You Lost Me At Hello

Yesterday Yahoo Finance ran this article from BusinessWeek about a "rule" for assessing where your savings compares to where it should ideally be. Meaning if you are 50 years old you should have X. X is not a number but a multiple of your salary. The basis for the formula cited "starts with one of the basic tenets of retirement planning—that people need at least 70% of their pre-retirement income during post-working years." Insert scratched record audio file.

Rules like this are woefully incomplete. Complications arise in individual circumstances, vagaries of the market beyond anyone's control and any number of other things.

For what it is worth, the article says that a 45 year old should have 3.6 times his salary saved, a 55 year old should have 5.4 times and when you retire you should have 7.7 times your annual salary.



If you still work what are your biggest expenditures? If you are retired what are your biggest expenditures? What are the likeliest changes to expenses between working and retiring? Our biggest expenses are estimated tax payments and savings. If I ever stop working and start living off of savings then I would think tax payments would go down and savings would mean taking less out of the portfolio one quarter.

If your biggest expense is your mortgage do you plan to have that paid off when you are retired? Many people say yes but some say no. Do you have car payments and credit card debt? Do you plan to eliminate that debt when you retire? If you answer that question with a yes, then you must ask yourself whether you really are capable of eliminating that debt (ouch).

Most people probably assume healthcare expenses will go up in retirement and in general at a rate faster than inflation. That is a good assumption but I don't think there is a realistic way to figure out how much healthcare expenses will go up and it is difficult for several reasons to know what, if anything, you will need.

Another ouch is about disciplined spending habits. Anecdotally, living beyond ones means is a big problem and many people living beyond their means are either in denial about it or don't understand how the numbers work. I'm telling you this afflicts a lot of people.

This might be a good spot to bring up one of my favorites, the one-offs. Some people never have to deal with anything major while others may be very unlucky. Envision a scenario where a year starts out with an expensive trip of a lifetime (we all need to have fun) followed by needing a new roof, then a deadbeat adult child (sorry but they're out there) hits you up, then the car needs a new Johnson rod (Seinfeld reference) all coming in a year that the portfolio turns out to drop by 20%. That combo may not be a deathblow but it would surely cause some sleepless nights. Now how much planning can you do for that?

This is not a knock on financial plans at all. A good plan will give a couple of assumptions for portfolio growth and they allow for telling you when you are getting too far off track--very important stuff. But over-reliance such that the forest gets missed while looking at tree and betting your financial future on overly simplistic rules of thumb is a rotten idea.

No matter how much planning, saving and investing you do you will have what you will have and it will either be enough or it will not. If not then something has to give. Period. The roughness of this road can be mitigated by saving a lot, living below your means (this concept is totally ignored in the article) and doing something that produces enough of an income when your are older such that some of the burden is taken off of your portfolio.

In the past I've posted a few ideas about working or otherwise generating income as part of a post-career life and a couple of new ideas came to me yesterday. Bud Selig turned 75 yesterday and obviously still works the the commissioner of Major League Baseball. Being the commissioner of a professional sports league pays millions. Selig has had that job since he was 64 (in an official capacity). This would be one place to look for work and I'm sure most sports fans would enjoy being the commissioner of a professional sports league.

The other idea I had is inspired from the baseball card above of former Red Sox backup catcher Bob Montgomery. Bob is 65 and while not the Sox' regular announcer does do some other broadcasting work. Being an analyst or play by play announcer can be quite lucrative, admittedly these jobs pay less than being the commissioner but low six figures announcing games for part of the year could be a huge helper for relieving the burden off of your portfolio.

Ahem.
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More Stock Picking vs Fund Picking

GlobalTrends has a post adding to the ongoing debate about stock picking versus fund picking. Generally they come down on the side of using ETFs. My take has always been to use whatever you think is the best tool to capture whatever you want to capture. It doesn't make sense that one product/wrapper can be the single best way in to every asset class and market segment.

Obviously ETFs, maybe we should say exchange traded products, are covering more and more ground and covering it with useful products even if many of the funds never really catch on with the investing public. For a while I have expected that I will write a post one day called The Only Stock You'll Ever Need and be referring to the one part of the market still not covered by ETFs. I'm only half joking.

There are plenty of spots in the market not covered ETPs. I've been a big fan of Norway for years now. There is no ETF and I doubt there ever will be. There is the Fidelity Nordic Fund (FNORX) but that takes in at least four countries and being an open end fund you never know how much Norway you have today. While I could probably make an argument that these countries are preferable to the bigger countries in Europe, Swedish bank exposure to Latvia notwithstanding, Norway has specific attributes that I doubt the fund captures very often. Indeed the fund has lagged the OBX index at almost every turn in the last few years.

There are other potentially important, or maybe more correctly interesting, segments that ETFs may not be able to cover for a lack of stocks. A lot of the obscure market segments I have tried to explore fall under this description. I think owning a publicly traded exchange has some merit but the two ETFs that I am aware of with meaningful exposure also have a lot of investment bank (the former IBs anyway) and asset managers. These funds certainly offer differentiation from a mega cap sector fund that is top heavy with banks but if anyone wanted to go narrower they would have to buy a stock. There are ETFs with as few as 20 stocks but I do not know if there are even 20 exchange stocks.

In doing research on airports I have 14 added to a Yahoo watchlist. When I looked I found a few others that seemed to be listed but not trade (not sure what the story was) so while there may be 20 airports it would be a very difficult (read expensive) fund to run. Similar situation with toll roads. There are three in China (that I know of), several in Europe and then a bunch of strays here and there. What about Norwegian fisheries, they have skyrocketed this year. There's only four or five of them. They will skyrocket again at some point (not a near term prediction but a generic observation) and there will never be an ETF there obviously. Ditto farm stocks, one example being Black Earth Farms (BLERF).

Anyone who says investors don't need these sorts of things; I will generally concede the point. I'm not a believer in broad proclamations about what other people should or should not buy but I realize most folks are not inclined to spend the amount of time needed to choose one of these stocks.

These types of stocks allow a portfolio to look very little like the broad market which is at times exactly what is needed and why I devote any time to them. A lot of them got crushed in this bear market, so they were not an effective tool on this go around and I was lucky not own any airports or whatever. I believe the pounding that these segments took has a lot to do with the type of bear market we had. Many of the cash flow stories also have debt and need access to the debt market for capital intensive improvements and whatever else. The nature of this bear market impeded, either in reality or perception, that function thus many of the stocks were hit.

While I obviously have no way of knowing when this crisis will be solved it is a good bet that just as this bear market did not originate with excess in the tech sector the next one won't start with excessive and reckless lending into an overheated housing market.

I can't envision a scenario where I own all of these or even more than one but there is interesting potential with this. Working on the assumption that a combo of SPY, IWM and EFA will not cut it is becoming possible to build a portfolio with narrow based products capturing some very specific characteristics and precise weightings with 80-90% ETFs and then just a few stocks. For some people broad based only will always be the way and so this post is not for them. But to the extent that the investment world is evolving then the concept here could level the playing field some for people.
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A Little Process Down Under

Part of the process for navigating market cycles is looking a couple of steps down the road to try to figure out what you might own in the future. I've talked many times about my expectation of needing more foreign exposure. For now I don't typically exceed 3% in a single country but as I mentioned a couple of weeks ago some countries will probably increase to 5-6% of the portfolio. They way I tend to do things that probably means adding a second stock from some of these places or rebuilding the exposure entirely with new stocks or an ETF or stock ETF combo.

One case in point is Australia. For most clients the Australian exposure has been one of the banks. It was of course hit hard but there was never any realistic chance of a deathblow. While I still like the bank I will not put 6% of the portfolio into it and I do not think owning two banks from one foreign country is a great idea. If I turn out to be catastrophically wrong about the bank I own I imagine all the banks would feel that pain.

This leaves me needing to figure out another way in. One obvious place to look would be in the materials sector, it is a commodity based economy after all and there are a couple of mega caps to go with as well as dozens much smaller miners. My hesitancy here is that there are other countries with fewer investment choices but for which materials is a way in so I'd like to try to find something else if possible.

One possibility is infrastructure sorts of thing like Macquarie Airports (MAP in Oz and MQRSF on the pinks, apparently there is no ADR). Macquarie Airports owns airports in Sydney, Brussels, Copenhagen, two smaller ones in England, the passenger terminals at Haneda Airport in Japan (domestic traffic mostly) and several small airports in Mexico. Growth in revenue and earnings from each airport has been mid single digits for the last couple of years or so. Revenue comes from every aspect of the airport including things like restaurants and parking.

The company appears to have cut its debt considerably (I say appears because I found something about one part of Macquarie buying from another which muddies the water some). Really in looking around the website and the annual report there are an awful lot of moving parts. Complicated is not necessarily ideal and from what I know about various Macquarie funds swapping assets it creates a variable that cannot be managed.

The stock has been very volatile per the chart. I would hope that an airport would be a bit simpler as a cash flow story and a smaller debt load but no dice. It is these things that perhaps made the stock more volatile than the ASX 200 as opposed to less.



Transurban (TCL in Oz, TRAUF on the pinks and apparently no ADR) owns toll roads mostly in Sydney, one in Melbourne and 75% of one in Virginia. It used to pay a whopper of a dividend but has had to cut it dramatically for the last two payouts. The debt load is considerable and the average interest paid is 6.8% for an average maturity of ten years (maybe the debt, if accessible would be better). Earnings, revenue and cash flow are all headed in the right direction. It was much easier to move around the website and pick up information. The business is not simple per se but simpler than Macquarie Airports. This may be why the stock has been much smoother than MAP.

I threw in Auckland Airport on the chart but did not look at any info. Interesting to me is that it has been far less volatile than the two Aussie stocks and the Aussie index.

I'm not thrilled with either one (MAP or TCL). MAP is a no and TCL is doubtful. There are two ETFs, one very heavy in the banks and one heavy in the big miners. For now this is a work in progress with no resolution. There are quite a few agriculture related stocks in Australia but there we are drifting into materials. It may turn out that there will be no other Aussie stock. Working through all of this is what it is about. It is interesting to learn a little about these companies even if most of them don't make the cut.
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Emerging Market Catch All Part Deux

The fascination with emerging markets continues on the web and in the market. China is up over 80% YTD and there are other markets that have also had eye popping gains. I wrote about emerging markets last week but since then there have been a few more things that have come up that could be worthwhile to address.

First was the Barron's interview this week with Arjun Divecha who manages the GMO Emerging Markets III Fund (GMOEX). Barron's said the minimum initial purchase is $50 million. I thought the minimum was $10 million but either way with that type of minimum I wonder why they even use the OEF format.

Be that as it may he had one particular line of thought in the article that particularly resonated. He said;

The main thing in emerging markets is that getting the country right matters more than anything else. If you can pick sectors and stocks in the developed markets, that is what really matters. But in emerging markets, if you don't get the country right, it becomes much, much harder to add value.

If you've been reading this site for a while you know that broad based funds are not my favorite way into anything. Investing to at least the country level and/or the sector level may or may not lead an investor to the "right" part of the market but it can help people avoid the wrong part of the market which sometimes is easier. Additionally, country and sector selection can help with managing very narrow concepts like volatility and also make it easier to add countries with different attributes that the US which often results in better diversification over a broad fund.

I would place more emphasis on sector selection than Divecha appears to. Certain countries are proxies for certain things like Taiwan and tech or Peru and materials. People willing to select stocks can buy a tech stock from Taiwan, avoid the ETF which does have quite a bit of financial exposure, thus freeing up some of the portfolio for a country you like that may have fewer choices to buy in. The context for fewer choices is that almost every country has a big bank, big oil company and big phone company to invest in or it will be those companies dominate the country fund.

The other item from the web about emerging markets was this interview at Tech Ticker with William Gamble from a company called Emerging Market Strategies. Gamble was generally quite down on emerging markets but his reasoning was baffling to me. He talked mostly about legal risks, different rules for bankruptcy and about it being much more difficult to get information about companies. He also expressed concern that China might be in a bubble because of the manner in which lending has expanded.

As for the legal risks and so forth. These things are true but they are no truer today than they ever were. If you are unlucky enough to buy a stock that goes bankrupt, yes you are likely completely out of luck but this is not new. How much do you think the typical investor knows about US securities law?

Any company, I mean any company, can go to zero. Anyone not much for selling discipline can easily mitigate the consequence of owning a stock that goes to zero by not loading up on any one name no matter where it is from. What difference does it make if you own a large American financial company that goes to zero versus some small Malaysian stock that goes to zero? Putting 15% into a stock that goes to zero becomes the problem not what country it is from.

Anyone that really worries about this could obviously get it done with ETFs or other funds so they take no single stock risk. For China, which seemed to get picked on in the interview, there are several country funds and there are also a bunch of specialty funds with a lot China exposure. For example (and this is just an example) the PowerShares Global Coal Portfolio (PKOL) weights almost a quarter to China. The Claymore Solar ETF (TAN) has 30% in China. The EGShares Energy Fund (EEO) has 19% in China.

So using TAN for part of the industrial exposure and using PKOL and EEO (I saw no overlap between the two) for part of the energy exposure with each fund targeting 3-5% of the portfolio and you can pretty easily get to 3% in China. The point is not to copy that allocation because I do not own any of those funds but realize there are several different ways to build a country exposure with a modest weight so that if the lending-in-China issue does become a problem the portfolio won't be unduly crushed.

The Red Sox are retiring Jim Rice's number tonight which is a really big deal. He becomes only the 7th Sox player to have his number retired.
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How Much Is Enough?

The two posts this weekend drew out a couple of interesting subsequent threads one of which being how much is enough. Enough to entertain any sort of game over for taking on volatility typically associated with a "normal" allocation to equities.

My initial response, short as it was, is that this question is quite philosophical and while it is there are also many practical considerations to think about as well.

The first practical consideration is that many people (all people?) are down from their highwater marks and there is a just get me back to even mentality at work. If I can only get back to even then I'll....so the mind may be more open to game over than it otherwise would. Figuring out how influenced you have been by this line of thought could be huge and be the difference between lagging a bull market and missing it altogether. Most investors are unlikely to really beat themselves up if they go up 150% in an up 200% bull market (remember Hussman says the average bull market is 180%). Up 10% (compounded interest maybe) in an up 200% bull market would be a different story.

The other big practical consideration is not as psychological but is very difficult to predict which is one-off financial events. Maybe your bills (including various insurances) are $3000 a month. Maybe you need another $1000 for walking around for the month (the occasional dinner out, a round or two of golf for those so inclined, gas for the car and so on). Then what might you need for taxes? What about travel? Ok after that it gets far less predictable.


I've said before, look at your Quicken register for the last twelve months. How many vet visits, car repairs (oil change, brakes, tires, worse), Home Depot-type fixits or wedding invitations do you see and those are the small things. Then every so often there will be bigger things. This year summer my wife broke a tooth, what if something horrible happens to the roof or plumbing? And there are obviously more serious things than that and all of it is unpredictable. You may get lucky with these things or not there is obviously no way to know.

As for the philosophy, there were plenty of comments but I don't think they the came at it in the way I would. Most people might come at this wondering do they have enough money. People associate having a lot of money as being the way to mitigate money problems and of course the thinking is correct but it is not the only way to come at this. And in fact accumulating a lot of money is quite difficult to achieve.

The other part of the equation, other than how much do you have, is how much do you need to cover your lifestyle? I would submit it is much easier to choose a modest house, drive a car for ten years (Toyotas and Nissans), not buy $300 shoes, realize that clothing can be bought at Costco, don't use credit cards (other than for the cashback or rewards programs), don't buy every gadget, learn how to fix things yourself, take lunch to work and so on. Keeping the predictable expenses low would seem to be much easier to do because it usually just depends on self-discipline. The self-discipline required may not be easy but it does boil down to a person doing for themselves.

If you have a lot of money then you may not have to worry about having enough but if you have no mortgage and no car payments then you probably don't have a lot of money worries either.

Big congratulations to Jim Rice for being inducted into the hall of fame. In 1978 he became the first and only player to lead MLB in homeruns, RBIs and triples. Triples.

On another sports related note, it was a great Tour de France this year. Lance's third place is a monumental achievement in my opinion and it was thrilling to watch. Interesting comment from Phil and Paul at some point over the weekend that if Alberto Contador had stuck to the script that Astana could have gone 1-2-3 on the podium. Well, let's see what team Radio Shack can put together in 2010. It will be interesting to see how many of the guys from Astana want to go over to Radio Shack. That could say a lot about what was really going on with the Astana during the tour.
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Sunday Morning Coffee

I wanted to expand on the game-over allocation concept discussed in yesterday's video. As a quick summary, as a theoretical talking point I noted that in an average bull market stocks go up 180% so that means some bull markets go up more than that and some less. At some point there will be another bull market where the S&P 500 will triple and simplistically speaking someone invested in equities will have tripled their assets. Depending on the age that this occurs would an investor be wise to greatly reduce the volatility of their portfolio to avoid getting cut in half as happened to a lot of folks, at about the worst possible time, in this bear market?

Let me reiterate that this is simply a conceptual exploration and the building blocks here include being a diligent saver, having a proper asset allocation, not being likely to take defensive action in the manner I write about so frequently and of course that after a big bull market it would make any sense to entertain this with that portfolio size. If a portfolio quadruples to $200,000 after a bull market then no soup for you.

It might be interesting to think about a scenario where there has been a bull market in global equities and an investor in global equities has two and half times what he had five or six years ago. What next? In the context of totally reworking the asset allocation to do away with normal stock market volatility I would think about the following segments to own;

• Global Equities
  
• Commodities
  
• Absolute Return
  
• TIPS
  
• Foreign Sovereign Debt
  
• Domestic Fixed Income
  
• Cash (foreign or otherwise)
  

If you did not watch the video then you may be surprised that equities is included but doing away with normal stock market volatility does not have to mean no exposure to equities. In thinking about a small allocation to equities, like no more than 20%, several broad based ETFs covering domestic, developed and emerging would work unless even a small allocation turns out to be a lot of money, then building a "normal" equity portfolio utilizing some narrower products, even if no individual stocks are used, could be suitable.

As I mentioned the other day I like the idea in commodities of gold, broad based agriculture and then some single commodity (maybe an industrial metal or soft commodity) for this part of the portfolio. If someone were to go to 10% commodities I think this sort of mix would cover a lot of ground but some may want to add a second single commodity so maybe one industrial metal and one soft.

Absolute Return may be the most difficult piece of the puzzle because there are a lot of funds in this space but not all of them work. My ownership universe includes RYMFX, DLSAX and NARFX. I have plenty of faith in them to be sure but the allocations are all quite small in case something goes wrong at the fund or I just turn out to be wrong with them. If 15% makes sense here I think it could entail four or five funds in case one does something unexpected. I think the IndexIQ ETFs could work in this regard, as opposed to really being like hedge funds but we are years away from wondering whether a bull market is long in the tooth or not giving the entire space time to prove itself one way or another.

TIPS, either the real thing or funds, are easy to buy but the weighting depends on where the investor is; 60, healthy and wanting to work probably has different income needs than 68 and unable to work. Someone not needing the portfolio income can go heavier with TIPS and anyone needing the income would probably want more in regular bonds.

Foreign sovereigns are important, IMO, but very difficult to access. For now I believe minimum order size is $100,000, it is at Schwab anyway. There are plenty of funds in the space but it would be nice to be able to go a little narrow than the entire planet ex-US. I do believe this will become a little friendlier to retail investors in the next few years.

One thing that this exploration is not calling for is lazy portfolio. IMO any sort of portfolio needs to actively followed meaning staying in reasonable contact with the basics of any countries where you own equities or debt. Additionally I think owning any sort of mutual fund that is "supposed' to do something needs to be watched. This exploration is about how much volatility to take on after a very narrow outcome and then whether anything about such a narrow outcome can be applied more generally. As I believe in defensive action and very active following of holdings the idea doesn't hold much real world appeal but perhaps reiterates the importance of knowing that at times it makes sense to take on more vol and at other times less vol. No one can be right all the time but being cognizant of the concept is the start to adding a risk adjusted dynamic to your portfolio.
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The Big Picture for the Week of July 26, 2009

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Friday Randoms

A few things this morning. First you probably know that Pimco has filed for a few ETFs including a 20 year zero coupon ETF. This could be interesting. Zeroes don't pay interest. They are bought at massive discounts and accrete toward par at a prevailing interest rate at the time you buy. If interest rates rocket higher right after you buy the price of a longer dated zero will get crushed. I remember buying zeroes for a client when I was at Lehman Brothers with rates, if memory serves, at about 9% on their way below 8% (this was in 1990) and these people made 20% in what seemed like ten minutes. It was the first trade I ever did that worked out in that manner.

That of course was in the middle of a colossal bull market for bonds. The fate of interest rates from here is far less certain and a 20 year zero fund bought at the wrong time would get pasted. But the fund would be a great way to add volatility to a bond portfolio which can be appropriate for some people. The idea of buying 20 years for only four point something percent does not sound good to me but if rates get up into the sixes or so then going out that far becomes a lot more attractive.

However buying zero coupon bonds is very easy to do, same as regular treasuries so I'm not sure why a fund is necessary here. I may not have written about zeroes ever before as generally I don't to add yieldless volatility in for clients but maybe I'll view it differently if yields go back to 7%.

This article reminded me about the two carbon ETPs (one is an ETF and the other an ETN). If you link through you will see that they have done quite well of late in conjunction with the equity markets' rally. While the concept is quite intriguing if it continues to correlate with the stock market it may not pick up a lot of traction. The carbon stuff turns out to be a play on corporate activity, more correctly the market's perception of corporate activity. Maybe that will change later but that remains to be seen.

Next up is that apparently ETF Securities' first US fund is due to launch according to this article and this one. If the name ETF Securities rings a bell these are the folks that listed all those exchange traded commodities in London a few years back. They had filed for platinum and palladium funds and these were expected to the first to actually list but it turns out it will be the silver ETF and it should have symbol SIVR. Since we already have a silver ETF I'm not sure another one will make a big impression but platinum (in an ETF versus ETN) and palladium could be interesting and useful for some people.

I like the idea, in commodities, of gold, broad based agricultural and then a single commodity that has some basis for an out sized return. I would think that an industrial metal or a soft not well represented in the broad based agricultural product chosen could work in that context. I have the first two covered for clients but have not yet delved into that third category. For some ongoing context I would still only go to mid single digits with the total commodity exposure.

Finally the full piece about Harvard in Vanity Fair by Nina Munk is on the web. Maybe it has been out for a while, I don't know but I just found it yesterday.

The article is not so much about HMC by itself as it is the problems at the school now, some of the decisions made, the politics involved and HMC's role in all of it. One of the big problems was excess. The largess of the various construction projects coincided with incorrect assumptions about what the endowment would be able to do and how long it would be able to do it. How different is this from what happens to many individuals? Someone buys as much house as they can afford, have a couple of car payments, a few hundred in credit card payments and all is going well until some sort unforeseen bump in the road comes along and fouls it all up.
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Emerging Market Catch All

There are something like four posts in the last couple of days at IndexUniverse about emerging market ETF flows including this very thorough article that had all sorts of data (it was ten pages long).

There is all sorts of ground to cover with this article. The first point is that of moderation. A reader left a comment to this interview about an advisor currently allocated 50-60% in emerging markets on the way to 70% (per the article). I should have something up at theStreet.com later today with more detail on this but right or wrong 50-60% is not moderate.

Over the weekend the WealthTrack program ran a couple of old interviews with Peter Bernstein (recently passed away) and one of the points he made was that some risks are simply too big to take. Too big is obviously in the eye of the beholder but the next time emerging markets drop 25% in a month out of the blue, and there will be a next time and then a time after that, a portfolio that heavily exposed will get crushed.

Emerging markets is a crucially important asset class, it has made a huge difference in results in this decade and may be more important next decade but in the context of working with a financial plan, targeting 7-8% annualized growth and assuming you are saving properly how much extra volatility do you think you need to take on in order for your plan to work? Then what is the risk you do the wrong thing because your allocation pukes down lickity split one month? I think people want to own an amount such that they do not panic out of anything after a big drop.



If you like broad based funds you probably get most of what you need (even if not an ideal exposure) from something like iShares Emerging Market (EEM). If from there you want to add a little octane you already know you can add a small position in a specialty fund of some sort to capture some outperformance. There are plenty of funds like that to choose from.

The next point is a response to the following quote addressing a possible reason for increased flows into EM ETFs;

a genuine pattern illustrating a general shift in the market from active to passively managed money in emerging markets.

From the beginning of this site I have been writing about using passively managed products in actively managed accounts. If you look at all the commentary about ETFs (both print and TV) it is obvious that this is becoming more popular. Two paragraphs above this one I give an example of this. Here is a more specific example. Someone has EEM as their core exposure, they believe emerging is going to take off for some reason so they add something like GlobalX Colombia 20 ETF (GXG). If the market is in fact going up then adding volatility becomes a good idea (the work is in selecting the right vehicle). Since GXG's inception in February EEM is up 40% and GXG is up 60%. This is not surprising, the time was right for emerging markets generally and there have been no coups or recession inducing natural disasters so that the Colombia ETF would outperform is not surprising.

To be clear, I think you need a fundamental basis for buying anything and I have no plans to buy GXG. After such a move, someone who fancies themselves as being an active trader might want to take the GXG off and go back to the core exposure.

This flows into the final point. If people really are gobbling up emerging market ETFs then I view that as a flashing yellow light. As I just mentioned EEM is up 40% in five months and now we are seeing people buying a lot? Taking a cue from Hussman I might think risks of a pullback outweigh the chance of more big moves higher for a while.

I included the chart above because I thought it was interesting but don't have a lot to say about it.
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The Consequence of Caution

Last October I first wrote about the publicly traded Norwegian fisheries. I was immediately intrigued but needed to learn more about them.

After that first post they kept going down a little longer but you can see from the chart that YTD they have been en fuego.

Jumping headlong into something you don't know much about is not a good idea but occasionally you will find a group of stocks at a time that is right for the stocks but wrong for you and this is what can happen.

Longer term I think this group can be a way in to Norway in the context of it being a 6% country. I have owned Statoil for Norwegian equity exposure for years now and plan to hold it forever (unless they do something really stupid) but the fisheries could be another way in as could Yara or maybe something else.
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Siegel versus Bodie?

That would be Jeremy Siegel and Zvi Bodie. Both have contributed much to the investing stream of consciousness in their time but they have much different views on how to get there from here. That is the focus of a paper Geoff Considine wrote for Advisor Perspective.

Siegel wrote Stocks For The Long Run, is a proponent of owning equities and it is his research that is the foundation for the WisdomTree dividend weighted ETFs. Bodie is most known (I think) for a paper from 1995 where he advocates putting almost everything into TIPS and a little into equities similar to what Taleb advocates (a reader made that point the last time I mentioned Bodie's work).

The Considine article works through both sides of the argument. Quite candidly I have a tough time comprehending Geoff's commentary so I'm not going to delve too deeply into Geoff's conclusions. Some of the main points though are that a lot of this can be a function of circumstance. In looking at 50 different possible outcomes over long periods of times in which either all stocks would be best, all bonds or any number of combinations of the two could be the best there is no way to know ahead of time what will happen during your time of investing. This bit of luck could go a long way to determining your outcome. Ouch.

The risk of all stocks is that equities drop at the worst possible time leaving you unable to make it back thus leaving you with not enough money. The risk of all bonds is that inflation reduces the real value of your holdings thus leaving you with not enough money. TIPS give a better chance for keeping up with inflation (by definition) but you kind of run in place as opposed to growing assets.

Because of the strange decade we have had for US equities combined with a massive decline in interest rates over the last 28 years there will be studies showing that bonds having done better than stocks and will conclude that they will continue to outperform stocks going forward, we have seen some of this already.

There is obviously no way to know what the next ten or 20 years will bring. Perhaps bonds will outperform but it makes sense to zoom back some and look at the bigger picture. Ten years ago today the S&P 500 closed at 1360 so at 954 today it is down 29% in ten years not including dividends. Bond yields continued lower all through the decade. The idea of favoring bonds after a horrible, but not unprecedented, decade for stocks and a fantastic 30 year run for bonds has the horse has already left the barn feel to it. This would seem to have buy high (the bonds) sell low (the equities) written all over it.

My take on this has been the same for a long time. At times it makes sense to go heavy versus your target in equities and at other times you want to be underweight the target. Often if you should be underweight equities at a particular time you should be overweight fixed income BUT NOT ALWAYS. Each needs to be assessed independently and in conjunction with each other with an active decision made. Obviously passive/index investors would view it differently but if you know that every few years the stock market might drop by 30% (average bear market decline) do you want to try to avoid some of that? If you agree with me on that then you need figure something out that has a reasonable basis for working however imperfectly and if you think this is impossible then you shouldn't do anything to protect yourself.

Sorry if that comes off as harsh but most of the academic work I have seen comes closer to all or none than the way the real world works. Bodie can't be right all the time and neither can Siegel. This can't be a shock to anyone can it? If things are changing then it becomes a situation that requires an innovative solution so either figure something out for yourself or hire someone who think can.
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Collectibles

FT Alphaville linked to this article from Bloggingstocks about investing in collectibles, specifically the article was about investing in stock certificates a hobby called scripophily.

I tend not to be much of a collector, I have several collections of things where three or four items is the extent of what I have. I own a Boston Celtics certificate, a Yahoo certificate (I talked about this in a video post a few months ago when I bought it) and a certificate for the Jerome Mining Company (Jerome is a neat little town near where we live) that is pretty old.


This first picture is from the article. The Moosehead is pretty neat. Apparently Four Wheel made trucks for the military in WWI that could be converted to go along the railroad if need be.

The Buffalo $10 bill is my favorite currency. Years ago there was a catalogue of WallStreet stuff that had this for sale. Anyone remember what I'm talking about? I seem to remember it being for sale back then in the low five digits. Last January we went into the collectible currency store in Palm Beach and they had one for sale and the price had seven digits, yikes!

I actually have this baseball card. I think it is hysterical. Just a fun post to get us through the monotony of Bernanke day.
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Kuehne +Nagel

Yeah, I never heard of it either. It is a Swiss company whose CEO was interviewed on European Closing Bell yesterday. The company does things like logistics, freight management, supply chain solutions and the like. That description puts it in the industrial sector. According to the website it had very good top and bottom line growth in 2005 and 2006 (vague footnote alert however), it then slowed down quite a bit in 2007 and 2008. Yesterday it reported half year results and net earnings were down 16% versus the first half of 2008. The stock was up slightly on the news.

The company is not very big. Businessweek has the market cap at 9.5 billion but does not say if that is US dollars or Swiss francs. It trades at a little over half its revenue, 18 times earnings (extrapolating the first half result). It looks like it pays two dividends a year, the 2008 divs (they were lumpy) totaled CHF4.40 versus a price of about CHF64 giving it a yield of 6.8% based on the price when the second dividend paid in December. So far this year it has paid CHF2.30 in dividends.

The stock is a component in the iShares Switzerland ETF (EWL) but has a tiny weighting. Based on the chart it seems to correlate closely to the Swiss ETF although it has come back a little quicker than EWL and the SPX (that is as far as Yahoo finance goes back).



Today's post is a follow on from the last couple of days. If someone wants to own Switzerland they will have to choose between a fund of some sort or individual stocks. I would imagine that most funds will be heavy in Nestle, healthcare and financials as is the case with EWL. The big industrial stock from Switzerland that you have probably heard of is ABB (ABB) which has a 4.6% weight in the iShares fund.

One reason to seek out stocks for Switzerland is that because there are so many ADRs the country is pretty easy to access, more so than a lot of other places. A point I have made before is that most countries have a big bank, a phone company and oil company to invest in and chances are these types of companies will be heavy in country funds. Chances are that if all you do is buy country funds for foreign exposure then you will end up overweight sectors you don't really want to be overweight in.

iShares Switzerland is 21% financials. By using only country funds it becomes very easy to get above 20% in financials in the entire portfolio. Colombia could be an interesting investment destination and recently the GlobalX Colombia 20 ETF (GXG) listed making it very easy to buy the country. That is cool but the fund is 52% financials. I really doubt I ever want to exceed 20% in any sector. Really I probably don't want to exceed 15% very often.

So Kuehne+Nagel, by example, could be part of the solution. It is a way into a country that I might want 5-6% in at some point. I've had Novartis (NVS) for clients for ages targeted at a 3% weight in most instances. The bull case for Kuehne+Nagel probably goes something like: they help companies be more efficient so the demand for their services could go up and then going forward when the economy gets better it will catch a tail wind from the entire Swiss market and you get paid what looks like a pretty good dividend while you wait.

Hold the phone, I've spent about ten minutes on this thing and pulled that last sentence out my ... well use your imagination. I don't know the stock and I am not buying the stock but this is part of the process. I heard about something that on its surface is not clearly horrible, the numbers are not ghastly and it looks like the debt load is manageable. I tend to be in no hurry with these sorts of things. I'll put it on the watchlist (literally add it to a long list of names I follow) and see how it goes. As far as no hurry, I mentioned yesterday I sold New Zealand awhile back and while I know I will go back in I do not know when; well it is three years and counting since I sold NZT.

If you want to look at Kuehne+Nagel for yourself the ticker in Switzerland is KNIN, the US five letter designator is KHNGF and there might be an ADR with ticker KHNGY but it doesn't look like it has ever traded.

Take this as process not a recommendation. The industrial sector lends itself to so many themes that I doubt a Swiss logistics company will make its way in.
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Great Quote From Hussman

From this week's post;

If an investor consistently takes positions based on forecasts, and changes those positions only when the market proves those forecasts wrong, that investor's life will predictably be dominated by hope, uncertainty, disappointment, reaction and frustration. If an investor constantly takes positions by responding to opportunities and conditions as they develop, with equanimity to what will happen next, making a habit of purchasing favorable value or early strength, and a similar habit of selling overvalue and early weakness, that investor's life will most probably be dominated by a sense of peace and control. Though it is not obvious which investor will have better results, my own opinion on that should be fairly clear.

Good stuff.
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New Zealand

It has been a while since posting anything about New Zealand as an investment destination. I used to write a lot more about the country. The economy is much different than that of the US except for maybe the deficits. NZ is a much simpler economy with dairy and other farm products being a big part of what goes on. It has been several years now since I sold New Zealand Telecom (NZT) and as I said then I'm sure I will be back but I don't know when and I still don't know.

The chart below captures some of what I think of WRT to NZ in that the decline was shallower than in the US but it did start to rollover sooner than the US did. Not captured in the two year chart is that the US and NZ correlated very closely in the middle of the bull market but before that NZ outperformed significantly with the occasional run of negative correlation to the US. It is probably not accurate to think that NZ was a great place to hide out during the bear market.

Alan Bollard (RBNZ chief) said last week that New Zealand would be early to come out of the recession. This was almost simultaneous with Fitch lowering its outlook on the country to negative (the outlook not the rating). FWIW an analyst named Brian Redican from Macquarie said on Squawk Australia this morning that Fitch was late and that his firm tended to think Bollard was closer to right on New Zealand's relatively early recovery.


A good way to research what stocks are available is to go to the NZX website and just look around. There are plenty of stocks that have five letter US designators including a couple of ports, one airport, several farming related stocks and a couple of consumer names. While many of them can probably be accessed they may be difficult to find deep enough markets to get trades done. Many of the stocks have very low share prices so even a small position could be several thousand shares which could mean higher commission and your broker having difficulty finding shares. I have faith that this will become easier in the next couple of years but that remains to be seen.

The catalyst for this post was this article about Fonterra, the big NZ dairy co-op. Fonterra is not publicly traded but there is a small chance that it could have a public listing soon. It stands to reason that a publicly traded Fonterra could be a reasonable proxy for the country. A big road block, as I understand it, is that the farmers who belong to the co-op believe their dividend pool would be reduced with a public listing. In addition to selling milk in the region there is also a business where they offer consulting-like services for dairy management.

In the context of yesterday's post I think New Zealand would be in the 2-3% portfolio weight category. I also think that at some point down the road there could be a little room for owning the currency or a little short term debt (but not both).
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Sunday Morning Coffee

In this week's video I referenced a webinar from IndexUniverse that focused on emerging markets, specifically about allocating to emerging markets in a diversified portfolio. I think the whole thing was about 45 minutes which I felt was worth the time but they also have link to just the PowerPoint instead of Matt Hougan's presentation. I mentioned I wanted to get a little more in depth on emerging market allocation.

A long running theme on this site has been the need for increased portfolio exposure to foreign markets without making too large a bet on any one country and also owning different types of countries; if all you buy are surplus-commodity based countries you are not diversified. At some point that will bite you hard, it would have in 2008.

In the video I said something about 6-8 countries weighted no more than 6% each which gets you up to 36-48% of the portfolio. As a side note 6% would work out to two stocks at 3% each or three stocks at 2% each. I haven't done a lot with country funds but if you would allocate as much as 6% to any single country there would be certain country funds that I think would work for capturing the country that way.

In addition to 6-8 countries weighted above I think there would also need to be several other countries weighted smaller like maybe 2-3%.

Longer term I expect client portfolios might need to get up near 65-70% foreign. For most of this decade I have been in the 30s expecting to get closer to 50% early in the next decade and then maybe 65-70% after that.

A while back one reader asked about going all foreign. First there is a long way between here and 70% but there are several domestic stocks that we own that I think we can hold forever like Johnson & Johnson (JNJ), FPL Group (FPL) and Philip Morris International (PM). I would have included Bank of America (BAC) in that list a year ago but I didn't hesitate to sell it when it did something I thought would be ruinous. I have to think in owning a defense contractor one of the US companies will always be a good bet.

In thinking about countries I would go to 6% in (I am not weighted that heavily in any foreign country now) I would consider Norway, Canada, Australia, China, Switzerland, the UK, Sweden, Chile and Brazil. There might be a couple of others. In the 2-3% category Israel (could be a sixer though), New Zealand (in a few years maybe), Finland, Japan (from the bottom up there are some interesting companies but I don't own any), Taiwan, Singapore, Peru, a couple of Eastern European countries (at some point they will make sense), Morocco, Egypt, Vietnam and there are more.

That obviously is a ton of work but the workload is not the only obstacle. A big one is access. Morocco, well I know the big phone company trades in France which makes it a little easier but getting trades done in European stocks is not necessarily easy. Everyone has heard of Vestas Wind right? Its a biggie in Denmark but trading the ADR just depends on when you come in. Recently the volume has been low, a couple of months ago it was pretty good.

Also for many countries your choices, forget liquidity for a moment, are limited to very few stocks like a phone company, a bank and a few others. Well you can't buy 20 phone stocks and call it a day.

There are country funds but many of them may not be very effective proxies. The Peru ETF (EPU) is probably the best fund for being a narrowly focused proxy for a country. That is not a buy recommendation but the fund is 65% materials for a country that lives and breathes commodities. I also think the Taiwan ETF is a pretty good proxy for tech and again, not a recommendation. EGShares offers emerging market sector ETFs but they are all very heavy in BRIC countries. This will make a lot of sense for a couple of sectors, like maybe energy, but not all.

Another long term tie in is the need to follow many countries and choose them selectively. I've written quite a few posts about Latvia (probably never going to invest there) and Kazakhstan (maybe one day).

Matt Hougan's webinar focuses on thinking about emerging markets differently than we have in the past. I would expand that to all foreign market investing; the need to think about it differently than we have in the past. I might expect comments expressing this would be very difficult. Yes it will be. Others may opine it is unnecessary to do all this. Then those people should not do it.
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The Big Picture for the Week of July 19, 2009

The LOLFed link and the GoldSeek link.
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International Man of Economics, Baby

Yesterday's mid day lift was credited to Nouriel Roubini's having said the worst was behind us. Later he backed away some from those comments, you can read that here. Before I get into this I am hesitant to be overly reliant on explanations for why the market does anything. Taleb has written about this and I tend to agree with him. That sort of analysis is right except for when it is wrong, if you take my meaning.

In the above link from Roubini he talks about his having expected the recession to be 24 months which means it would end at the end of this year so nothing new there. Additionally he says there will be slow growth coming out with a high risk of a double dip in late 2010 and unemployment peaking at 11% in 2010.

So either the first impression of what Roubini said will turn out to be correct or his clarification will turn out to be the result. Maybe even a different scenario will be the real deal.

My original thesis was the stock market bottoming in the second quarter (later on in the second quarter) but along the way I would have expect one more scare the hell out of them decline after the one in early March. At this point it is too early to say I'm wrong.

Regardless of right or wrong on this part of the bear market process there are some big picture concepts here that can be applied to all big declines. Quite a few times I said the chance of a huge decline is a lot less after a huge decline. That drew quite a few heckles over at Seeking Alpha especially in late December 2008 and early January. Back then fear was much higher than it is now, there was real fear about the end of days WRT to the US financial system and even the American way of life. That fear seems to have receded a bit.

Every time the market has one of these little (or big) feel good moves I typically say the same thing, that this is either the real deal or it isn't. But back to the line about the chances of going down a lot are less after it goes down a lot. At SPX 940 yesterday the market is 39% and 22 months away from its high. Once the market falls 35, 40, 45% the need for a lot of defense becomes less. Do not mistake that as a call to go all in at those points.

To that point in the last few months I rotated into a couple of more cyclical names, increased net long exposure a little with tech but also put on a little SDS. A comment I've made numerous times is that for now I am content to be less volatile than the market (down less, up less) but do not want to completely miss a big rally. Lagging a big rally is a different thing than completely missing one.

One last point is that the odds of going down a lot being low after the market goes down a lot would seem to be an emotionless observation. It will not be right every time of course but putting on a lot of defense after a 40% decline is generally a bad idea. I've echoed these same ideas before the bear started, at various points along the way and will probably do so after this event is over; the point there being consistency.
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Forget Evolutionary, This Could Be Revolutionary

IndexUniverse has a post up about an ETF filing from a firm called FactorETF that could be huge. The basic idea is that the ETFs would capture performance dispersions between different asset classes or different segments of the stock market. The filing appears to be for 22 funds.

There is one fund listed that captures 200% (they are all levered) of the difference between US value over US growth and then one that captures the difference between US growth over value.There are similar pairings between large cap and small cap, US and developed foreign and US and emerging markets. There are three funds that capture the excess return (or lack thereof) of a US sector over the broad domestic market and two similar funds for groups of stock over the broad market. There are pairings for stock versus government bonds, plays on the yield curve, credit spreads and inflation versus bond yields.

These funds, if any of them actually list (sorry to be negative but look at page two of the ETFWatch on IndexUniverse), offer a tremendous step up in portfolio sophistication for certain types of hedging. For example for a period last year certain foreign stocks lagged domestic because of a panic rally in the dollar. The FactorETF 2x Non US Developed Factor Shares could help offset this. The yield curve products could be especially helpful now given the likelihood of higher rates coming down the road. The FactorETF 2x Financial Factor Shares could be a way to buy into the sector without buying the sector. Making a couple of assumptions, someone nimble enough to have bought financials in March could have bought a small position in 2x Financial Factor Shares which would have gotten progressively bigger in the portfolio as the sector began to rocket higher ahead of the market.

There are caveats galore here. First, this is just a filing who knows if any of these will ever list. If any of them do come to the market I would give them quite a few months to show how they actually trade. There is a lot of learning that needs to be done between this post and actually buying one of these in terms of strategic implications in addition to whether these funds would actually work. The biggest caveat is anyone who would consider using these, and they will not be right for everyone, would be advised to do so in moderation.

Assuming they work, I would still prefer SDS (clients have a small position in this now) for the bulk of my bear market hedge. The Factor equity funds would have more application in mitigating the consequences of getting things wrong like growth versus value for people that invest that way and so on. They could go up in a bear market as growth might drop 2% one day and value 3% so the growth fund would be up but you know SDS will go up on a down day.

Part of my first reaction is to compare these proposed funds to the ones from IndexIQ. They have two ETFs trading; a multi hedge fund strategy ETF (QAI) and an emerging market macro ETF (MCRO). You can look at the full list from IndexIQ here. I'm a tad underwhlemed by QAI and MCRO but maybe some of their proposed arbitrage funds could be useful.

Hopefully these funds list and we can have a more productive look at these.
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ETF Ratings, Feh

Tom Lydon a post up questioning the utility of ETF ratings as put forth by S&P (and to a lesser extent Morningstar). According to Tom's post S&P makes recommendations about overweighting or underweighting ETFs based on "a number of factors, including S&P’s research into the fund’s underlying holdings."

Over the years I have been very critical of Morningstar for analyzing ETFs from the bottom up using their value bias. The way Tom's post reads this is a new thing for S&P and there are comments from other advisors in this article about the same thing. I don't really agree with what the other advisors are saying either, well what I think they are saying anyway.

ETFs, the simple ones, are just exposure. Anyone looking to add industrial exposure to their portfolio has quite a few industrial sector funds to choose from along with some specialty funds that are heavy in industrial companies; for example the PowerShares Aerospace and Defense Portfolio (PPA) is very heavy in industrial stocks.

If you wanted to capture a theme or add more volatility you would probably look at one of the specialty ETFs to be part of the mix and if you were less certain about the near term prospects you might go with one of the mega cap sector funds like the Utility Sector SPDR (XLI). All of these funds offer exposure. If the market tanks does it matter that based on earnings estimates or reported earnings or whatever that the largest five stocks look attractive so the fund is attractive?

Conversely if the fundamentals look lousy and the market skyrockets what do you think the ETF will do? The financial sector SPDR is up 75% off the March low, anyone think that is a fundamental story? In a bear market these ratings will be correct for every fund the don't like and be wrong for every fund they do like. The opposite will be true in a bull market. This is not very useful. I will say that if a fund has 15-20% in one stock you should probably know a little about that stock.

Reading through the above it makes the case for top down portfolio construction but there are bottom up applications too, just not the way S&P and Morningstar do it. If someone wants exposure to the solar group for whatever reason their choices are to buy a stock (or a few stocks) or a fund of some sort. The way in would just depend on the person but the way this is framed it is about a person wanting solar. Regardless of the ratings from anyone, if oil goes up 50% the TAN ETF will skyrocket, that fund went from about $5 in March to $11.50 in mid June. Now oil has corrected some and TAN is trading down in the eights. Valuation of the underlying stocks are way down on the list of what matters here.

An ETF is just an exposure. The reasons for wanting that exposure are either correct or not and the timing is either correct or not. In selecting between funds things like foreign exposure, cap size (comes into play when considering a specialized fund), volatility, subsector all come into play in terms of picking the best fund for you. I've written about how I go about that many times if you are so inclined to search for it in the archives.
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Failure of Fail Safe

That is the title of an article from Tom Lauricella at the WSJ and picked up on by Abnormal Returns. In the last year or so there has been much lament over asset allocation appearing not to have worked. Whether it worked or not is more likely in the eye of the beholder because while I am not sure that failed is correct it certainly worked differently.

This is going to come off as very harsh, and while I may not be 100% correct I believe I could be on to something.

In my opinion total reliance on some sort of long standing formula is simply lazy (talking about people who get paid to manage assets). Every asset class has fundamental dynamics that change in some ways over time and over reliance on some sort of static allocation model ignores what should be intuitive; nothing stay exactly the same forever.

Most of the time asset allocation has worked and it will work most of the time in the future but not always. This ties in with the passive argument debate that pops up here occasionally. One question I always ask is whether the passive indexers do any sort of forward looking analysis. Invariably this line of thought draws out a comment or two about speculation and how difficult it is to look forward.

A big part of looking forward is to see when risks of more trouble than normal are prevalent. In a way this is the most important forward looking analysis one can do. It is certainly more important than picking between two alternative energy stocks during a bull market and betting on the one that ends up rising by 120% as opposed to the one that only goes up 80%.

I have very little sympathy for a lazy advisor who bet on the status quo and was let down. There can be no guarantee that any action taken in advance can be successful in avoiding pain but I do not know how you tell a client "I never saw this coming and it never occurred to me to try to do anything to protect your assets."

Obviously no one would word it that way to a client but that is the net result by many advisors for their clients. One theme on this blog has been the evolution of all things related to markets and investing. Obviously I didn't invent the idea, many other people have said essentially the same thing.

I obviously believe in the work of managing money and being proactive and make efforts in that direction as obvious from the blog posts but no one cares more about your money than you do and no one should have more respect for whatever it took to accumulate your money than you (IMO too many don't people respect their money which contributes to big bets, over-spending and other forms of recklessness) If you pay someone then you should like his answers to questions about this. Keep in mind no one can be correct every time but I think someone willing to make the effort to protect your assets and who can explain it easily to you is probably a keeper.
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Schwab in Barron's

Charles Schwab was featured in Barron's this weekend. It was not an really an interview but there were a lot of quotes from him on all sorts of things including portfolio construction and what sorts of expectations investors should have.

8-10% equity returns are not realistic, "we are building a vast reservoir of inflation" perhaps 10% in a few years, 20 years ago he thought 15% was good for foreign exposure now it is more like 40%, "it's better to invest in companies that are more commodity-based" and he doesn't think about bonds in terms of the age rule of thumb but then said that is a good rule of thumb--don't quite get that last one.

I have also been in much of the same camp in terms of portfolio construction and expectations.

Also addressed in the article was Schwab's entry into the ETF space. They have started the process and offering some funds seems inevitable but I have to say I do not know what to make of Schwab, or for that matter Pimco, issuing ETFs. On one hand I can't see how the world needs more broad based domestic equity or US treasury funds. The odds that an index of the largest 500 stocks will perform differently than an index of the 1000 largest stocks for any length of time. So why buy an ETF that offers the same exposure but has fewer assets and trades less?

On the other side of the argument; apparently there are 140 OEFs tracking the S&P 500 and the world seems no worse for wear. If ETFs are going to continue to be more mainstream then funds covering the same indexes will proliferate. It would be easy to see firms like Schwab creating portfolio services (kind of like Amerivest) where all the ETFs used are proprietary (not sure if there are rules about collecting expense ratios and asset management fees but they'll work that out).

If things do pan out this way, fine, but I think more important will be the specialized funds that iShares and PowerShares seem to be so committed to issuing lately. I obviously prefer small positions in many narrow based funds to build a portfolio. Other folks will go core with broad based funds and explore with the specialized. While I think either of those approaches would be better than any sort of Amerivest-like solution those will likely start to pop up all over in the next few years.

Well the sun is setting on our Oregon adventure. We saw a little of the state, ate some good food, bought some crap stuff and our friends' wedding went off without a hitch. Not too shabby.
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Sunday Morning Coffee

Barry Ritholtz has an interesting post up about a Jason Zweig article that hammers away at a big chunk of the foundation of Jeremy Siegel's Stocks for the Long Run. As Jason tells it the data from 1802-1870 because of selectivity over stated the yields of the time dramatically which throws off a lot of the numbers that Dr. Siegel's book is based on.

As a Barry says; oops. So, does this matter? And if it does matter how much does it matter? There would seem to be implications for asset allocation modeling. This comes at a time where after a horrible ten years for returns many people are questioning owning stocks at all. Perhaps this is a building block for what Dr. Hussman has in mind for the revulsion of equities.

If we take this at face value, the data was bad and the results are skewed it does not change that the fact the most of the time stocks go up and that after 30 years of owning a bond all you have is your principal (unless you never spent an interest payment). Also no different is that occasionally stocks go down a lot, they often provide some warning (I heed the S&P 500's breaching of its 200 DMA). When trouble seems likely, regardless of the reason, then you need to reduce exposure.

I also don't think that any flaws in the data changes the importance of foreign exposure. Growth rates and other indicators of health have not be "normal" in the US for a few years and seem unlikely to be normal anytime soon. Growth rates and other indicators from other countries have been healthier for a while and seem likely to be healthier for a while still.

In various pockets of the investment world (certain themes and countries) money is being spent now and will continue to be spent regardless of the validity of any book or any data and while buying those ideas for your portfolio will guarantee nothing there is a tailwind effect that you capture with this sort of thing.

In a more theoretical sense that a building block like stocks for the long run could be coming under fire is fascinating. A long running theme here has been the evolution of everything (asset allocation, investment products and big picture ideas) is happening and success in the future likely means remaining in touch with how the world is evolving and implementing this evolution into your portfolio. Fifteen years ago what was the typical allocation for foreign stocks (rhetorical question)? How crucial have foreign stocks been to returns in this decade for US based investors?

While I am not really a contrarian or innovative thinker I do have enough interest in these concepts to have explored them where possible and implement them into client portfolios. Looking forward this will still matter but not necessarily in the same way has over the course of this decade. I'm not smart enough to know what that will be but it will be and I will try to find it, blog about it and implement it.

Yesterday we went back into downtown Portland in the late morning to the Old Town Street Fair for some touristy milling and shuffling. Joellyn got a bracelet and I got a wallet made out of duct tape. You can see it here, the artist has a website. Apparently duct tape comes in all sorts of colors and there are even specialty tapes made with designs screened on. The one I got is mostly back and brown with a cowboy theme. It cost me $20 and takes her about ten minutes to make. The thought I had was about creating a little income stream as part of a post retirement financial plan doing some sort of craft you've always enjoyed. We went by the Voodoo Doughnut shop four times, BTW, and resisted the temptation. Moderation is good.

The picture is from where we stayed down in Newport on Thursday night. We were right on the water, the entire back wall was glass (window or sliding door) and that was our sunset.
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The Big Picture for the Week of July 12, 2009

We spent Friday driving up from Newport to Portland and then we hiked around the Pearl District for a while before going the rehearsal dinner (we are in Oregon for a friends wedding). The picture below is of yours truly at a place called Voodoo Doughnut. I know from my wife's love for the show Amazing Race, the one that ended in Portland, it is a famous place.

In the picture I am eating a doughnut that is flavored like an orange creamsicle and it is delicious. Doughnuts can cause all sorts of problems depending on how they are used. This is of course similar to many realms of the investment world.

Exotic countries like Peru, unusual commodity holdings like nickel or swing for the fence levered ETFs can be used such that the provide a little extra at the margin or cause a massive move in either direction.

Personally I don't think there is anything wrong with eating a doughnut every now and then--ie moderation. If you eat two for breakfast everyday and wash your lunch down with a soda or two then you probably not where you need to be health wise.

If you have 20% in various emerging market funds, 15% in various commodity products and 10% in a double long fund you probably are not where you need to be portfolio wise. The kick that those can give when markets are generally going up can be fantastic, the pain they could cause on the way down could be panic inducing.

It seems that no matter what happens people will always be risk junkies and it seems they are willing to take that risk at a bad time. Start with the idea that the average return for the broad market in a given year is close to 10%. If your return ranges from 8-12% and you save properly your probably going to be ok. So in that context, if you put 3% in the Peru ETF in a year that it doubles you are getting 300 out of the 1000 basis points you need for the year. If you also factor in getting 250 basis points in dividend yield for the year then you are more than halfway to what you need for the year and the rest of the portfolio doesn't have to work as hard, meaning you don't need as much volatility in the rest of the portfolio.

Practically speaking it is tough for a country fund to go up that much compared to a stock. One of the reasons I like to use more individual stocks than ETFs is that if you own 30 stocks and some ETFs to build a portfolio the chances are good that one stock will double or come close to doubling. It seems that during the bull market there were plenty of stocks that did this and that will likely be the case in the next bull cycle as well. This is not a brag about stock picking ability, I think if you look at the holdings in any mediocre mutual fund you will find a couple of stocks that have gone up 50-100%.

I would also add that very few stocks go to zero during bull markets. If you buy a stock and every other stock in the group goes up 20% the one you chose drops 25% you probably need to reassess the story. And if you did get one wrong, by having a moderate weight you don't blow up your portfolio.

Buying the iPath Tin ETN (JJT) a year ago at $51 only to have it cut in half on you in six months is not the worst thing you can do and may not even be that detrimental. Putting 10% in into JJT and it then cutting in half could have been a problem though. I mention JJT because I remember reading something very bullish and even more compelling about Tin about a year ago. I had all I needed in the way of commodity exposure, which is to say very little, but it was a good story.

The key to all these exciting investment themes and tasty doughnuts is moderation. An occasional doughnut for someone who is generally fit will not kill them. A small exposure to country that blows up will not kill a portfolio.
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More On The EQL ETF

Apparently the interweb is working here this morning. Reader JCarr just asked it if made more sense to own the underlying stocks instead of the EQL ETF to capture the strategy because of the expense.

I can't imagine that after paying commission on 500 stocks (do you really mean stocks?) it would be cheaper. Further if he meant buy the nine ETFs it depends on how many shares you buy plus you are looking at a new commission for every ETF when you rebalance.


One thing I did not get to in the GreenFaucet post or in the video is that I would rather make decisions on each sector, this would be obvious to anyone who has read this blog for a while. One investment advisor was quoted in IndexUniverse's coverage of this fund talking about the benefits of not being overweight certain sectors. Yes there clearly are benefits to not being overweight certain sectors but what if something horrible happens in utilities and/or materials you'd be hideously overweight those two. I would submit there would be much more benefit to taking these reigns yourself as opposed to always targeting the same 11% in each sector no matter what is happening.
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The New Equalweight ETF

We are in Newport, Or. The video, sorry for the poor audio BTW, was shot at Cannon Beach. We have very shaky internet service here so I am timebomb posting the video Thursday afternoon to publish Friday morning.

It is very short so if I have time and a connection I will add a little more later.
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The Reflation Trade Is Over!

I don't actually think so but all things emerging, commodities and inflation have been correcting pretty hard in the last little bit. Does this mean the theme is over? Should it be chucked altogether?

What is going on is either serious or it isn't. That may seem silly to say but whatever is going on in the last couple of weeks has no bearing on the long term supply and demand dynamic for this space or the long term economic impact either. Notice I am not saying commodities have to go up or that we are doomed to suffer hyperinflation. Whatever your perception here is, the market action has not changed the fundamentals.

If you think the entire commodity theme is hooey, there should be no reason to be convinced you are right and if you think gold is going to $2000 there is no reason to think you are wrong. To the extent that commodities and whatever will happen with inflation are long term idea they do not changed based on a couple of weeks of trading.

Example; last fall the financials got pasted then they banned short selling and they skyrocketed. Problem solved some folks thought but of course the worst was yet to come and the market action of taking them up in the last two weeks of September meant nothing (except maybe a short term trade for anyone nimble enough, to the bigger picture.



Commodities, emerging markets and and other reflation plays are generally volatile. The more you add the more volatile you make your portfolio. In the very short term, a search engine, server farm and a B2B China, Brazil and a nickel ETN will not not diverge much if reflation is fizzing out. I'm just trying to add a little humor in expressing it that way but if this goes on for two months then anyone with 30% of their portfolio in reflation securities will feel a lot more pain then everyone else

The first picture is from a coffee house in Astoria and the second is as we go over the Lewis and Clark Bridge. If you've ever seen the show Ax Men on the History Channel; we drove all through where the show is filmed, saw a lot of lumber yards and logging trucks.
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Goings On In Oregon

"And this ring is where this great old tree survived a forest fire Billy" with apologies to Gary Larsen.















A Bank of America branch in a double wide trailer? Really?











We are big coffee people and we got a helluva mocha in the town of Hood River.
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What To Make Of The Market (special Hood River edition)

We are in Hood River, OR. We got here yesterday did a lot of milling around the town, down toward the Columbia River where there was some sort of kiteboading event going on. When we got on the plane at about 10:30 yesterday the S&P 500 was down 1.35% and things got a little worse in the second half of the day. I heard a little of CNBC in the car on the way to the airport but I imagine the tone there was somewhat dour?

I think I covered a lot of this ground the other day and maybe now it is playing, or it isn't. There is tremendous psychic value in preparing mentally for a decline when odds of one are pretty good and after a 40% rally... The green shoots sentiment was bubbling up pretty good there for a while. I thought that excitement was overdone and if the market goes down to 700 on the SPX then I imagine that the fear (or whatever other feeling it might create) will be overdone as it was a few months ago, IMO.

Not to be a wise guy but the US financial system and ordinary way of life was perceived to be in serious jeopardy. We have all sorts of problems the magnitude of which are quite bad and if you think of policy in terms of either speeding up a fix or hindering a fix we might all lean toward hindering right now but there is no need to stick a fork in the US--even if the SPX does break the March low before this is over.

I will continue to say that the better way out for most portfolios will be with more foreign exposure. The US probably creates a drag for a lot of countries, yes, but it will not cause all countries to grind to a halt however.

At this point, down a ton from the peak and churning around for a while now, I think it makes sense to still have some defense on and also start to think about adding to themes you believe will be important over the course of several years. I've got a couple of things mostly figured for the next two or three purchases when the time comes before now have cash built up, a little less than I did earlier, and now a full starter position in SDS (recall I added some a couple of weeks ago).

There is one reader (I think just one) who keeps posting asking what I'm going to do now that we are below the 200 DMA again. He also asked before it went below, what I would do. A few things, first I will not front run anything I might do for clients in a blog post. Second, we are not handing out fish here, do your own work. Third I just added some SDS a couple of weeks ago. No one should copy anyone. This means you should not copy me. I don't have all the answers I have the framework for a strategy that I have been working with for a while now and while you can look at the quarter end videos to get a sense of how it has gone, do you really think you are helping yourself if you copy someone else in the middle of the event?


That is just not what this site is about. For the rest of you, thanks for indulging me that.

We are headed out to Mt Hood this morning before heading over to Astoria. Hood River reminds us a lot of Durango, CO. On a hillside, some water down below, somewhat touristy, some neat buildings. Candidly we had a tough time getting any pictures we really liked.
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