in commodities has been extreme for the last few years as perceptions or realities (take your pick) of demand have changed, investor awareness has increased dramatically and the space can now be accessed by retail investors through brokerage accounts with an abundance of choices with more product to come.

The commodity space has all the allure and intrigue of Frau Farbissina (pictured above). I have been on board with the theme and had exposure for the duration and will keep exposure (subject to the occasional tweak) but there are some important things to keep in mind about commodities now and these things will pertain to other spaces in the future.

The point here is not to analyze the supply and demand for any part of the space as I am as bullish as anyone but we do need to recognize the human/market behavior that has accompanied commodities over the last couple of years or so.

There can be no disputing the fact that commodities are up a lot in recent times, there are many people who are new who have bought in one way or another (mostly with ETFs and ETNs) and that the investment industry has created a lot of new supply in the form of investment products to meet demand for this "new" and exciting area.

Still not thinking about fundamentals for a moment something that can go up a lot in value in a short time frame can go down a lot in a short time frame. The Shanghai composite has cut in half in a very short time. People will say China is/was a bubble and they might say commodities are not. I think the word bubble is over used and prefer the word mania instead.

The underlying fundamentals can be great and prices still take on mania-like ups and downs. I think the fundamentals in China are great (I readily concede there are negatives) but that did not prevent prices from going up too far too soon and coming right back down (maybe too far too soon?).

Given the human factors cited above and what this has meant in the past a swift decline in commodities could easily happen even if nothing changes with the fundamental story. Jumping on me for suggesting commodities could encounter a dip is counter-productive as I am as bullish on the supply and demand as you are. But remember gold dropped 10% from $1000 in about half an hour (intentional hyperbole).

How much exposure do you have? If there was a six or seven month stretch that took prices down 30% (Shanghai dropped 50% in about six months) what impact would that have on your portfolio and how would you react? You should look in the mirror on that one now while everything is going gangbusters. I'm not trying to predict a big decline, I'm just asking what you would do if it happened.

The fundamental story for China looking out for a decade or more is fantastic but that did not prevent the market from cutting in half. Exploring the other side of your trade is crucial for risk management.
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Mid Morning

Robert Shiller from Yale is quoted in this WSJ Marketbeat post (and elsewhere too I'm sure) as saying the decline in housing prices on this go around could be worse than in the Great Depression although maybe this house on the east side of Molokai would be spared some of that pain.

If so that would be more than 30%. He said that so far prices are down 15% from their 2006 peak.

Part of the reasoning attributed to Shiller is that housing prices went up by 85% from 1997-2006.

If you have done any reading on this you may have seen that prices in the Baltics, Spain, Ireland, Sacramento and Riverside county have all dropped precipitously, more than 30%.

The 85% number is a tough one for me to wrap my hands around. Based on comps of three sales within a mile of our cabin prices here almost quadrupled from 1998 to September 2006. One of my brothers lives in Iowa and as you know many places in the Midwest have practically sat out the boom. Hawaii started slowing down or rolling over or however else you care to describe it a little earlier than many other markets (my perception anyway).

There is no doubt that if Shiller turns out to be right it would create a nasty headwind for the economy. We can debate whether he will be right or not and we can debate what the magnitude of consequence would be but if correct it would be rough going for a while.

All of that is beyond our control and so as a matter of philosophy I tend not to worry about things beyond my control. I do think it is worth remembering that there is value in having a place to live, there is psychic value in enjoying the place where you live and that if you have no plans to sell anytime soon and no plans to raid your equity (assuming you have equity) the decline in prices may not have to impact you in a meaningful way.

I do not deny the whistling-past-the-graveyard element to this but there is a kernel of truth to it too.
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Theory Time

Ok, first let me say I am not claiming originality here but let's explore this and see where it goes.

I have been writing since day one about taking defensive action when the market goes below it's 200 DMA.

$10,000 bought into the S&P 500, and just held, 25 years ago would today be worth $83,800. Had that same $10,000 gone out when the SPX went below it's 200 DMA and went back in when it went back above the 200 DMA would be worth $126,500.

Following this to the letter the investor would have sold in October and still be out. My numbers. BTW, are not scientific, I was looking at a Yahoo chart going ten years at a time so the numbers are close but not exact. Anyone wanting to do it exactly and post the result is more than welcome.

The chart above includes the Swiss franc versus the USD (note it is charted backwards to show the franc going up or down to make the point easier to understand). The chart goes back only as far as Yahoo has currency data. In looking at the two extended periods where SPX went below its 200 DMA (11/2000-3/2003 and 10/2007 through today) the swissi went up 26% and 18% respectively.

So the theory would be stay in SPY while it is above its 200 DMA and swap into the Swiss franc when SPY goes below its 200 DMA. The reality might be a little different. First, so far all we've done is look in the rear view mirror. I would also note that the dollar rallied against the swissi during the relevant periods in 1987, 1994 and 1998.. So either the world changed between 1998 and 2000 with respect to the dollar and or the Swiss franc (this is entirely possible) or the last two times were just a coincidence.

The bigger macro is to explore for the possibility for a better mousetrap. I have unyielding faith in the 200 DMA as an indicator but taken to the extreme of getting out entirely (not practical but this post is about a theory) and finding a currency likely to go up while out of equities is interesting to ponder. Maybe instead of a currency it should be an absolute return product?

Another problem with the S&P 500 or any broad domestic equity proxy is that there is visibility for the US market to lag other markets for a while (nothing apocalyptic but maybe 5% a year instead of 10% for example). Perhaps instead of SPY maybe the long equity exposure should be the iShares All Country World Index ETF (ACWI).

When ACWI is above its 200 DMA then it's all in. When ACWI is below its 200 DMA then it's out of ACWI and into some foreign currency (what about the Sing dollar or the renminbi?) or some sort of absolute return fund?

I find this sort of thing to be fascinating. The point is not should I do this but how can analyzing a theory like this help my actual portfolio.

What do you think would be good proxies for the equity exposure and the defensive exposure?
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Mid Morning

Michael Shedlock had a scary nugget in a recent post, quite eye opening actually.

In the 20th century the Dow Jones Industrial Average went from 66 to 11, 497. Michael says that compounds to 5.3% annually.

If that 5.3% were to repeat in this century the Dow would be at about 2,000,000 on December 31, 2099. He goes on to note we are 8 years into the century and we have only added 1300 points out of the roughly 1.99 million Dow points we need this century just to get 5.3%.

That doesn't have to be scary. Anyone starting a clock from 1968 forward for ten years comes up with a volatile round trip to nowhere yet the market skyrocketed in the 1980s and 1990s. The Great Depression was another volatile round trip to nowhere. Even if the century comes up short there will be boom periods for the market along with one or two more decade long round trips to nowhere.

Worrying about this sort of thing is counter productive because it is beyond our control. There are two action points from this which, as is usually the case, are save more than you currently do and live below your means.
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"You're Bumping Me From Career Day?"

Back in mid-March I had the longest email interview I've ever given with Money Magazine for their May issue and I think I got bumped.

Yesterday after my workout I drove over to Barnes & Noble with the excitement I used to feel as a kid opening that first pack of baseball cards for the season to see what they look like only to get to the article that I think I was interviewed for (they even wanted a picture) but they found better people for the article.

Very funny egg on my face.

Anyhoo, a couple of things this morning.

As a follow up to the stock picking post and comments from yesterday (great dialog, thank you) one reader asked "Isn't the sector or country more important than the individual stock?" Well that is what top down portfolio construction is all about.

If right now is the right the time of the stock market cycle for a certain sector, a certain cap size, a certain style, and a certain country that probably leaves you with very few choices to choose from but the types of factors cited should put the wind at the back of all of the names that pass the "screen." From there pick the one you think will make the best proxy. Of course picking is where you go through whatever you think is needed to analyze a stock.

It is also at this point where the decision of whether or not an investment product of some sort (like an ETF or something else) would be better than a stock for the given theme.

This process guarantees nothing but I think it makes it easier. If you agree (regardless of whether you are stock picker) then you are also top down, if you think otherwise you are bottom up. Nothing wrong with bottom up, there are obviously plenty of people that are very successful with it and chances are they think bottom up is easier for them.

The other item is that Christine Benz from Morningstar was on the Consuelo Mack Show over the weekend and her pick for The One Investment was the Dodge and Cox Balanced Fund (DODBX). She said it has not done well of late. In looking at the Morningstar page for the fund it has had a couple of periods where it lagged a couple of different benchmarks and for 2008 it is down 8.0% YTD through March 31 (according to Morningstar).

I do not know Dodge and Cox very well but I believe their track record is outstanding (someone can correct me if that is wrong). Like all active managers do, they having a period where they are lagging their benchmark. This is not a big deal but Benz' opinion that things will improve soon is nothing but a look back at what they have done before and simply believing they will go back to beating their benchmark.

There can be no analysis because no one can know what the managers will do six months from now--even the managers themselves cannot be certain what action they will take six months from now. This does not have to be a reason to avoid all actively managed products, I have a couple of actively managed products in my ownership universe (albeit narrower than DODBX). The managers of all of these funds are trying to be forward looking and sometimes they are right and sometimes they are wrong.

If you are inclined to buy actively managed products you just need to be aware that there is no real way you can do a forward looking analysis on the manager's forward looking analysis. If the managers have a track record for being right more often then they are wrong that is great but in the future they will be wrong some portion of the time.
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Mid Morning

A lengthy comment came in that I suggest you read (click here) that covers a few points some of which are fair and some of which are off base.

The gist is that it takes decades to truly understand a company, he says individuals cannot do this, he questions whether I know the companies I own, he says no one person can possibly understand more than an handful of companies, thinking otherwise is hubris and that investing differently than what he says is irresponsible.

The first question of how well can someone know a company is the most reasonable question asked. No matter how well you think you know a company it is a guarantee that there are holders who know it better than you and holders who do not know it as well you, I am certainly no exception. I would think this would be obvious because when you buy someone else sells.

That it takes decades to understand a company makes no sense to me whatsoever. If it did only 60 year-olds who had been in the business since they were 20 could possibly do the job but then how could they be in the business in the first place?

The other obvious thing about decades is that many companies have not been around for decades or that the business has evolved in such a way that the companies are much different than they were ten years ago let alone decades ago.

Stock picking is not easy and not for everyone, I have repeated that countless times but it is no where near the rocket science that this reader will have you believe. If you pick stocks you will get some right and you will get some wrong, it's that simple. If your ratio of rights and wrongs (and magnitudes of each) allows you to sleep comfortably and stay on track for your goals great, if not then don't be a stock picker.
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Decoupling...Sort Of

Chile has been a favorite investment destination for quite a while. I was out for a while before getting back in late last year (I have disclosed this a few times).

The chart shows the bank stock I bought in green (the name does not matter), the benchmark Chilean index in blue and the S&P 500 in red.

One of the reasons I like Chile is that only 15% of its exports go to the US so its fate is not that tied to the US. The chart shows there was sympathetic price movement but the fundamental link between the two is not that strong.

There are several reasons I went with a bank stock including that while Chile is obviously a commodity based economy I had enough materials stocks and this bank in particular has fewer moving parts than a lot of banks including no tier 3 capital.

One popular way to access Chile is with electric utility companies. This very well could be a way to invest but Chile is facing an issue with not being able to generate enough power to avoid rolling brown outs. I may have this wrong but rolling brown outs would seem to be a negative catalyst for a power generator or distributor.

As obvious as that seems to me I should note that the iShares Chile (ECH) has outperformed my bank stock YTD and it allocates 23% to utilities, Enersis (ENI) is up even more than ECH. For now the market does not care about this (IE I am wrong for now) but I think it makes sense to avoid what seems like an obvious issue.

The other important catalyst for Chile, that I have written about before, is that they have what is essentially a privatized social security program which creates a constant demand for Chilean equities.

Other than the privatized social security Chile is not that different from other commodity based economies. The country is at a different point in its economic cycle, it is a surplus country (not all of them are, however) and there are far fewer moving parts than in the US.

The point is not that you should run out and buy Chile but the work needed to understand the big picture is not that complicated. This is true of many countries.
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Sunday Morning Coffee

Following up on yesterday's video a reader commented that he has been in a lot of different holdings each with small weights but he feels that it could become too time demanding to follow a lot of holdings.

He did not quantify what a lot is. I have mentioned quite a few times that when fully invested I hold 40-45 names for the equity portion of the portfolio. I'm not sure that 45 is a lot but it is not a little.

How many holdings can you comfortably keep track of? Part of the answer depends on what you hold and what your idea of keeping track means. If a stock is a proxy for a country then in addition to knowing a little about the stock you also need to know a thing or two about what is going on in the country.

A reader left a comment on a recent post asking what sorts of problems Hungary has. Anyone thinking about Hungary, the easiest way in would probably be Magyar Telecom (MTA), of which I have no position and no plans to initiate a position, needs to be in touch with the deficits, the inflation that the central bank seems to be having a little trouble with and maybe that the rates there are quite high; that is probably a good starting point.

I don't think that burden is excessive but not everyone will want to put in that sort of time. All I'm saying is know yourself and what kind of time you want to spend.

Could you cover 80% of it with half a dozen broadish-based ETFs and the other 20% with seven or eight narrower holdings? Maybe the narrower themes should only be 10% or maybe 30%?

Sticking with 20% for narrow ideas would it then be possible to decide you want exposure to water so then analyze one of the water ETFs and then also a few stocks like maybe Hyflux (HYFXF), Valmont (VMI) or Veolia (VE), as examples? If you decide you like Hyflux would learning a little about Singapore be a possibility time wise?

Then could you repeat this five or six more times? How about more than six? Or less?

A mix like this sounds easy in a way but I think it potentially adds a layer of analysis that should be done. Anyone thinking of going narrow in the manner described in this post with 20% or more needs to be very aware of how the "satellite" portion fits in with the "core" portion. Quite a few times I have mentioned that most emerging countries have a big bank, a big oil company and a big phone company (the other day a reader added big cement company to this). Putting 3-5% into the big oil company of a country might leave you very heavy in energy which might not be bad (generically speaking) but you should know that you are overweight.

At this conference I just got back from someone familiar with my blog mentioned how loyal the readers of this site are. He is right and I should take a moment here to say thanks. Blogging is a lot of fun, I know I learn from it and hopefully you do too. Thank you.

The picture is obviously the Hoover Dam. There is a lot more going on there than I realized from watching Austin Powers and Lost In America. To repeat from the other day, if you are in Las Vegas it is worth driving the 30 miles to see it.
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The Big Picture For The Week Of April 20, 2008

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Nest & Egg

So we are here in Vegas and man is it different than what we are used to. I will say that anyone who comes here should definitely drive down to the Hoover Dam (I'll pictures on the computer by tomorrow night).

The dollar has taken another step down of late. One position I have had for about ten months has been exposure to the Norwegian krone via what was two year paper when I bought it (I have disclosed this position quite a few times since I put it on).

When I first went in USDNOK was around 5.95, I see it printing now around 4.98 which is a huge move (the smaller the number the stronger the Norwegian). Norway is a strong country economically so that isn't so strange but Hungary, for example, has a slew of problems yet the greenback is down 8% YTD against the forint.

I have never been real sure about quantifying where the dollar could go. I think it is right to be positioned for more weakness but I think the slope of the decline might be a little less going forward. I have thought that for a while but that is the sort of thing most people don't need to right about (meaning magnitude).

I am warming up to the StateStreet International Inflation ETF (WIP). I bought it for a couple of new clients, I bought a few shares for my SEP and will probably integrate into more client accounts over the next few weeks.

If the dollar continues lower (regardless of how quickly) WIP should do well but if the dollar goes up in a meaningful way it will be a big drag for WIP. My hope for this is that it would be a boring hold but that every few months I'll notice that its up a few percent or so.

If you look at the back test for it you will see a huge move up for this but I would not bet on that repeating itself.
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China

The Shanghai composite is now down about 45% from its peak.

A quick bit of history on my position on China. I first got in in 2003 with PTR, swapped into SNP shortly thereafter, sold the last of SNP last June because I felt it had gone too far too fast and I was worried about a big drop.

I was four or five months and about 85% too early with the sale.

All along I have assumed I would get back in and although I am not getting back in today it makes sense to start thinking seriously about figuring a way back in. There is no realistic probability of a market going to zero so after cutting in half what is the risk?

If China is/was a bubble then should we compare it to the Nasdaq? I'm not sure that is right but if it is then the risk might be another 25% down from the peak or put another way maybe it could cut in half again to total 75% from the peak?

The reason I don't think comparing to Nasdaq is right is that the Chinese economy is not rolling over, the companies that are part of the mania are the building blocks of the country (how many non tech stocks dropped by more than 50% from 2000-2002?), the various surpluses make the country very sound and there are others.

China does have all sorts of issues too. No one seems real comfortable with the numbers from the financial companies, pure capitalism is not their strong suit, if the oil subsidy every gets lifted it could be a game changer for the Chinese consumer, the pollution is awful, they're not scoring points for their ideas on humanitarian issues and there are others.

Like every theme/investment destination there are pluses and minuses but now down 45% the minuses don't seem to weigh as heavy. I am not saying it can't cut in half from here (I'm not that pie in the sky) but I don't think it is the most likely outcome. If I go back in it would be one company with only a 2-3% weight so if I am wrong and the market cuts in half I might have a source of lag not something ruinous.

The bigger macro for China since before I first bought in in that the country will become more important globally and that a lot of money would be spent to modernize the country as a middle class develops. This bigger macro is no different than it was five years ago, no different than it was at the peak last October and is the same today. Regardless of what direction the next 1000 points is for the Composite the story on the ground will be the same.
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Goin To A Conference, Gonna Eat Me A Lot Of Peaches

That title is a play on the song Peaches by The Presidents of the United States which was popular for about ten minutes in the mid-1990s.

I am headed to an ETF conference in Las Vegas tomorrow. I will be on a panel with Richard Kang and Tom Lydon.

So give me some input here...

What would you want to say or ask to any people in the industry or anyone else who writes about ETFs.

I have no idea who will be there but if something is on your mind I will try to bring it up with whomever your question would be appropriate. Obviously if you have a question about iShares and no one from Barclays is there you're out of luck.

One thread to this sort of post from the past has been for more fixed income and currency products. We are seeing more progress I think but is that progress good enough for you?

I hope you'll leave a comment I can take with me.
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Mid Morning

A reader left a comment on an old post in which I opined that 20% in REITs, per David Swensen, is too high for my liking.

The reader asked;

What is your opinion of WPS? WPS is in its lower range. Do you see WPS gaining in the forthcoming days? Is international real-estate moving better than domestic?

WPS is the iShares S&P World Property Ex-US. Like many broad, foreign RE ETFs the largest holding is Westfield Group which is an Australian mall operator with about half of it's properties in the US. Also like other similar funds it is heavy in Japan and Hong Kong.

I don't really know what to expect for WPS in the coming few months let alone "the forthcoming days" so I responded with questions for him to think about and I thought it would be useful to post here in terms of exploring process a bit.

A lot of what I have read lately talks about the real estate crunch just now getting to places like Australia, Ireland and Spain (here is a synopsis from Mish). How does this impact Westfield, if at all?

Further, WPS is 20% in Japan. Personally I want no part of Japanese equities or real estate, I have never been in the camp that this is the year for Japan and that has not been wrong very often.

The peg of the Hong Kong dollar to the greenback does strange things to interest rates and inflation in Hong Kong which would seem to pose some sort of risk. Clearly real estate companies in Hong Kong have done quite well this decade but the peg creates a risk I don't think I can quantify especially as the dollar has gone from being generally weak to getting pasted.

Lastly I asked the reader if he was interested now because it was down from where it had been or because he had some sort of forward looking reasoning for thinking it would go up from here.

I have no idea whether the reader should buy WPS but in deciding whether or not to buy the fund these are the issues I would want to sort out before doing so.
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I Doubt Its This Bad

Charles Kirk linked to an interesting post on a site called Economic Survivalism that gave 12 "survival" tips for the coming great depression (the article's assessment, not mine).

Coincidentally several of the tips have come up on this site although the context is a little different.

Below are the 12 without Economic Survivalism's commentary but instead a thought from me.

1) Avoid debt at all costs

Depression or not this is not a bad idea. This ties in with our ongoing theme of living below your means. Literally no debt is tough for most folks but no credit cards, less house than you could otherwise afford and holding on to a car longer than five years is within people's reach.

2) Get out of your mortgage

I don't really know what they mean by this one, it just warns that you could be underwater by lot if you don't but it doesn't say that you should leave the keys in the mail box either. Hopefully you've got enough financial cushion if you ever need it.

3) Buy cheap land in a rural area

Like in Chile or Uruguay? I would put this one in the I doubt its this bad category but if you are going to do this, do it before you walk away from your mortgage in item number 2. This one goes on to say that once you buy your rural parcel park an old RV on it or build a house yourself. I had a similar idea a few weeks ago here about cheap mobile homes and refurbishing the hell out 'em.

4) Go off the grid

This is another one from this week. It plays on fear and appeals to the greenie/survivalist in all of us. There are mixed opinions out there about the economics on this but it would be better to be off the grid if the infrastructure failed economics be damned.

5) Cultivate some skills that will always be in demand

Again this is a good idea depression or not. When I was in high school I should have had more respect for this and taken a class or two like this. As an adult I have come to learn more than I ever expected, clearly not any sort of expert, along these lines and I would say it is never too late to learn how to replace a water heater, do basic electrical or (sticking with my favorite example) operate a back hoe (don't have this one yet).

6) Offshore yourself

This one is about being cheap labor for a foreign company that would pay you in very cheap dollars. I think a better idea is to be self employed but that won't be a fit for everyone.

7) Invest in the ultimate counter cyclicals

They mean booze and tobacco stocks and I can't argue with that.

8) Invest in some euros

The bigger macro is own foreign currency. I've been on board with this one for quite a while now and still believe it is quite important going forward.

9) Have some liquid funds on hand

This one is more about SIPC than anything else but like several items listed so far this is a good idea regardless of whether there is a depression or not.

10) Learn to hunt

Ouch. I'll just say again I don't think it will get that bad.

11) Stockpile medications

Again, I don't see it getting that bad.

The title said 12 ways but I only saw 11 in the article.

Part of managing a portfolio is contemplating what to do in a bear market. In that vein part of being a financially responsible adult, IMO, is contemplating negative events like losing a job having a large unexpected expenditure.

The commentary from Economic Surivalism that this post refers to is an extreme line of thinking but is not that unique. I think the more realistic application is to think about what you would do if you lost a job you needed. How long would your savings last, what could you do for work right away and how much of your nut would that work cover? Losing a job seems more likely than your prescribed medicines not being available.

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Mid Morning

The plane leasing segment has gotten crushed in the last few months.

I've written about these a few times with a combination of hope and skepticism. Most of them are scheduled to pay huge dividends (in the sevens and eights before the declines).

The primary business would seem to be simple. They own and service planes and they lease them to airlines. I wrote about them for TSCM quite a while ago and back then the client rosters were very geographically diverse but the complexity comes from the balance sheet leverage and those high yields.

One point I have tried to make and this has been echoed by some readers is that when something yields 8% in a 3% world there is risk--you either understand the risk or you don't. The context that I have talked about in terms of ever buying something like this (the hydro funds in Canada would be another example) has been to go small, like maybe 2%, into something like this and know that there is risk.

There is has been a dislocation in the market and it has hit a lot of these levered products very hard, for some of them it is probably justified and some of them are just going along for the ride. The dislocation will end at some point and the ones that have just gone along for the ride will be safer relative to themselves at that point.

The plane leasers is the type of thing that if they had done better for longer they would have been more popular, more people would have owned too much (like the Canadian Trusts when they got hit a year and a half ago) and we'd be hearing more about this.

Owning one of these (to be clear I do not) is not the worst thing but owning too much might be.
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Future Thoughts

The current issue (I think it's the current issue) of The Economist has a special report about modern day Nomadism which is the word they use to describe people who work from anywhere wirelessly not even with laptops, just smart phones.

WiFi and gadgets are doing away with the need to have offices allowing for people to be anywhere and not only get the job done but have a better quality of life. This is not telecommuting because telecommuters are stuck at home where as the Nomads can go anywhere.


It seemed as though one of the conclusions was that everyone will be able work and live this way.

Maybe I am adding 1+1 and getting 11 on that conclusion but obviously being a wireless Nomad does not lend itself to everyone, certainly not half the population and I am not sure about even 10% but is it is interesting relative to the recent post about moving to a foreign country.

If you can be a wireless Nomad then you could move to a place like Punta del Este, Uruguay (first picture) or Valparaiso, Chile (second picture) and get the benefits of those places while also getting the benefits of working in the Unites States.

Just for the record I am not going anywhere but as I said in the first post about the topic it is intellectually interesting to ponder. Part of it of course is that the entire topic plays on people's sense of fear of the future of the country. It's a reasonable question to ask. Things like deficits and trade imbalances have not really mattered but what if they do at some point in the future? What if the dollar gives up the status of world reserve currency? What will happen if the US is ever forced to update the infrastructure faster than is financially feasible? It's ok to wonder about this stuff.

In that vein buying a $50,000 farm house, as a hedge, on the outskirts of a bigger city in central Chile or the outskirts of Montevideo might not be the single craziest thing you ever do.

Given the playing on people's fear aspect of this I had a thought about solar. I think solar energy is vitally important for the future. I still think the landscape for the solar stocks will look much different in five years than it does today but the technology will be very important.

There was an article in Barron's over the weekend about the economic viability of thin film solar improving in the next few years but I think the marketing ploy for solar, until it does become cheaper, should be to play on people's fear of grid failure, either from mechanical breakdown or because oil/gas/coal becomes too expensive (these don't have to be realistic, the point is people's fear).

From what I have read, paying for the equipment needed to go solar would take many years of no electric bill before it would pay for itself. We have looked into it and with an average $60 bill per month it would never pay off for us--until it gets cheaper. So the idea would be for the solar companies to really hit on grid failure because there comes a balance of money spent versus peace of mind of knowing you'd have electricity if the grid failed. It appeals to the little survivalist in all of us.

Do solar companies already do this?

Even if this post isn't interesting the links to The Economist and Barron's are.
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Mid Morning

Michael Thompson from Thomson Financial was on CNBC for what seemed like a very peculiar interview. Maybe I heard wrong or am being unfair but he appeared to be literally whining about the current state of the market, how long it will take for things to turn around and it seemed to go on throughout the entire interview.

Thompson was very bullish very late and candidly I can't recall anything he has ever said opinion-wise (as opposed to giving data from analysts they survey which has some utility) having much value or being right very often. If you know something different please leave a comment.

It is possible this is just some sort of show because he is often strangely upbeat, now today he was whiny. Maybe he really feels the emotions he displays. Whatever the reality (a show or the real thing) I don't think it is anyway for an analyst to act and potentially elicits an emotional response on the part of some investors which does a true disservice.

I have no idea what his background and experience is (presuming it is pretty good) but just as leaves fall of the trees in autumn, bull markets give way to bears at some point.

Hopefully you can see the forest for this sort of tree and know to discount the credibility of an emotional response from someone who is supposed to be a professional.
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Reader Comments

I was up in the Bay Area over the weekend attending a bachelor party for a wedding I'll be standing up in later this summer.

We went to a Giants game in the afternoon and a Warriors game at night.

A lot of follow up questions came in on General Electric (GE). One reader asked why I am not a fan of GE given that they seem to involved with a lot themes I care about.

Well, the short answer would be how'd those themes help last Friday? The company is involved in a lot of businesses that cannot move the needle. They might move the needle in the future but they don't now.

There was some great chatter about a 4% withdrawal rate to pay for retirement. RW kicked it up a notch talking about the difficulty in modeling returns very far out into the future (oy). Adam noted that if you only take 4% of whatever you have you'd never run out of money--mathematically speaking. One reader noted, correctly, that planning for inflation can't really account for healthcare costs accurately.

Well, on a theoretical level RW is right about future returns. I can't tell you there will be no problem in the future finding generally normal returns. I believe they may be a little harder to find but that could be too optimistic. Despite my bearish views about the current state of the markets I am an optimist by nature and choose to believe that global markets will reward investors as they have--that is to say capitalism will continue to work (not saying RW is not a capitalist but the tone of the question as I read it is to ask if capitalism still work).

Adam, a person can plan to live within their means, be disciplined enough to do it and still encounter an event that causes them to have to exceed their annual number. Say person's portfolio number today is $32,000. A high speed chase ends in their spare bedroom and through the magic of insurance our person is $15,000 short of what they need to properly fix the damage. In that given year the extra $15,000 means exceeding their number by 50%. Now if all this happens in a down market the person might have a real problem. Just an example off the top.

WRT to healthcare issues, I have a thought that, no doubt insensitively, could tie in with living below your means. Maybe the solution should include reducing the extent to which you are exposed to inflation. Is this even possible? Well maybe not but when you buy a car how about keeping it for 20 years? How about skipping one trade up cycle for housing? Doing these things would not spare you from having to endure getting jacked on your health insurance premium but not moving from a $400 car payment today to a $500 payment next year to an $800 payment six years from now wouldn't hurt.

One reader asked why I would take money from my HSA for a health related emergency. Well maybe it is not the ideal thing but the way I view it, if something health related came up and I needed to tap into an IRA to pay for it, there is no tax consequence for pulling from the HSA. In this vein there was some chatter about insurance policies tied to HSAs being lousy. Well I won't defend an insurance company but the savings perk is a great thing on a couple of levels. It allows you save an extra $5850 (I think that is the max) above and beyond whatever you can put in your regular qualified plan.

Lastly Stephen Drone left a link to a Kessler like article by Gary Schilling about US Treasuries. I only skimmed the article. I would be very wary about bond market studies that start in the early 1980's. This has been the greatest bull market in the history of the bond market. Rates went from very high to very low and are still very low.
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Sunday Morning Coffee

Last week I made my 2008 HSA contribution and I thought it might be useful to write about the relevance of saving versus performance.

In most posts about planning or long term results I try to throw in that saving is probably more important than results and the HSA might be a good example of this.

HSA stands for health savings account and if you are unfamiliar you can read about it here.

2008 is the third year I have funded it. For 2006 I believe I put in $2500 and $5000 each for 2007 and 2008 for a total of $12,500. I have this money invested very conservatively in an account at Options Express--in my view an HSA, compared to other types of IRAs has the most visibility for being tapped in an emergency so I do not want this account exposed to normal stock market volatility.

I won't disclose the current value so as not to violate rules about stating performance but the goal is along the lines of bases on balls (using the baseball analogy of singles and doubles versus home runs).

Using the value of the contributions as a dollar benchmark it is clear that the $5000 every year will be the more important thing for many years to come than whether I get a 5% or 10% return on the money. After my 2012 contribution, assuming zero growth, the account will be worth $32,500. If I somehow made 5% in 2012 after the contribution that would be $1625 which would be a small fraction of the $5000 I would contribute in 2013.

The way I view things the act of saving will be far more important than the return I get on the money for many years to come. That being said I am obviously going for better than zero and have disclosed owning a couple of absolute return products in past posts (the names are not relevant to this post) that hopefully will do very little month to month but that every so often I'll notice that hey they're doing ok.

In certain IRA and 401k plans that allow for larger contributions there is a similar effect of savings being more important for a while than returns. To be clear a normal IRA or 401k it is appropriate for normal stock market exposure relative to your target allocation and clearly returns matter but if you $10,000 a year into a 401K I would submit that going from zero to $100k in the first ten years will be the big thing. At some point, whether it is less than ten years or not, the returns become the more important piece but giving up on savings at the point would be a bad decision.

A 50 year old with $400,000 in his 401k planning to work ten more years can add another $100,000 ($10k per year) which is meaningful amount of money compared to the $400k (I have been a SEP person for a while and while I believe the 401k max is more than $10k I do not know the figure) but probably not as meaningful when compared to averaging 10% per year on the $400k if he should be so lucky.

The picture is from New Zealand.

I am coming back from San Francisco this morning and published this via Blogger's new time bomb publishing and won't be able to respond to comments until late this afternoon.
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The Big Picture For The Week Of April 13, 2008

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Mid Morning

The Mother Ship has broken down by the side of the Galaxy.

GE missed their numbers, toned down the guidance, had problems with their finance business and their healthcare business.

The way this is being portrayed is that they really did not see it coming until very recently.

This is a perfect example of how an ETF can be a better proxy for a sector than a stock. I have never owned the stock in my time as an investment manager.

The thought process all along has been quite simple. Earlier this decade, so early in the bull market, the stock had the headwind of it being the wrong time for mega caps, then as the time that mega caps should lead came upon us my thoughts focused on whether or not a huge complex conglomerate was the best way to access the industrial sector and again my answer was no.

Part of it is that I don't like media which ironically was a bright spot but more importantly I have not been a fan of financials for ages.

We are hearing that infrastructure was strong so maybe that is a reason to own the stock. Well maybe, and of course at some point the stock will at a minimum ride the coattails of a bull market (maybe it'll even provide leadership?), but wouldn't make more sense to own a purer infrastructure name?

There is going to be billions and billions spent over the next decade or two on infrastructure globally, this is not debatable, so it is reasonable that stocks in this space will do very well over that time period (note this does not really create urgency right here right now).

I can't rule out luck for having avoided GE but it has been a woeful laggard and despite so many people coming on CNBC who have talked it up I think the best it can hope for over the next few years is riding the market's coattails.
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Debate Over Citi

There was an interesting debate about Citibank, Citicorp, Citigroup (C) between Hugh Hendry and Bob Olstein on CNBC yesterday.

Hugh thinks that Citi is going to $10 per share noting that the financial sector has "endured" a bubble and that when a bubble pops you need time to get better. He cited examples of stocks like Cisco and Microsoft being way below their 2000 highs and that it took Schlumberger 16 years to get back to where it was after peaking in the early 1980s.

Bob thinks Citi is going to $40 in the next 24 months noting that the stock was at $55 eight years ago. He said there is $4 of "earnings power under the write offs." Olstein said to look at the cash flow and that the stock is down "70 or 80%." Bob closed out saying that eventually free cash flow determines values of companies.

So there are two very different schools of thoughts and both can be correct. We could see $10 and we could also see $40 by April 2010.

I don't think it will go as low at $10 or as high as $40 in two years but I expect more downside as the bear market goes through its process and I would expect that, generically speaking, there will be a stretch off the true bottom where financials do rocket up. Using Citi as an example but not a prediction there would be nothing unusual about it bottoming at $15 and doubling in the course of a year.

Yahoo bottomed below $5 in September 2002, a year later it was above $18--almost a quadruple. I don't think a financial with a $100 billion market cap is a candidate to triple or quadruple in a year but a double, coming off meaning event driven bottom seems plausible.

Cisco bottomed around the same time just above $11. A year later it was around $21.

I gravitate closer to Hugh's line of thinking. The way I view it, everything Olstein said about the stock could be true but that does not have to mean the stock goes up. If as a result of the credit event the financial sector stays down and out for four years then the valuation metrics Olstein cites are very unlikely to lift the stock while all the others stay down.

This example is exactly why I prefer top down. I find having the wind at your back makes the job much easier than making a case that a stock should go up because it is cheap.

That was a crazy beatdown BC put on North Dakota in the Frozen Four last night, 6-1 with the one coming with 1:16 left in the third.
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Mid Morning

I have noticed an interesting tone to some of the comments in the last day or two, no not referring to the attire of any TV personality on any of the business networks, about indecision and owning cash.

One point I have made many times over is that no one can have all the answers all the time.

One thing that has generally been working this, in terms of smoothing out the ride, has been absolute return products.

Not that they are not down but many seem to be down less or up a little. Down less is a valid goal for a down stock market and if you can find one or two things that are up, all the better.

Conversely there are some things that you should not think would have a shot of going up in a down market. One name in my ownership universe along these lines is the Vietnam Opportunity Fund that I have written about a few times. YTD the Vietnam Index is down 42% while the fund is down about 5%. Part of that could be to the fund having a 7.5% premium to NAV as of its last reporting date. The fund holds a lot of other things besides equities and so it doesn't always correlate.

It is probably a lucky thing the fund isn't down more but if it were that would not be the important thing. This is the time for less exposure to this sort of thing and more exposure to cash or whatever you think of when you think about what to do if you are one to take defensive action.

A little exposure to a frontier market now is not the worst thing in the world but increasing the allocation now if you aren't prepared for another 20% down is probably a bad idea. As global markets start to show signs of sorting themselves out it might makes sense to increase a little, for anyone inclined to invest in frontier at all.

Tonight is the frozen four semifinals, talking college hockey here. The action is always good so if you've never watched, check it out.
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Riots In Egypt

You probably have heard about the riots going on in Egypt over the rising price and rationing of bread (wheat).

I only know what I read (here and here). Knowing what is really happening there is difficult as function of being far away and news accounts sometimes don't correctly capture the essence of these things.

It is much easier to understand that part of what is causing the problem is a distortion of some sort in the price of soft and agricultural commodities. I say "some sort" because quantifying the distortion is not really the point and I doubt I am the person to do it. I think successful navigation is more important than successfully quantifying such an event.

Wild, wild price action, regardless of direction, happens every so often and the most important thing for most folks is simply to recognize something is not right and if something is not right in a serious manner then the chance of consequences in other seemingly unrelated markets is quite high.

A year ago rough rice was trading around 11. It started 2008 in the 13s. The July 2008 contract now appears to be above 20.

The chart is of the Wheat ETC (WEAT.L) traded in the UK. It started the year at 5, up to 7 and now back below 5.

The action is wild and creates visibility for problems in other markets either directly or as some sort of secondary effect.

In addition to the commodity markets being a little cattywhompus so is the bond market. Yields are absurdly low. Either yields stay very low which causes one set of problems or we see a violent run up in yields (like in July 2003) which causes another set of problems. An orderly correction is rare event.

I'll leave predicting what all this means and what it will domino into for the smart guys in the room. It is more useful to know risk is heightened both in places where we expect it (stocks and commodities) and where we don't (bonds and money markets).

The rioting will hopefully end very soon but the market events triggering the riots could have fallout for quite a few months (some will say longer) and so continued defensive posturing seems to be right. If this thought turns out to be wrong then obviously the world will be better off.
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Mid Morning

So the Red Sox had a legends day yesterday for the ring ceremony before the home opener. Very neat to see all those guys but what is a Boston sports legends day without Eric Fernsten (now that is an obscure reference)?

Chile is going to start a sovereign wealth fund with about $6 billion.

I have been a fan of Chile as an investment destination for a long time preferring one of the banks. The country has a lot going for it including only 15% of its exports going to the US.

On a different note Northern Trust has finally started listing its ETFs under the brand name NETS. The site has information on six funds; Australia, the UK, France, Germany, Hong Kong and Japan. These six are really not that new but they have filed for some others that could bring something different to the table.

I'm not sure why NETS is leading off with me too funds (well, they are slightly different) but it is a start.

Claymore filed for a frontier market fund. I don't know much about the fund yet but over a full stock market cycle this will be a crucial asset class. I am saying that even if the fund comes out at the wrong time it is still a very important type of holding for your long term result. Note I am talking about the asset class which I do know a little about as opposed to the fund which I do not.
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Reader Comment

A reader left a horrible comment on a post of mine syndicated on Seeking Alpha that reveals a lot about long term thinking and my hope is that we can all learn something from it.

You can read the full comment here.

Basically the reader is 50, wants to retire at 62 and his plan appeared to need (based on how the comment read) 15% annual growth for his portfolio plus additions made every year. By his numbers and math that gets him to just comfortable not wealthy.

I don't disagree that the number he is shooting for is below that of wealthy. He goes on to share how much less he would have if instead of 15% he only averages 10%--only 10%. It pains me to say that the entire plan is a disaster.

You can only take what the market gives. This is a cliche of sorts that basically means you can't expect 15% in an 8% world, if 8% is what the average ends up being over the next 12 years. Certainly someone could end up with 15% in an 8% world but a plan the relies on it is a plan that needs to be changed.

People don't beat the market by that much with that sort of consistency unless they are Warren Buffet (I don't know what his actual track record is but you get the point).

I have had many posts about this sort of thing and I take a very simplistic view (although I realize it is also cold) which is save as much as humanly possible, live below your means (I am becoming more aware all the time how difficult this is for people) and then when you do retire do not exceed more than a 4% withdrawal.

If 4% doesn't give enough then you need to figure something else out besides "I 'll take more this year but next year I'll take less." If you have a gap and you are lucky you can work part time, figure an effective way to down size (this is not so easy to figure) or do something else but "I'll take less next year" is bad, bad solution.

The 50 year old commenter does not have plenty time to make his number if he want to retire at 62 but he does have plenty of time to calculate a more realistic expected return, determine if there will be a gap between what he can safely take and what he needs and figure out what he can do to fill that gap.

A slightly different take on my "whatever you got; 4%" meme is that in life there will be times where yo do need to take more money out in a given year as you get older for maybe a health matter, to bail out (literally or figuratively an adult child) or maybe pay for something for your 96 year old parent. Sticking to the 4% will allow you to more easily absorb some unexpected expense.

The reader in question will probably tell me to go to hell but hopefully you can learn something from what he is doing.
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Mid Morning

This is a chart of Garmin (GRMN) for the last six months.

This makes for a good talking point after the recent post on Johnson & Johnson, client holding.

The stock is down more than 50% coming in to the day and then down a bunch today on what appears to be news about a competitor.

Garmin obviously makes gadgets, not to minimize the utility at all, but a gadget maker is one type of stock that can have a great run for some period of time (could be many years) and then run ends for reasons that are easy to see and understand or for no apparent reason at all.

This does not make it a bad area to invest in but it does make it different than, say, a phone company that you pay your bill to for decades or a company that you have been buying cookies from since you were ten.

I don't follow Garmin very closely (I wrote positively about it for WallStrip in Nov 2006 but can't find it on their site) these days but something must have changed (I see a downgrade or two and maybe there was bad guidance too?). Another issue, and I think this is important, the climate for stocks has generally not been good since the stock peaked.

Clearly a double digit decline in the broad market cannot account for why a stock would more than cut in half but it does create an environment where any bad news is likely to be punished more than normal.
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Closed End Funds

I can recall in 2004, 2005 and maybe even in 2006 seeing many a closed end fund being launched with a celebratory bell ringing at the NYSE. Lately, not so much, if at all.

There could be several reasons for this. The ETF/ETN format has become more popular, although not always superior. There was really a deluge, especially covered call funds, of new listings--so a lot of new supply. Lastly is that panic in the market caused an over reaction in the market prices relative to the NAVs, which by the way is a common reaction in times of turmoil. I have repeatedly referred to June/July 2003 as an example of what can go wrong with CEFs and I think the last few months are another example.

CEF are simply a tool, they have strengths and weaknesses and the big weakness is that they do over react to market events and often end up disappointing people looking for safe havens.

I have several CEFs in my ownership universe, one has held up pretty well, a couple have been fair but not great and a one has been hit hard.

That a fund is down at a time that is bad for CEFs is not a bad thing in an of itself but clearly a bad asset allocation decision, IE owning too many of them, is a bad thing.

I wrote countless posts and articles about call writing funds over the last 3 1/2 years as I buy into the concept but in just about every post on this topic (I am hedging a bit here because I am pretty sure I did this every time but can't be certain) I urged moderation, no more than 3-4% of the total. Most of them went down a lot and some of them are working their way back up faster than others. From where I sit nothing has changed if the exposure was moderate which it is in my case.

While many different types of CEFs have faltered there have obviously been other things like commodities, ag and currencies that have generally worked to offset, or maybe more than offset any decline from a CEF.

One contrarian thought that I am unlikely to pursue is whether or not the lack of new listings and the poor market action makes this a good time to buy CEFs. This is not my type of trade because I don't think I would be very good at gaming the narrowing of a fund's discount and I look at CEFs for very specific exposure as opposed the broad nature the question is framed.
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