A bit of a catchall post.First up is a reiteration about why domestic banks are still best to be avoided. We heard earlier this week about another round of stress tests for 19 banks. On top of that is the issue of put backs which Barron's goes into in tremendous depth this weekend. Basically the banks could be on the hook for mortgages gone bad where things like poor lending standards can be shown to be the cause. The way I read the article the burden for this is not all that difficult--not to say this is a lay up but bankers are already conceding there will be some put backs.
This is exactly the sort of thing I had in mind several years ago when I first started talking about more shoes to drop for the banks. Was this the biggest financial crisis in 80 years? Well then there will be fallout for a long time and getting in front of it with your portfolio is very unnecessary.
The interview in Barron's this week was with Donald Coxe about all things commodities. Coxe prefers equities of commodity producers over the actual commodities believing that returns in the stocks is superior.
It makes sense to qualify Coxe's comments a little. I don't think the two (the stocks and the actual commodities) should be thought of as an either/or where each one delivers the same effect to a diversified portfolio. I would say that each offers different attributes. According to ETF Replay the Energy Sector SPDR (XLE) has correlation of 0.91 with SPY. Over the last two years the correlation has ranged from 0.83 to 0.95. The SPDR Gold Trust (GLD), which we own for clients, currently correlates at 0.44 having ranged from -0.33 to 0.67. While that is not exactly an apples to apples it does make the point. Commodity stocks are stocks and should be expected to correlate somewhat closely to a broad equity index even if there might be a fundamental case for them to outperform a broad equity index.
In an environment where stocks are dropping a lot I would expect commodity stocks to drop right in line with the market or maybe more depending on the event due to their cyclicality. This is not a knock on the stocks as I have been overweight the materials sector for longer than this blog has existed but to repeat they offer different attributes and there is room for both in a diversified portfolio.
Lastly is an article written by Matt Hougan from IndexUniverse that showed up on Barry Ritholtz' site. Matt set out to debunk recent commentaries warning that ETFs could collapse, are threats to market stability and are impeding the function of capital markets. Matt quickly dispatches the first two and notes that the third one is a little more complicated in terms of price discovery and market efficiency. Matt made a couple of points that I would frame a little differently.
Matt says that indexed assets represent a small fraction of the stock market's value making the idea that they, ETFs, are the tail wagging the dog simply incorrect. While I agree that the tail wagging the dog is not a real problem it is not nothing either. Matt didn't say the size of "fraction" but it is bigger than he thinks in that there are shares that exist that are held in accounts that will never come into play in the market. We have several stocks in the portfolio that have been there for years that are unlikely to ever leave (not impossible they get sold but improbable). The more useful number here would be ETF volume versus average volume. If you look at that you will see where occasionally where ETF volume is very important.
As a dramatic (and easy) example take a look the new Global X Norway ETF (NORW) on the first day that the fund started. NORW opened for business on November 11. The second largest holding in the fund at 14,900 shares is DNB Nor (DNBHF) which is a bank stock. The ordinary shares average 1600 shares per day but the day before the fund listed it traded 31,200 shares. I imagine that whoever Global X bought the shares from had to buy them from someone else creating a double print of sorts. I could be wrong about how the fund was created but if I am looking at this correctly it creates the chance of being briefly disruptive but not permanently disruptive.
Further on Matt notes that "ETFs reject single-stock analysis as the best approach to investing." This implies that no stock analysis needs to be done and I think this is less than ideal. There are a lot of funds that have meaningful concentration issues. Back to NORW which has an 18% weighting in client holding Statoil (STO). I think STO is a great stock but anyone buying NORW might want to take a moment to understand the production dynamics in the North Sea and what Statoil has been doing to mitigate this issue--the management doesn't really let grass grow which means the company changes and these changes need to be kept up with. Additionally the stock occasionally has periods of extreme volatility. It would be very easy to only look at a one year chart and not see some of the past volatility. To use an example I have used before; the iShares US Telecom ETF (IWZ) allocates 15% to AT&T and 11% to Verizon. Are you really going to buy that fund but do zero work to understand those two stocks? I know some people will not do any work but I think that is a big mistake.
Did you see any of that football game between Illinois and Northwestern at Wrigley Field? Very neat.
6 comments:
yup, very cool seeing football return to wrigley. The illini win made ILL bowl-eligible and very likely saved the head coaches job. I'd love to see this become an annual event (both ILL-nu at wrigley and ILL bowl-eligible).
Go ILLINI!!!
Good discussion points Roger.
I have a counter-point to make. Not meant to argue, just mean to expand the discussion.
In typical advisor portfolios, I have seen it quite common to just use a standard 4% position size for a typical stock.
So if a manager wanted to own something like AT&T, it would hardly be considered odd if they were to allocate 4% of the portfolio to it (not 4% of equities but 4% of the total).
Now if you instead bought IYZ -- the telcom services ETF that has 15.23% allocated to AT&T and lets say you put 10% of your portfolio in this industry ETF. Your actual expsoure to AT&T in this case is 1.52%.
Its more complicated than this because in the first portfolio, you might own AT&T as your only telecom stock and therefore you only have 4% allocated to telecom services whereas in the second situation you have 10% allocated to telecom services.
But either way, the necessity of your knowledge of AT&T specifically is reduced if you use the ETF -- though you could argue your knowledge of telecom services as a group must be higher to justify the position.
Just to complete the loop, you would have to alloate 26.3% of your portfolio to IYZ in order to get a 4% position in AT&T.
(.263 * .1523) = 4.0%
Thanks in advance for your opinion, always nice to interact with Chief Investment Officers.
anon I think we are saying very similar things. I have no problem with an ETF having a very heavy weighting in one stock--it simply means I need to understand that stock some. I use more individual stocks that ETFs so single stock risk is not an issue, my point is more about making sure people understand that putting X% into an ETF might give them single stock risk that they should take the time to understand.
4) Do I care about whether a stock is volatile or not? Yes. Stock price volatility is a sign of low creditworthiness, and usually I only buy higher quality stocks.
David Merkel (from a couple of days ago)
Roger, OT, this was posted by David Merkel a few days ago. He is like a you a finncial professional and I respect his opinion. Do you agree that volatility is a sign of poor quality in a stock? I have been studying volatility( observing a number of stocks by sector) and have not observed that correlation myself. Your thoughts, please.
Sam
obviously there are countless ways to succeed in the equity market. the idea that volatility must equal low quality is more absolute than I am willing to be. Is VALE, which is a client holding, low quality? It sure is volatile and been a big winner for us. Ditto Caterpillar.
further i would say that a diversified portfolio owns equities of all types which means low quality and or volatile names. you may not want to favor those types of stocks (or maybe you would?) but some exposure is key to my idea of proper diversification--obviously not David's.
Thanks for the input. I have learned from you that high volatility in a good stock allows me to allocate less money into more holdings. All else being equal, I favor high volatility in my selections.
Sam
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