Sunday Morning Coffee

A reader, maybe a heckler actually, left the following comment.

Betting on any country that is not America and not in debt and has natural resources is an easy call.

This was a reply to some things I was writing about foreign country selection and the simple act of investing in countries with different economic attributes.

I can't be certain he is heckling me but either way I agree with him, it was an was an easy call. I guess since I made that call (plenty of other people did too) I can say it was easy.

The reader's comment brings up two points. First it is potentially a case of hindsight bias. Like "of course the Asian Contagion in 1997 was not the end of the world and stock market came right back after the decline." Sticking with that example most people were really quite afraid of the Asian Contagion. The previous two sentences could also be said about the LTCM blowup in 1998. I have no idea about the reader who left the comment but all of these events are big and scary to many people (otherwise there would be no decline).

To the extent this is about hindsight bias the notion of realizing an event for what it is in terms of not mattering much in the big scheme and buying at a moment of general panic is going to be very difficult to do. Far less difficult is to realize an event for what it is in terms of not mattering much in the big scheme and just not panicking yourself is much easier to do.

Maybe the reason hindsight bias is even a term is because things are often obvious after the fact but then people don't necessarily learn from these episodes and benefit on the next go around.

As for the specifics of the comment that picking commodity based countries was easy, again I think it was but I do not believe that the majority of people really did this. There was and is recognition by the masses that emerging markets is an asset class that should be owned but how many people own something narrower than iShares Emerging Market (EEM)? EEM has $30 billion in assets. While I don't know I would venture to say that EEM is bigger than every other emerging market ETF combined (if anyone would care to double check that ...) and while I do not know if that is correct or not it is pretty close to being right and it means that no the commodity based countries are not obvious to everyone. As an FYI South Korea and Taiwan combine to make up 25% of EEM and China (has resources but not a commodity based economy) is another 15% of the fund.

The reader's comment notwithstanding very few people are willing to make sector decisions or single country decisions. That certain sector and country decisions have been important for returns in the last few years is obvious but my focus in writing about these things for so long been about how to reduce volatility for the portfolio-- to avoid some of the drawdown that ended up happening.

The picture is from the Dakar 2010 fan page on FaceBook. For some odd reason the big trucks are my favorite vehicle class (as opposed to SUVs and motorcycles). Going to see the Dakar is on my "life list" and since they moved it to South America it is a little easier to get to.
Read more!

The Big Picture for the Week of May 31, 2009

Read more!

Virtue In Being Early?

Trader Mark has a post up about Chile (hat tip to a reader) that was inspired by this Wall Street Journal article. Both the blog post and the WSJ article have a lot of meat on the bone.

Mark says that he'd never written about Chile before and based on what he wrote I presume he is favorably disposed (apologies if I read that wrong). I've been writing about Chile for about four years, following it a little longer than that and have had exposure more often than not over the years. It has been quite clear to me for several of the reasons cited in both links that Chile offers a lot of potential utility as an investment destination.

This post is not about whether you should think Chile makes for a good investment or not. To be clear neither Mark nor the Journal are late. I think, though, this is a good example of how investors will learn about new (to them) destinations and the potential value in having exposure to these places before that happens.

Although that is a fairly obvious point I know (you do too depending on how much stock market television you watch) that many investment professionals are reticent to be early in adopting something new--safety in numbers. I know from some of the conferences I go to, and by some feedback from my Street.com articles that not many folks invest at the sector level, for example, and individual countries are also uncomfortable.

I believe that the way markets and investing are evolving people will have to go narrower than they do now. This means seeking out specific countries that provide a reasonable expectation of a low correlation to the US and Western Europe.

I have had many posts over the years about the countries that I favor in this context and if you have been with me for a while you've probably noticed that the list doesn't change too frequently if at all. I've had some decent luck with the country picks, not because of any brilliant analysis, but because I wanted different economic attributes. Making a list of "different" countries is pretty easy, selecting which ones to buy is obviously more work but the task of figuring where to look would probably only take a few minutes.
Read more!

Another Working In Retirement Example

A big focus on this site has been the need to seek out ways to supplement income during retirement in order to relieve the burden placed on the portfolio. For people willing to spend some time being creative and laying some ground work early on there are many ways to achieve this in such a way that fits any given situation.

I mentioned the other day that Joellyn went up to the Best Friends Animal Sanctuary with a couple of her dog-lady friends. Sticking only to the pertinent details a friend a friend of Joellyn's is in her mid-60s and does copy-writing for the sanctuary. She lives up near the sanctuary but is moving, coincidentally, to Prescott and can continue to do the job via telecommute.

Presumably she has some knowledge of animals and writing which makes this a good fit for her. Not knowing this person at all it is safe to assume that she will be able to do the work for quite a while. Obviously it doesn't pay $10,000 a month but it does provide benefits so it putting this in your terms how much would you need to make to relieve your portfolio's burden? And how much more would that be worth in exchange for benefits?

If something that was in your wheelhouse (you can do it and enjoy it) paid just $10 per hour for 25 hours a week and your portfolio need was $4000-$5000 per month then I would submit that the $1000 in this example would be huge. Even if you needed $10,000 a month the job in this example is helpful.

Depending on what you read about social security, potential stock market returns and any other related topics it would be very easy to get disillusioned by the whole thing. This may a personality thing but we are all going to have to address this in our own lives (or maybe you already are). As there is no avoiding it I think it is more useful to view it as a problem to be solved--a challenge of sorts. Hearing or reading positive stories is encouraging as is, I believe, trying to proactively take the bull by the horns.

The picture is of a barn on the Best Friends property built by Disney for a movie.
Read more!

Tuesday Tidbits

In case you missed it the Emerging Market Sector Funds have started to come out, you can check the EGShares website for the particulars. I did a favorable write for theStreet.com that should be out today about the first two funds that are actually trading; the energy fund (EEO) and the materials fund EMT. I did a generally negative write up about what will be the financial fund which should have symbol EFN yesterday on GreenFaucet.

The website has the info for all the funds (including the ones that have not listed yet) which provides a great chance to look under the hood. There is generally a lot of BRIC and South Africa exposure in the funds. Some funds will be more useful than others but generally they will be useful for adding emerging volatility in for various sectors for people that do not want to pick stocks. Being able to narrowly manage volatility in this way is a big deal for people willing to learn about this.

One criticism of the current rally that started in March is the extent to which low quality and small cap stocks seem to be leading. The reason for the criticism is that because it is low quality and small cap that are leading it means that much of the rally is from short covering. David Rosenberg has been writing along these lines of late. It may be so that the rally is being driven by short covering but generally speaking it is small cap and the like that lead off the real bottom.

This is more of a how the market works concept and there certainly can be fakeouts but it is a good bet that the stocks leading now, ex-financials IMO, will lead whenever the turn comes. FWIW I think there needs to be at least one more run down but I will slowly heed the call if the SPX goes back above the 200 DMA which has dropped precipitously of late.

This brings up an interesting point. If the SPX does go above the 200 DMA anytime soon I have said that I will buy a name or two if it is still there late in the day on the second day. Invariably there will be a couple of comments asking why I didn't wait for the 200 DMA to slope upwards or wait for the 50 DMA to cross above the 200 DMA.

Aside from the fact that no strategy can be the single best for every bear market and my goal was simply to avoid the full brunt of the bear I think changing tactics in the middle of an event is bad idea in terms of opening the door to be less disciplined. If you pick a strategy that has a reasonable basis for working, as I would say has been the case for the 200 DMA, and you did so ahead of time when there was no emotion involved it is not a good idea to second guess some part of it now if you are feeling uncertain. Uncertainty may not be an emotion but it might as well be. The time to make a tweak or pick something different is before the next event not in the middle of the current one.

From the this one goes to eleven file Bill Luby mentioned that all the Direxion 3X ETFs are now optionable. Oh boy. Bill also noted that Direxion has 3X treasury ETFs which I did not know about. The 30 year bull is ticker TMF, 30 year bear TMV, ten year bull TYD and ten year bear TYO. Obviously you can't count on them offer 3X anything over longer periods of time but as a reminder when the interest rate of the ten year moves 1% it works out to about an 8% price move. A similar move in the 30 year yield is more like a 12% price move. Staying wrong in one of these funds could have a big price impact on the fund you buy.
Read more!

Swensen on WealthTrack

David Swensen was the only guest on the Connie Mack show this week and had some interesting things to say.

He said that when he first got to Yale the typical endowment had 50% in US stocks, 40% in US fixed income and 10% in alternatives and that mix made no sense to him. He said that diversification is a great thing. It was a great thing then and it is a great thing now. Endowments may have thought they were diversified but he said there is no way you can argue that having 90% of your assets in US marketable securities represents diversification.

If you have a long investment horizon you should have an equity orientation because over long periods of time equities should produce superior returns and if they don't, Swensen said, then it means capitalism isn't working. He also echoed a sentiment mentioned by many which is that after a decade long decline for stocks and more than a decade of big gains for bonds, stocks now are likely to outperform and bonds underperfom.

Roger chiming in: Despite the emotion that exists today this is a logical way to think of things.

Back to Swensen who noted that diversification isn't going to help in the middle of a financial crisis. It "failed" in 1987, 1998 and now. During a crisis people rush to treasuries which causes them to go up in price and everything else to drop in price.

To him this crisis reminded him the people pay too much for illiquid investments like hedge funds. Too much in terms of the extra return they provide.

He thinks that the things that are important about diversification for endowments are just as important as for individuals but the path to that point means different types of products. He noted disappointment in not being able to replicate the Yale endowment for individuals with ETPs . He said the type of active management needed for all the asset classes is not available for individuals. Investors need to be either very active or completely passive. Individuals are probably better off being completely passive because he believes the quality of the management in the mutual fund industry is not high but it is very expensive.

He spelled out some of his model portfolio for individuals and has made two tweaks from the book. He reduced his REIT allocation from 20% to 15% and increased emerging market equity exposure from 5% to 10%.

30% US stocks
15% treasury bonds
15% TIPS
now 15% REITs
15% foreign developed equities
now 10% emerging markets

Ok, all done paraphrasing Swensen.

I have been critical of his model portfolio mostly because of the 20% in REITs. Even the new 15% is way more than I would ever want. When people talk about correlations going to 1 during the crisis REITs are the first thing I think of. I had one REIT targeted at a 2-3% weight toward the end of the bull market but I sold it early on. REITs will be a fine hold again at some point but I no longer trust them in terms of being a diversifier.

On a brighter note I believe it has gotten much easier to build a portfolio with the type of diversification that Swensen seems to be looking for. Private equity remains elusive but I am not really a fan of that anyway. Certain types of hedge fund strategies are available but not the ones that go up 500% thanks to shorting all the stuff that dropped 90% in 2007 and 2008 (or whatever the equivalent of that type of trade will be in the future).

Long time readers will know that I find what the endowments do to be fascinating. They provide a great opportunity to learn but not emulate. That people have learned a lot of things about their own tolerance for volatility from the double bear market of this decade is a good thing, that it might send them to a portfolio of 30% equities, 30% bonds and 40% "diversifiers" would probably be a bad thing especially for people younger than 60.

If something more like 15% in diversifiers for someone with a low to middling tolerance for volatility is right then I think the investment product landscape offers a lot of choice with more choices to come.

One thing that Swensen addresses (along with many other people) that I try to emulate is to not let the conversation get too far away from logic and how markets tend to work. The point above he makes about stocks having a good chance to outperform bonds after how the chips have fallen over the last 20 years or so is very logical. An asset class has a good chance to outperform if it has lagged for a meaningful period of time. The sentiment guarantees nothing but it puts the odds in the favor of equities.

This is not a conversation about where or when the bottom is but looking out over some number of years the odds are that stocks will outperform. That is not an emotional statement it is a logical statement about probabilities.












On an unrelated note last June I went to my Mecca Fenway Park. This past weekend Joellyn went to her Fenway, the Best Friends Animal Sanctuary just outside Kanab, UT. You can see her there on top of the green monster with a view of the scenery of Southern Utah. The trip was a big deal to her as was Fenway to me and she got some fantastic pictures that I will post as time goes on.
Read more!

Holiday Theorizing

Between the D-2 and D-3 college lacrosse championships and the Red Sox game it took some masterful Tivo work to take in David Swensen's appearance on the Connie Mack show (the show is on Sunday afternoons in Arizona).

I'll write more about the appearance later but as Swensen was talking about diversification and the high regard he has for TIPS I started thinking about the debate over whether we may or may not have big inflation or serious deflation, whether equities are dead and all of that I thought it might be worthwhile to explore a the notion of a non-equity portfolio.

It should be no surprise than many people are in the process of giving up on equities. As Eddy Elfenbein mentioned, equities are down 39% decade to date so it is reasonable to ask a few questions.

If you are going to give up on equities you still have to address the potential loss of purchasing power. If deflation wins out over the next few years, ok, but at some point inflation will matter again. At a 3% inflation rate our expenses will go up 50% in 15 years and if some inflationistas turn out to be correct 3% inflation will fall short of reality.

Avoiding the stock market can't mean all cash. The obvious answer might be all TIPS. Well maybe but the idea of 100% in any single type of thing no matter how "safe" seems straight up crazy to me. I'm not likely to be the guy to see the complete breakdown of how TIPS function ahead of time but anyone can avoid having a complete breakdown wipe them out by not going 100%.

Obviously part of the inflation story would be the dollar getting weaker against other currencies. This makes a lot of sense but just as it seems obvious, what might the US dollar do in the face of some sort of geopolitical event? Just because the US seems willing to let the dollar devalue does not mean that five years from now there can't be some sort of big dollar rally, like in 2008, even if it is counter trend. So putting everything into a basket of foreign currencies (either just the forex or via t-bills) is not something I would do either.

Commodities will very likely be a big part of protection against eroding purchasing power. If you read enough articles you will find recommendations for 20% or even more in commodities. I have what I think of as a lot of exposure to commodities and that is in the low to mid single digits (which is very low to some folks). If someone can stomach the volatility of 20% in commodities why not just have some equity exposure? While its is true that commodities cannot go to zero the plight of crude oil over the last year shows us they can go down 70%.

Some combination of all of the above and (with a nod to Jim Rogers and Marc Faber) a little farmland will allow for sidestepping some of the vagaries of equity markets like bad earnings reports, poor management decisions, options scandals and the like. However, avoiding equities does not mean avoiding diversification, does not mean avoiding home work and does not mean avoiding volatility.

While some folks may not want to hear this, I think avoiding equities in the context of this post is a mistake. We've endured a bad run. That bad run may have more to go but the equity market has had bad runs before and after the last two events like this one the stock market skyrocketed. Maybe a better plan is to tell yourself now that you will sell your stocks when the S&P 500 gets to 3300. Think that's nuts? Well maybe it is but from a low of 96 in April, 1942 the Dow went up (not in a straight line) to 987 in January, 1966. Then from a low of 808 in July, 1982 the Dow went to a high of 11,700 in January of 2000. So SPX going to 3300 would be a five bagger off the low compared to precedent for ten baggers.

To be clear I do not think equities are forever broken and if the SPX were to go up five fold over the next 20 years I would expect foreign markets to do much better than that which is why I have been planning to increase my foreign exposure slowly but steadily.
Read more!

Sunday Morning Coffee

Barron's had a some interesting stuff this weekend. First up was a profile of Roy Niederhoffer who has a brother named Victor you may have heard of. A big thing in the way I try to do my job and navigate market cycles is to keep things very simple. I like diversified stock and bond portfolios, tend to heed very simplistic indicators for taking defensive action and am quite content to get what I need for the portfolio with exchange traded products (stocks, bonds and funds).

Read the profile of Roy and it is clear that his approach is not simple in the least. His is a high frequency trading model, Barron's said holding periods can be a few hours or a few weeks. His offices have 160 computer screens. About halfway through the article there was mention of his at some point having added 60 new (trading) rules in addition to however many he had previously.

His results have obviously been good (otherwise there'd be no profile). My point is not to bag on him in anyway but to point out that success is possible with very simple methods like just buying index funds to complex programs involving dozens of factors requiring very beefy computers to execute. If success can be had with many types of approaches then we can conclude that approaches different from our own are not wrong but perhaps wrong for us. Ray's approach is not wrong but wrong for me just as mine is wrong for him and so on. This does not mean we cannot learn from people who trade markets in ways completely different from what we do.

Alan Abelson had some interesting thoughts from Louise Yamada that we've touched on before and that some other folks have discussed about the current market being like 1938 as opposed to 1932.

The idea being that the decline in 2008 was the second big decline in the decade. The chart I included has a big black arrow at the point back then that looks like the 2009 equivalent. I don't think this is useful for predicting percentages but in terms of certain types of behaviors repeating over time the notion of years of frustration as Louise puts it still to come is plausible and reasonable.

One thing to take from the chart is that from 1938 forward the market was more than halfway through the economic event of that day but there was still plenty of ups and downs (big volatility) yet to come. Some of those declines were straight down. For months I have been using the term stumble along the bottom to describe what I thought things would be like. I'm not sure if wide, volatile trading range that makes no progress for a couple years is aptly described as a stumble along the bottom but this sort of thing is what I had in mind but not lasting as many years as what happened back in the late 30s/early 40s.

For a while I wrote about expecting a bottom in Q2 2009 but things seem to be playing out on a longer time table. SPX 666 may turn out to be the bottom but if the SPX goes back down close to that number again does it matter whether another decline stops at 700 (not a new low) or 625 (would be a new low)? If we have another fast decline down to those types of numbers what matters is that it will scare the hell out of a lot of people and many will sell at precisely the wrong time.

Joellyn took this picture when we were at Kalawao where Father Damien built the church on Molokai. We're not rally cat people but I think it is a great photo.
Read more!

The Big Picture for the Week of May 14, 2009

Link to Mish's post.
Read more!

Friday Randoms

The first of the emerging market sector ETFs from Emerging Global Shares set sail yesterday with the energy fund ticker EEO and materials fund EMT (I like the that ticker symbol). The website is supposed to be up today (haven't checked yet) so we can look under the hood a little bit. IndexUniverse reported that the energy fund is 36% in Russia which I take to mean a lot of Gazprom and a little less Lukoil but we'll see. The company seems to believe that hedge funds will be big users of their funds but I would think there stands to be utility for any investor willing to build at the sector level.

Yesterday S&P downgraded the outlook for the UK to negative from stable. Then later Bill Gross piped up about about the US' AAA rating being in jeopardy at some point which should not be a shock to anyone. We also saw the ten year yield and gold whiz higher maybe spurred by Gross, maybe not (doesn't matter whether Gross caused it or not). The entire financial crisis and the measures taken to try to fix-it puts upward pressure on treasury rates and gold. Yesterday may serve as a microcosm of what is coming even if it does not go in a straight line.

I've never been a gold bug or the like but rates would seem destined to at least go up to a normal level and most commodities should nudge a little higher.

Matt Hougan has an interesting post about a reflation trade portfolio.

Vanguard Emerging Market (VWO) 20%
Vanguard All World Ex-US Small Cap (VSS) 10%
iShares Global Materials (MXI) 10%
iShares Brazil (EWZ) 5%
SPDR China (GXC) 5% Matt has the wrong symbol in the post
SPDR Gold Shares (GLD) 20%
SPDR Internations TIP (WIP) 20%
WisdomTree Emerging Currency (CEW) 10%

Lemme disclose MXI, GLD and WIP and get that out of the way. Well this baby will reflate alrighty but seriously it is a fairly narrow focus relying an awful lot on reflation being the outcome. To make the conversation simpler and more generic, if we all "know" that we are going to reflate and then we don't the portfolio might get hit badly, obviously the market very often confounds what everyone "knows" will happen.

One outcome counted on is a weaker dollar. There is no convincing me that a dollar bull case makes sense. I have been a dollar bear for a long time but that did not stop the dollar from having a massive risk aversion rally a few months ago. I am not predicting that now but if it happens, I say if it happens, Matt's portfolio will get whacked painfully. Matt clearly says this should not be 100%, 50% or even 25% of someone's portfolio but that sort of warning sometimes gets lost in the weeds.

David Rosenberg thinks the S&P 500 will take out its March low "because consumer spending hasn’t shown signs of a recovery," hat tip Barry. Fantastic.

Yesterday's picture was from Hellnar, Iceland which as of 2006 had a year round population of nine.
Read more!

Financials Still Stink

Yesterday there was a post in the FT about Moody's issuing warnings on 12 Korean banks, nine Malaysian banks, nine Philippine banks and ten Indonesian banks. Additionally the world has now awoken to the possibility that US regional banks might have trouble with commercial real estate.

I've been quite public with my plight in the financial sector. I was modestly underweight years ago because the sector flirted around 20% of the S&P 500 and then went a little more underweight when the yield curve inverted and then got flat out lucky selling my Irish bank, Barclays and Bank of America when I did and then bought one of the exchanges too early.

I'm actually not meaningfully underweight anymore because my Canadian bank and Chilean bank went down a lot less (I have been writing about these exposures for years so this will not be new to long time readers).

What brought me to Canada and Chile was what I thought were favorable top down environments and I was looking for banks that had far fewer moving parts than US and European banks. I held onto my Australian bank which did drop a lot and while it will likely need to raise some capital it is not in as bad a shape as most big US banks.

Now in trying to look forward and figure out what to do it is difficult for me to think there is much of a fundamental case to invest in US banks yet (I've never liked insurance companies). Some folks have been able to get fantastic trades but of course getting a fantastic is not really about fundamentals. It is a good bet that for people so inclined there will be other chances to get great trades off before this is finally over.

But for now the event is not over. Despite how popular this subject is on stock market TV it is unlikely for many reasons that financials collectively have made any meanigful progress toward health. For the foreseeable future I am happy to sit with my foreign banks and exchange stock and look for other parts of the sector (if any) that show signs of health. Unfortunately the foreign financial sector ETFs have a lot of Europe and or Japan. I think the EG Shares emerging market sector ETFs are very close to coming to the market but obviously I do not know what their financial ETF will own but perhaps that could be a way to go for people who do not want to pick stocks, stay tuned for that.

For a little fun, is the picture from Hawaii or Iceland? Both have a lot of the black stuff.
Read more!

More On Thematic Investing

Yesterday the FT linked over to an article by Leo Kolivakis, who has some good cred, about several aspects of investing including themes.

To Leo's themes;

• Inflation/ deflation
• Alternative energy (solar, wind, nuclear)
  
• Chindia (China & India)
• Demographics (healthcare, biotech, etc.)
• New technologies (nanotech, etc.)

The inflation/deflation theme is not so simple. Clearly the world is enduring (or should we put that in the past tense?) an asset deflation. From 2007 forward the price of just about everything has dropped, except for US treasuries, including commodities. So we have enjoyed lower prices at the gas pump and for home heating whatever you use. At the same time healthcare costs (I can vouch for insurance) have kept going up at what I hope turns out to be an unsustainable pace.

For inflation you know to buy TIPS and commodities. Deflation is trickier. Mish has made the case before for gold as a deflation play. A true and widespread deflation I would take as having a lower probability than inflation. If we really do have deflation then I would think that would be an utter sinkhole for stocks and depending on how it played out I expect to have very little US equity exposure and hopefully there would be some foreign equity markets that would be attractive.

Alternative energy seems to be a no brainer conceptually but I can see where the road to actually getting there will be very lumpy. The things the whitehouse is talking about notwithstanding the next time oil goes to $120 or some other scary number there will be an outcry for someone to do something and all of the alternative energy stocks will go up. Think about that sentence, what will happen to oil stocks of oil goes to $120? The stocks will go up. They will go up with the alternative energy names. The correlations tend to be high but the alternative energy names tend to be more volatile. It is easy to believe in alternative energy, more like root for it to become mainstream, but for now it has a high correlation to fossil fuel stocks but with more volatility.

Some readers may know I favor China over India. I get the feeling that China is more committed to improving the quality of life on the ground than India is and it seems like there are many more ways to invest in China than India. A reader left a comment about corruption in India being relatively bad and the investment restrictions in India strike me as being more onerous.

The demographics play is a big one and one I have mentioned before. To this end I own one of the medical device makers for clients (human replacement parts) and there there is an iShares ETF fro this space, not sure if there are any other device ETFs. I also think generic drugs work here as a proxy. We will collectively take more pills to stay healthier longer and the generics seem to be obvious here. While certain US sectors will become less attractive to invest in, I think healthcare will be an exception. I also think the manner in which retirement communities are evolving away from the nursing homes that most people dread will become an investable theme at some point.

New technology is tough because I think it requires individual stock exposure which many folks may not want to do. The reason I say that is that in many very narrow areas there is competition between a couple or several companies. Often one company wins at the expense of its competition (I thought this was a big problem for the Healthshares ETF that were shut down). I don't know much about nanotechnology but can every company in the PowerShares Nano ETF be a winner? Maybe a better question is can every company survive?

I might favor a couple of different themes than Leo. I think infrastructure is important along with certain commodities and certain countries. To my way of thinking these are easier to understand and so then easier to build into a portfolio.
Read more!

We were looking for 'What is Tungsten, or Wolfram'.

That quote is from an episode of Seinfeld called The Abstinence when George was getting all the Jeopardy questions correct.

I finally got around to checking out WolframAlpha which is an information source that I'm not sure the best way to describe. It is not just a financial resource but if you plug in ticker symbols you will get a lot of information, some of which is the same as other sites but also some unique info (more likely info not available on every finance site) like correlations, mean variance optimization and volatility information.

A reader asked about this over the weekend and in hindsight I misunderstood his question. I only spent a little bit of time on WolframAlpha but it strikes as the type of thing that once learned could offer a lot of utility. At a minimum, time spent plugging in different symbols will give you an idea of how stocks might relate to each other within the portfolio. This sort of subtle stuff is very important if you build your portfolio using stocks and narrow based products. It did seem to have trouble withETF tickers. It recognized the Energy Sector SPDR (XLE) when I entered it with two oil stock ticker symbols.

Maybe we can have a bit of an open thread. If you have used WolframAlpha some and have a few tips please leave comments. Perhaps we can all learn how to use the site together, so to speak.

Ron Lieber at the NY times has an article up about various website services that provide different levels of help to individuals with their portfolios. Presumably the focus of these services is ETFs and index mutual funds. These types of services make me nervous. Generically speaking I cannot envision relying solely on models that determine "ideal" allocations with automated rebalancing. Seeing the forest for the trees, which I think strict adherence to computer models can miss, is very important, IMO.

Did you watch How Bruce Lee Changed the World on the History Channel? I know that he was innovative, had magnetism and influenced many things and obviously I've seen Enter the Dragon a few times but I did not know how far reaching his influence was/is.

A few minutes in, maybe the eight minute mark they had this quote from him;

Adapt what is useful, reject what is useless, and add what is specifically your own.

I'd never heard that quote before but it has applications to many aspects of life including investing. I believe it is similar to a point I have tried to make over the years about taking little bits of process from different places to create your own investment process.

There was also talk about the importance of the journey versus the importance of the destination which I find to be very instructive. In yoga this might equate to being in the moment. Anyone can take from this what they want (which may be nothing) but I think it is good stuff. Investors who can begin to wrap their heads around mental impediments to investing have a better chance for long term success, at least I believe this to be true.
Read more!

"A Man Has Got To Know His Limitations"

The quote in the title of this post along with the picture are from the movie Magnum Force which is from Clint Eastwood's Dirty Harry series. Reading this post from Rortybomb about saving and consumption served as a good reminder that I am not one of the financial world's great thinkers. I don't know if Mike at Rortybomb is but I know I am not.

Every market participant has limitations, the sooner people discover their limitations (or some of them anyway) the easier it will be for them to navigate market cycles. A synonym for limitations that I have used before is blindspots. Limitations can be behavioral in nature or blindspots in understanding of certain things. One blindspot of mine was the homebuilder stocks. I never understood the supply and demand dynamics for new homes so I never have owned a homebuilder stock or ETF. An example behavioral blindspots could be the inability to realize (remember) that markets panic down occasionally, like 1997 or 1998, and then come right back and big selling into those is a bad idea (more of a general comment not pertaining to the current bear market).

The bigger tie in could be the idea that it is not bear markets that do people in but their own behavior. Was it Albert Einstein who defined insanity as repeating the same behavior and expecting a different outcome? Investors repeat certain behaviors and get done in by this. I'm not sure they expect different outcomes so much as fear prompts them to sell at the wrong time, greed prompts them to buy at the wrong time and they cannot help it.

I have a lot of conversations along these lines both with clients and acquaintances which leads me to believe that many people struggle with this stuff which is why I write about it a lot. It is consistent with top down theory. The most important part of the top down process is deciding when to be on the defensive in your portfolio or when to be all in. History shows time and again that the best time to be defensive is when the market feels good and the best time to go all in is after big panics when fear is paramount. We have had numerous reminders during this decade of this effect. How difficult is it to sell at the right time or buy at the right time? Not only do people confront their own foibles in this but they also confront "smart people" on TV playing into people fears and greed.

This is not easy stuff. That it is not easy is why my most important decisions are triggered with objective measurements and why I do all that I can to remove emotion from the process. For you, the end user managing your own portfolio I would add in addition to the above that you take bits of process from many sources and create your own process (long running theme).
Read more!

Sunday Morning Coffee

From Alan Abelson this week; ...such as President Obama's remarkable revelation that China might grow tired one of these years of lending us money (who knew?). And that, he posited, might pose a serious threat to our ability to continue to happily live beyond our means. Wow! Good stuff.

This article brings up some of the reasons I favor Norway as an investment destination.

According to this guest post in Barron's about demand for natural resources there are 306 million farmers in India. According to Google Public Data that exceeds the US population. Yikes.

Yesterday a reader asked what type of tools I use for stock selection with the context, as I took it, being along quantitative lines. Obviously there are plenty of quants who are wildly successful by every definition of the word but there must be an element of what's right for you in this discussion as well.

The reason I am not comfortable with quantitative analysis is that I perceive there to be a too much of a head down in the books and never looking up aspect to it. Generically speaking models cannot account for everything and occasionally when a quantitative model misses something the ensuing blow up becomes newsworthy.

While the tone of this may be unfair, it is my perception so my reality. I feel as though value can be added by relying on common sense.

A possible tie in to this week's video; I was saddened and shocked to hear (three months after the fact) that former pro-beach volleyball player Mike Whitmarsh committed suicide in February. Whit and his partner Mike Dodd were one of the dominant teams on tour, mostly in the 1990s and a little into this decade. He was living in San Diego, working in real estate in some capacity, had a beautiful wife and two kids. As a player he earned $1.6 million which may not have made him wealthy after netting everything out but handled intelligently it was enough to make things easier than for most folks.

I believe the tie in to the video is along the lines of the importance of figuring yourself out (which may not be easy and may be an ongoing process) before getting too caught up in how much your portfolio is up or down. Very sad news indeed.

The picture is from a simpler time for our fire department picking up hose after a drill (if you watched this weeks video that comment will make sense).

Full plate=short post
Read more!

The Big Picture for the Week of May 17, 2009

Read more!

The Latest From The Yahd, Hahvard Yahd

I found this article from Bloomberg with news of the latest filing dated March 31, 2009 but no link to the actual 13f. Shockingly I was able to find it here and you can compare it to the previous filing from December 31, 2008 here.

The Bloomberg article notes that HMC increased its exposure to China, Brazil and Mexico. Mexico is odd as it seems as though Mexico has become unpopular due to declines in production from the Cantarell Field. From the March low iShares Mexico (EWW) is up about the same as iShares Emerging (EEM) but EWW was a drag for the first quarter.

In the course of buying and selling the HMC apparently bought 1.47 million shares of News Corp (NWS). Generally speaking media stocks tend to be later cycle because advertisers are not the first ones in the pool coming out of a recession. Additionally with so many newspapers closing down there would seem to be very little reason to buy News Corp here. Of course it is easy to second guess someone else.

Not mentioned in the Bloomberg piece is that HMC added some exposure to one of my favorite destinations; Chile. It added 2106 shares of what the filing listed as MSCI Chile Index Fund which I presume is the iShares product that has ticker ECH. It also bought 4100 shares of Santander de Chile (SAN) which I own for clients and 1100 shares Sociedad Quimica y Minera (SQM).

I've been writing about Chile since early 2005. The story is simple, the country has a lot of copper and the world needs a lot of copper. Fiscally they run a tight ship. The social security equivalent is done via individual accounts and participation is mandatory for people who are on payrolls which creates a constant source of demand for equities.

If the theme of US based investors having to buy foreign equities comes true (I believe it will) then I think Chilean equities would be a big beneficiary.
Read more!

Sockitaway, Sockitaway, Sockitaway Now

If you are of a certain age you know the rock band Red Hot Chili Peppers and you might even know their hit from 1991 Sock It Away in which the extol the virtues of saving money for retirement. They have always been ahead of their time. To whit the second verse and remember this was 1991;

Greedy little people in a sea of distress
Keep your more to receive your less
Unimpressed by material excess
Love is free love
Me say hell yes

Well those words become even more prophetic as this week we have learned that social security will start burning money in 2017 and go bust in 2037. Medicare will be insolvent in 2017. These timetables have been moved up because of the current recession.

Oh boy.

Obvious, even if politically impossible, solutions include raising taxes, delaying benefits, reducing benefits and although tough to see now, if the economy begins to grow again it will buy the country a little time. For a little controversy maybe we could allow anyone into the country who is not a felon, get them on a payroll somewhere and then collect their payroll taxes to fund our retirements.

My thoughts about this have been the same since before I started the blog. I do not expect either program to be there when I am of age and so do not factor it into my planning. In this context I often write about working longer, spending less and otherwise being self-sufficient and resourceful in crafting your own solution.

If your interest in investing and personal finance is such that you seek out content from sites like this one you probably are reasonably positioned to figure something out for yourself. Unfortunately we know that many people live paycheck to paycheck, are the folks who have the average $8000 in credit card debt and only $36,000 in their 401ks. That combo might be OK for a 30 year old but not someone who is 50.

Something is going to have to give, I obviously don't know what will give, maybe everything, and the consequence of this will either be as bad as some people fear or it won't--again don't know.

I tend to make a priority out of personally avoiding potential consequences like this. For me, the solution is living below your means. If you can be so lucky as to need very little money to cover your nut then things like job loss doesn't have to be a disaster. I don't think I could function very well knowing I needed a huge income to cover the bills. If you make $10,000 or $20,000 a month that is a fine income but those incomes may not be readily available if you needed to replace it.

No doubt I am peculiar with this stuff but I just don't want the aggravation. One thing is certain, everyone needs to figure this stuff on their own at some point in their life. To paraphrase my wife's former boss/our friend Bill you can figure it out now or you can figure it out later but if you can figure it out now you'll be much happier.
Read more!

More Active ETFs A Comin'

IndexUniverse reported yesterday that Delta Global Advisors filed for three actively managed ETFs.

Grail Advisors just launched an actively managed ETF with ticker GVT that broadly targets large cap value. You can read more about it here.

The Delta Global funds are much narrower. The three are;

Claymore Delta Global Infrastructure

Claymore Delta Global Hard Assets

Claymore Delta Global Agribusiness

Generally I don't use broad based funds, where I am not using individual stocks I prefer narrow based funds which makes it easier to create the specific portfolio effect I am looking for. Something like GVT is unlikely to appeal to me but the type of funds listed above might. The problem with broad-based actively managed funds, regardless of whether you can see what they own today like you can with GVT, is that you have no idea what the fund will look like in the future. That makes integrating it into a diversified portfolio very difficult.

The Delta Global funds will always be proxies for some very narrow parts of the market. The agribusiness fund may or may not be a successful proxy for the ag stocks but it is always going to be invested in that space. Anyone who buys that fund can reasonably expect that they are adding materials and a lot of beta to the portfolio.

To the funds themselves or more correctly what the filing says. The infrastructure fund will include utilities, ports, airports, roads, railroads, water infrastructure, telecom build-outs, engineers and basic materials. IndexUniverse concludes that of the several infra ETFs that already exist the Detla Global fund will be most like the PowerShares Emerging Market Infrastructure Fund (PXR) but after looking under the hood of that one I would say that if the Delta fund does in fact regularly hold ports, roads and the like it would look more like the iShares Infra ETF (IGF) which I own for a few clients.

On the first run through the description of the hard assets fund I thought it was saying it would own a combo of stocks related to hard assets and the actual commodities via exchange traded products but after further review that appears not to be the case. This fund will focus on companies involved gold, silver, platinum, palladium, copper, nickel, zinc, oil, nat gas, coal and uranium. That list could expand but no word what they think about thorium, bauxite or tantalum.

The global ag fund will own companies involved with ag commodities, seeds and related chemicals. IndexUniverse says this is similar to Market Vectors RVE Hard Assets ETF (HAP) and I would say the Market Vectors Agribusiness Fund (MOO) would be more like it because HAP has large positions in Exxon Mobil (XOM), Chevron (CVX) and BP.

As the funds have only been filed for it is way too early to know whether they will be successful proxies or not. They may turn out to be so or maybe they can be paired with similar narrow based index funds for some sort of absolute trade--hey that could be an idea for the IndexIQ series of hedge fund ETFs if they ever list.

As a matter of disclosure I write a daily post called Roger's World for GreenFaucet (and am also a minority stakeholder) which one way or another is related to Delta Global. I'm don't know the corporate structure nor do I participate financially in any investment product Delta Global is involved with and perhaps I don't even need to disclose any of this, I don't know.
Read more!

Neuroeconomics

Paul Farrell is all fired up about something called neuroeconomics. I don't know much about neuroeconomics but it involves realizing you are irrational, training yourself to be rational by apparently looking at brain scans and a few other things and Farrell thinks it is balderdash (he did not use that exact word). While he's at it he also mentions not being fond of behavioral finance or investing psychology. This is kind of the opposite of what Taleb covers in his books as we discussed yesterday.

Maybe I was just having a bad afternoon but I had a tough time following the points Paul was making. When Jason Zweig whips out the pictures of the brain scans, I too am quite skeptical but I do believe that people are their own worst enemy and poor decisions cause more financial plans to fail than do bear markets. Poor decisions can include unrealistic expectations, buying high and selling low and spending too much money.

Perhaps you will have better luck deciphering Paul's article beyond his thinking it is bunk. This is one of those subjects where there is probably at least a little something there, how much is really there is probably open to debate and as is the case with most market science some folks will misuse it somehow.

I think there is utility here and it does not have to involve MRI tests. It is probably safe to say that every person has their blind spots when it comes to investing (and other aspects of their lives too). To the extent a person begins to understand what their specific vulnerabilities are and takes steps to try to mitigate them that would seem like a huge positive both for investment results and personal growth. It is not clear how this can be a bad thing. I imagine that if someone sells you a $1000 book in order to "help" you sort this out then maybe that would just be a scam.

As I said above I do believe that behaviors become huge impediments to success (however the end user defines his own success) and while no one will overcome all of their weaknesses I believe some can be overcome or otherwise addressed, depending on the person.

Obviously my way of addressing this is trying to minimize the times of being in the position where I, or my clients, have to face my behavioral quirks. In general people are more likely to do the wrong thing when their emotions escalate like when their portfolio drops a lot in value. Logically, preventing a large drop is the best way to avoid giving in to emotions. While no strategy will guarantee this obviously an objective defensive strategy can help avoid some of the drawdowns that occur every so often.

I guess I would describe it as not overcoming the behavioral threats but trying to reduce the number of times you are most exposed to those behavioral threats.
Read more!

More Media?

Eddie Elfenbein had an interesting take on the various media appearances by Nassim Nicholas Taleb. He titled the post Time To Go On The Record. Amusingly enough I had the exact opposite take in this post from February after Taleb and Nouriel Roubini appeared together on CNBC.

Eddie would like Taleb to name names in terms of specific and actionable advice in order to hold him accountable. Obviously I can't say Eddie is wrong but I don't necessarily think investment ideas is the best way to utilize every investment resource. If you read this and other blogs then you know who Taleb is and you probably have some sort of opinion about him--while not the most polarizing person I can think of it does seem like most folks do have an opinion.

If you have read either or both of his books why did you read them? If you see an interview with him why do you read it (assuming you would)? If you know he is going to be on a program why do you watch it (assuming you would)? What has been Taleb's contribution to this decade (assuming you think he has made one)?

I tend to have very little interest in stock picks made in print or on TV, by Taleb or most other people. If I think the person has a lot to add, either by virtue of having been very correct in the past or their making an outstanding first impression, then I want to hear about their process to reach their conclusions. For example if Jimmy Rogers and Marc Faber each think farmland is a good investment I would like to read about the process that takes them down the road to this opinion as opposed to just saying "buy Black Earth Farming (BLERF)."

BTW I do not own BLERF, am unlikely to own BLERF and am not recommending BLERF to anyone. Why mention BLERF at all then? When I first wrote about farmland stocks, maybe inspired by something I read from Rogers or Faber, I stumbled across the stock on my own. I read something about farmland stocks and began to look for what was out there. The theme is interesting and the stocks may or may not be interesting as well--that is up to you.

I do believe Taleb has made a contribution to the investing world in this decade. His contribution has been about how to think about allocating risk, where to take risk, where not to take risk, how to assess certain forms of sentiment, the various foibles that people are prone to. I view this more along the lines of building blocks/how to be a better thinker--even if you think what he says is hooey, that is what he writes about in his books. This has evolved into his commenting in the press on what is wrong with the global financial system. Again, even if you think he is full of hot air that is what he talks about.

The various pools of capital he has been associated with in the past have, to my understanding, focused on the occasional enormous moves that sometimes occur in capital markets via sitting on a lot of cash with a few out of the money options. I further believe the success of this has been middling as from 2003-2007 there were very few huge moves.

If he writes about how to think and bets on long shots using broad-based options then what is the value in having his opinion about a particular stock? I'm not sure he has built much of a foundation to convince people he is a stock picker.

Eddie notes that Taleb thinks this period of time is worse than the 1930s but is frustrated that Taleb doesn't say what to do with that opinion. At 929 the SPX is down 40% from its peak. If you believe that Taleb is correct and again he is saying this is worse than the 1930s then don't you believe that the market still has several hundred more SPX point to fall? If you believe this then what more do you want Taleb to tell you?

Hopefully this debate has utility and maybe even whips up a few comments?
Read more!

Sunday Morning Coffee

Barron's had an article about the current state of the the toll road stocks, specifically Macquarie Infrastructure Group (MIG in Australia and I think MCQRF on the US pinks), Transurban (TCL in Australia and TRAUF on the US pinks) and Cintra (CIN in Spain and CCIDF on the US pinks).

The chart below shows those three names traded on their home markets with another name in the group (in blue) that I'm going to refrain from mentioning for the time being.

The big problem with the three names in the article seems to be that when money was cheap and easily available they wildly overpaid for US toll roads--colossal multiples of EBIDTA that made the purchases tenuous when times were good and left no wiggle room for the type of slowdown in traffic you might see in the worst economic event since the great depression.

Basically the cash flow from tolls and anything else the toll road might own needs to pay for everything. If everything exceeds the revenue then there is a problem. If everything is not that big of a number then it will be easier for the operating company to ride out the downturn. Based on the Barron's article, Macquarie got hosed when it leased the toll road in Indiana (pictured above).

I still believe there is investment merit here if you can find companies that are relatively simple, and they do exist. If you do a diligent search you will find several of these types of companies that are not constantly levering up, moving things around and otherwise running complex businesses.

In the past I have explored all sorts of quirky investment themes including airports, farm land stocks, Norwegian fisheries and the toll roads. If you are one to invest in themes, and I am, then I would say part of the process has to be learning about more themes than you actually end up investing in. Or you may learn about something this year, maybe the fisheries, then keep an eye on them for a couple of years before buying one.

The toll road concept has merit but that does not mean that any of the companies were right before or are right now that depends on the person doing the research but the stock charted in blue is a toll road and it did the exact thing I had hoped for when I first started writing about this group. It certainly was not immune but did not implode as the others did.

It is ok to learn and study a theme for several years before doing anything. To the extent you believe in holding a stock for the long term (more correctly hope to hold it long term) then why not be patient with learning something new and taking your time before getting in?

In case it wasn't obvious the picture above is no Indiana. A while back a friend forward several pictures of this mountain road in Bolivia.
Read more!

The Big Picture for the Week of May 10, 2009

Read more!

Interpreting The Media Part I

An interesting comment thread broke out on yesterday's post about people going on CNBC and the like only to be very wrong about something "important" enough to overly influence people. One reader picked on Louise Yamada for calling for the SPX to drop down to 500 (taking the reader's word for this).

I am reminded of a bit Norm MacDonald did as Larry King on SNL;

Between taking Tylenol tablets and taking Tylenol gel caps, I'll take Tylenol gel caps anytime.

To make that relevant to this discussion;

Between being completely wrong on national television and being completely right on national television I'll take being completely right on national television anytime.

No one says anything on the air or in print with the hopes of being wrong. At a very basic level every market participant, ranging from total Homer to legendary guru, will get some portion of opinions right and some portion wrong. If you get the bigger decisions right or are right a little more often than you are wrong you will probably have a good long term result. Ending up with a good long term result will not preclude you or anyone else from being wrong about certain things maybe very loudly wrong.

I imagine that most people go on TV, get interviewed in print or write a lot of market related content are looking to help their business by becoming a "quotable source" as a friend of mine who is a marketing consultant would say. The first thing I ever got published was a short writeup in Barron's and after that I wrote some articles for the Motley Fool (the Fool was absolutely dreadful to work with). The motivation was not to develop a readership, I thought that was unrealistic, but to have a couple of published pieces where hopefully I was right about something that I could use to show prospective clients.

The way things evolved I realized I had a chance to help people, more people than I could ever manage money for, become a little more knowledgeable about the subject. Perhaps I am naive but I would assume most non-hucksters have both business and altruistic reasons for media appearances and writing. Maybe you disagree with altruism as a motivation but I think it would be difficult to disagree with the business aspect of this so to that extent no one tries to be wrong.

So if most pundits have a combination of good and bad calls, what the end user should do with any of this be it on TV or in print? If you can see your way to agree that the vast majority of pundits are not wrong 100% of the time then perhaps you are left trying to figure out whether the person you are listening to or reading is correct today or incorrect.

Instead of that though I submit it would be better to listen to what someone says and then decide whether you agree with them or not and why or not. For example with my blog posts early on in the bear market. Before it "officially" started I thought it would be a normal bear market down about 30% which would have meant a low somewhere near 1095. Upon reading my logic along with info from other people some readers left comments saying that there would be no bear market and why they thought so and other readers left comments saying it would be a lot worse than a normal bear and why. This was a productive dialogue that covered a lot of ground and I think someone could have taken all of the opinions to draw their own conclusion about what might happen.

Then later on I was pretty consistent in thinking that the market would not spend a lot of time below the November low and I said why. Again there were comments agreeing and disagreeing with vary degrees of emotion and logic for you to take it all in and decide for yourself what you thought. FWIW I count ten days from late Feb to early March that the S&P 500 spent below the November low.

To the point about participants being right and wrong along the way I'd say I was generally right about the bear coming, certainly wrong about the magnitude and right (for now) about how low it would actually go (or more correctly not go).

If you look at most people's work you will (repeated for emphasis) see some correct calls and some incorrect calls. Instead of blaming a pundit or praising him take his process, along with process from other people and create your own process and draw your own conclusions. Just remember that you drawing your own conclusions will have a combo of good and bad calls just like anyone else.

Part II will be this weekend's video post.
Read more!

Dow 30 Components In 1929

According to Bespoke Investment Group;

Allied Chemical
American Can
American Smelting
American Sugar
American Tobacco
Atlantic Refining
Bethlehem Steel
Chrysler
General Electric
General Motors
General Railway Signal
Goodrich
International Harvester
International Nickel
Mack Truck
Nash Motors
North American
Paramount Publix
Postum Inc
Radio Corp
Sears Roebuck
Standard Oil
Texas Company
Texas Gulf Sulphur
Union Carbide
US Steel
Victor Talking Machine
Westinghouse Electric
Woolworth
Wright Aeronautical
Read more!

No More Phreakin

Back when the selling was unrelenting a lot of people got very scared, there were very emotional comments left on this blog along with many other sites a I read. People felt (and maybe they still do) that stocks are a scam or don't work and that many stocks would be going to zero as this is "clearly" the second coming of the great depression or worse.

Throughout the ordeal, actually long before it started, I tried to brace myself, my firm's clients and blog readers for what could be coming. While I certainly got many details wrong the vast majority of truisms that I rely on and wrote about panned out one way or another. Things like denial of the turn to bear, certain types of stocks (like industrials and materials) going down a lot during bear markets, usually much more than the broad market. Also part of the process is big rallies that turn out to be head fakes until one of them turns out to be the real thing. Also part of this every time is rampant fear about this time being different and how the past episodes were obviously not that bad.

All of these things repeat every time, albeit with different details, and for some people there is simply no getting them to realize it.

Regardless of what comes next, take a look at a bunch of stocks you follow or have simply heard of and look at a good cross section. Here are some examples. Deere & Co (DE) fell from about $94 down to $25 at the March low and has rallied 88% up to $47. BHP Billiton dropped from about $95 down to $24 at its low and has more than doubled to $52. Royal Bank of Canada (RY) dropped from $59 down to $22 and has rallied 72% to $38. Transocean (RIG) dropped from $161 down to $42 at its low and has gone up 76% to $74. Even Starbucks has rallied 75% from its low.

I don't own any of those names they are just random examples. Just as hideous declines every so often are normal so are massive snapbacks up to a point. In trying to convey that this time was not different no matter how scary it might have been or might yet become I think a better way to phrase it might be to say that for the overwhelming majority of companies it will not be different. For Fannie, Freddie and AIG this time was different, in the last big one it was different for Worldcom and Exodus Communications et al but for most others it was not different.

As an example RIG probably going to be a big energy services provider for a very long time and RY is going to be a big Canadian bank for a very long time regardless of whether either one is a good stock pick or not. While it is reasonable to have your confidence shaken when a stock you own drops 75% most of the non-financial stocks that dropped that much in this bear market were simply never headed to zero and will at some point make a new high.

This should not be taken as an argument for buy and hold because I believe in trying to avoid declines like this at the portfolio level. The point, and it is easier to make now than it was two months ago is that the fear triggered by these events always exceeds the reality. In 2002 many tech companies with no revenue went bust and they were the vast majority failures. On this go around many financial companies that were too reckless (or whatever description you prefer) will fail and they will be the vast majority of failures.

Reading this now you might agree with me about fear exceeding reality but some of the people that do see my point now will forget on the next go around. Obviously some reading this will think I am 180 degrees wrong about this and for those folks they might want to take some of their 70-80% bounce names off the table right now.
Read more!

Counter Measures

My post yesterday on Greenfaucet;

What a great day yesterday was! It makes me very happy to see the market go up a lot and go into the green for the year. That type of sentiment is pervasive and IMO counter productive.

As I talked about at the start of the year and at a couple of other times, I added a 1% weight almost across the board in the ProShares Ultra Short S&P 500 (NYSE: SDS). I used SDS for quite a ways down on the market but should have held it longer. Now, after a 36% rally in two months I am adding a touch of defense with SDS.

I view the 1% as a chicken’s way in and would expect I may add another 1% if the S&P 500 goes 5% in either direction. I am not trying to hedge against a 5% move I am trying to hedge against a move that scares the hell out people which I think is quite likely. Bear market rallies tend to be huge and create a sense of security that is often incorrect.

In past posts (too numerous to link to) I had talked about putting some sort of SDS position back on if we rallied 30-40% off a bottom in a fast fashion and I had also toyed with the notion of buying some SDS at 900 or 1000 on the SPX. The reason I went in at 900 is because the rally has fallen in the middle of the 30-40% range.

If the trade is wrong then as small of a drag it would be at 1% it would become less of a drag as the market went up. The market going up would increase the value of the other holdings and the SDS position would hedge less of the portfolio as the portfolio went up and the price of SDS went down.

I would just add that if you've been reading my posts for a while you knew that this has been on my mind for months. That Seeking Alpha post I linked to yesterday that I wrote in late December had my thought process in it. A 30-40% rally was in my sights as a possibility and I laid out a rough framework of what to do months ago before it happened. Had the market not gone up in the manner I spelled out then there would not have been a trade yesterday.

At other points I had talked about putting some SDS back on at SPX 1000 but then the market moved a lot lower, then I talked about maybe 950 and again it moved a lot lower and then I believe I set my sights no lower than 900, we got there via a 36% rally in just under two months and I did the trade as spelled out above.

I'm glad I had thought it out early because it was not an easy decision, gut-wise to make but I feel as though pre-planning months in advance removed that emotion from the actual decision process. I felt emotion but did not let it determine the action taken.

Read more!

Feliz Cinco de Mayo!

Apologies for using such an overly sophisticated chart to make my point, ahem.

For ages now I have been writing about taking defensive action in hopes of smoothing out the ride for my clients ideally preventing them from succumbing to fear at the worst possible time. Then hopefully value would be added over the entire stock market cycle.

Although the bear market is now 19 months old the action YTD is a great microcosm of what I'm trying to do. At its low point on March 9 the S&P 500 was down 26% for the year. A diversified portfolio with a large cash position would have likely been down a lot less than 26% at that point. If a portfolio was heavy in cash on the way down and remained heavy in cash on the way up then the chart above might capture the net effect YTD; down less, then up less and coming out about the same. If you went down a lot less would you be ok going up less in this context? For someone interested in defense this might be a satisfactory result.

I talked about trying to capture this before the bear market started so I thought it would be useful to talk about it now that we are far along in the bear market process.

Another aspect of this is taking defensive action based on an objective measure, for me the 200 DMA. By using an objective trigger point it removes the need to be right or the consequence of being wrong about what you think will happen. For me, when the market goes below its 200 DMA I begin defensive action. When it goes back above I begin re-equitizing.

Opining correctly about what will happen in the market on a consistent basis is very difficult, obviously, and beyond your control. While being disciplined enough to heed your own indicator may be difficult at times it is completely within your control.

A good example to tie in with this discussion is a post I wrote for Seeking Alpha as part of their Positioning for 2009 series last December. The post was titled 2009: Expecting A Massive Rally. The post is both very wrong and somewhat right. Where it is wrong is that I did not expect the market to get as low as it ultimately did. Where it is right is that there was a massive rally off of a low and make no mistake 36% in two months is massive, even if it is not historic. I specifically wrote about bracing for a 30-40% rally which is what has happened thus far but it started from a lower point than I thought and a little later than I thought.

Despite the truly hateful comments left on that post it is a pretty safe thing to predict a huge rally after a massive decline but the tone of the post was more wrong than right. It is what I thought would happen but faith in the 200 DMA indicator dictated the action I took not my opinion. Obviously smaller more tactical decisions need to be made along the way but in subscribing to top down theory taking defensive action and then going back on offense are the most important decisions that get made.

I think this sort of things makes market participation much easier. In case it is not obvious, the picture above is a freehand drawing which captures no data.
Read more!

Monday Market Action?

Physi Cally Fit!
Read more!

The New Normal

On this week's Connie Mack Show one of the guests was Robert Kessler, the guy who always says to buy long term treasuries. He is not one of my favorites but he made an interesting point about one aspect of the new normal. He said that back in the old days people stayed in houses for 15 years but that recently that number has come down to seven years. While I can't vouch for his numbers the trend makes sense. He said that the trend will now turn back around and go back toward 15 years.

In a similar context he said that people will drive cars for much longer than they have been accustomed of late. He talked about car sales dropping from about 12 million down to 9 million and while he said many people are expecting a rebound he is not.

There will be economic implications to this and so by extension there will be stock market implications as well assuming you agree with Kessler to some degree. Quantifying the future importance of these to segments the economy is probably impossible but both have been huge in terms jobs supplied and dollars spent. If these segments become a smaller source of jobs and attract less new spending there will be a meaningful long term drag on the US economy.

From a personal finance point of view being less aspirational, or more correctly spending less aspirational items, is a logical reaction to the type of economic event we are now working through. Anyone who is overleveraged or thinks they might be will be motivated to figure some place to cut back. This ties in directly with the idea of certain other countries moving up to their perception of the American lifestyle while the US tries to hang on to what it's got.

I tend to be optimistic where the future of American social fabric is concerned but do not expect any sort of persistent stock market leadership to come from the US, further I believe the realities of our debt situation and other problems (repeat theme coming here) make the case for generally higher interest rates and slower long term growth which means US based investors would need more foreign exposure for their investment portfolios.
Read more!

Sunday Morning Coffee

One reader left two good questions that I thought I would try to tackle.

First up was a question about this article in the WSJ about widening the parameters for Monte Carlo simulations to include a greater probability for 50% declines than is typically used now.

Some folks like to use Monte Carlo simulations and some do not. I tend to come at this completely differently. A 50 year old could get a result from a simulation that then ends up "not working" for good or bad.

When you need to start drawing on the portfolio it will be worth X. It may or may not be what you need it to be regardless of what things looked like at any point in the past. If you don't have enough money when the time does come then something will have to give; mostly likely you get a job, draw less than you "need" or you run out of money.

Another point I have made in this context before and of which there is no convincing me otherwise is that there is more risk to financial plans from human behavior, mostly regarding spending habits, than poor results in the stock market. One extravagant purchase, and I realize the word extravagant can be subjective, right before a year like 2008 can wreak havoc on the likelihood for a plan working out. And often this extravagant purchase may not be on that person's radar ten years before they retire.

The amount you have when you retire will be your reality. If you keep it to a 4% withdrawal rate (more practically 1% per quarter) the odds are good you won't run out of money. Planning for a $2 million retirement but then only having $800,000 means, repeated for emphasis, something will have to give.

This is not to say you shouldn't have a plan and know how you are doing versus that plan but if you come up short then that is what matters.

The other question was about activist investing and whether I care about wrongdoing by corporate boards. The reader reasons that I as someone who believes in living below my means would be disturbed by "the excesses we have witnessed."

Disturbed is the wrong word. I have no emotional response to these things. If management creates a reason, IMO, to sell then I sell. This has not happened very often with stocks I own. The one that comes since I have been writing the blog is my sale of Bank of America immediately after news of the merger broke. As I wrote about at the time I did not agree with the merger from a big picture standpoint and I did not like the details of the merger so I just sold the stock. It was the only domestic financial stock I owned, figured I'd own it forever but did not think twice about selling it when I disagreed with a big decision.

I tend to not really understand when I hear or read an active manager talk about what they think the management of their long time holding needs to do to turn things around. How many people have you heard from one way or another in this capacity about Citigroup? It seems like they are willing to ride the thing all the way down to zero (I said on CNBC a few months ago I did not think it was going to zero, have not changed my mind, but that is not a reason to buy). Maybe it's just me but one good time to sell might be when the CEO gets fired in some sort of disgrace surrounded in controversy.

I view my job as a combo of growing assets and then protecting them. That does not including solving the world's problems. Perhaps that is an ugly answer but it is also my perception of reality.

How cool is the picture? Joellyn took it from our porch on Wednesday night.
Read more!

The Big Picture for the Week of May 3, 2009

Read more!

Can't Be Said Enough

Yesterday I had a chance to chat with someone who would know and unfortunately a lot of financial advisory practices are hurting as a result of the bear market. I did not ask too many questions and won't violate the confidentiality of the conversation but I will make a couple of general points about this.

A couple of times in the last few months I have been in social situations and they go nice to meet you, what do you do, ooh how's that going? I typically word my answer about as follows.

Occasionally the stock market goes down a lot. Then a few years goes by and it happens again. You'll be OK if you can remember that.

I love the simplicity of that sentiment. Invariably no one is shocked by that idea and anyone at least participating in a 401k knows this. In my opinion it is crucial to prepare mentally well ahead of time for large declines. If you are a devout indexer or buy and hold it is probably even more important because your equity portfolio will feel the full brunt of the decline or very close to it. If you employ some sort of timing device for defensive action you need to be disciplined enough to heed your timing device when the time comes.

No matter which of the two camps you fall into it will be much easier to do what you need to do (either gritting your teeth or taking action) if you are not emotionally caught off guard. Just because you might believe no one can see bear markets coming does not mean they don't come.

This site gets both individual and professional readership. For professionals I would say the key is communicating early and often with clients one way or another about what to expect when a bear market comes. If you are a passive indexer you will likely drop 50% if the market drops 50%. Clients need to understand that long before it happens. Presumably you explained what you do and why when they hired you. You obviously believe in the way you do things but clients need to understand all the particulars head of time.

This is one of the reasons why I maintain this blog and wrote so much about bear markets and my strategy back in 2004, 2005, 2006 and 2007. A bear market will come at some point, this is what we will do (or not do) and this is why, a bear market will come at some point, this is what we will do (or not do) and this is why, a bear market will come at some point, this is what we will do (or not do) and this is why--if your clients read that enough times from you then the odds of them being caught off guard will be much less. Not caught off guard equates to less panic which is better for clients and easier for you.

For individuals, in addition to the above about preparing, I would repeat that big declines in the market are not your biggest problem. The market dropped 50% a few years ago and made a new high within the same decade. The market has now cut in half again and will make a new high again. The time needed to make that new high is the variable. The biggest impediment for individuals (but of course this applies to many professionals too) is human behaviors. Even the smartest investor will buy high and sell low occasionally or otherwise have some sort of emotional response to a market event but repeated behavior of this sort will do you in.

There have been several times that I have referred to various studies from mutual fund companies that go along the lines of the S&P 500 having 9-10% average annual returns, actively managed mutual funds having 7-8% average annual return and the individuals holding those actively managed funds averaging something like 3-4%. Human behavior in action.

I find the behavioral/psychological aspect of markets fascinating.
Read more!