Predicting The Next Black Swan

Of course the title is a joke as a true black swan is not reasonably predictable, at least not by more than a couple of people. Businessweek has an recent interview with Nassim Taleb whom I always enjoy reading.

Here is one quote I liked; "People think they need to make money with their savings rather with their own business." I've mentioned many times his idea of going ultra conservative in t-bills with 90% of the portfolio and being very aggressive with the other 10% many times. While this is not really practical for most people the concept embedded in the quote and in the 90/10 portfolio concept is practical which I take as focusing on reducing volatility of the overall portfolio so that there is less personal consequence when the market goes down a lot. As I've said in the past, finding out the hard way you had to much volatility is a bad place to be.

In this article he offered a slightly different angle on the 90/10 which was making money in your business as one source of income, the most important source, with the 90% of savings being another followed by the 10%. In saying "you should have the consciousness that there is something called inflation" he might be suggesting TIPS. If he is suggesting TIPS he has company with Zvi Bodie. The newer TIPS can only have the par values go up or stay the same so if we continue on a deflationary path holders of the newer TIPS won't have a problem (well, unless there is a default).

The last quote I'll throw in was "The problem is that citizens are being led to invest in securities they don't understand by people who themselves don't quite understand the risks involved. The stock market is probably the best thing in the world, but the true risks of the stock market are vastly greater than the representations." This is a different version of his comment previously that if people really understood the risks of the stock market they'd never put there money there.

The other side to this line of thinking is of course to save more money. This is easier said than done of course but there are consequences for every path; too much stock exposure and you risk blowing up, too little exposure and you risk not keeping up with the number your plan calls for.

Short post, we had a little fire (not pictured) yesterday that took longer than expected and backed up the entire routine.
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Elusive Low Correlations

Two items today from yesterday's FT Alphaville.

One was part of an ongoing dialogue about correlation having increased lately and the extent to which high frequency trading (HFT) and the popularity of ETFs might be contributing to the problem. Concerns over correlation sprang up in 2008 when "diversification didn't work" and this has been a front burner topic ever since. It will not be a front burner topic forever however.

Whether it is HFT, ETFs or something else that has caused correlation to go up it will at some point recede. I've referred to this in the past, before the financial crisis, as an ebbing and flowing of correlations. Many things in the investment world ebb and flow and correlation is just one thing that does this.

In this case the correlation issue is simply a problem to be solved. A first step that anyone can do is to simply not expect inter-asset class relationships to remain constant. 2008 was a great example of why correlations go up and while the odds are against that magnitude of melt down in so many disparate asset classes it is possible. This is an argument against set and forget, if anyone still does that anymore.

One thing I've harped on WRT correlations has been the relative ineffectiveness of broad based funds with the idea being that the attributes of components get blended away in a broad based fund or components might be too small to move the needle. As two cases in point of countries I talk about all the time, in the last four years Norway's OBX is up a little over 3% versus the iShares MSCI EAFE Index Fund which is down just over 20% and the Chile IPSA Index which is up 100% versus 37% for the iShares MSCI Emerging Markets Index Fund (EEM).

The attraction to both places many years ago was their fundamental differences from the US but these attributes simply don't have enough of an impact on the broader indexes. This is the same point I have been making for a long time. The work for this part of the process is quite minimal. From there anyone investing in these countries, or any other individual countries, then needs to simply pay attention to what is going on. The third leg of the top down stool is obviously figuring the best way in which does take a lot of work.

One solution to the correlation problem is thinking longer term about this which is something I've written about repeatedly. As mentioned the other day gold is up four or five fold in the last ten year versus a drop of 20-whatever-percent for the S&P 500 in that time. Gold also did well in 2008 going up 7% versus a 38% decline for the S&P 500. I'm not sure this was too shocking as gold is a fear-commodity far more than any other commodity. Commodities more tied to economic need did not do as well as gold, for the most part. As we all know, US treasury debt, cash and broad inverse index funds also did well in 2008.

What I think this is boiling down to is focusing on the longer term and understanding the current market situation to have a better chance of realizing what things might not work so that more suitable action can be taken.

The other item is much shorter, about George Soros' investment in the Bombay Stock Exchange. Part of the modernization of some emerging markets will be financially as trading and investment products modernize. A while back I talked about publicly traded exchanges being part of the financial infrastructure of a country but as of yet none of the infrastructure ETFs have any publicly traded exchanges in them.

The picture is at the NYSE from up in the Squawk Nest from the one time was on the network live from the floor last November. Not a great picture, but not horrible either.
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Damn, Three Two Times

On Monday the S&P 500 closed above it's 200 DMA so I was prepared to sell our current inverse ETF position which is the ProShares Ultra Short Dow 30 (DXD) on Tuesday near the close. Typically I wait for a second straight day, which would have been Tuesday, as a sort confirmation in the hopes of reducing the chance of getting whipsawed.

As a reminder the goal with defensive action is avoiding the full brunt of down a lot should it happen, not every breach will result in down a lot so there will be times where a position is entered and then sold without the market having dropped a lot.

My plan yesterday was to sell the DXD, if necessary which would have been of the SPX was above the 200 DMA, five minutes before the close. Any closer to 4:00 and I can't be certain of getting the trade complete which would be a huge headache.

For most of the last hour yesterday the SPX was a few tenths of a point above or a few tenths of a point below the 200 DMA which stockcharts.com had at 1113.93; it will be a little different today. Given how the market was trading, within a few tenths of a point either way, I decided about ten minutes to the close to not place any trade even if it ticked back over the 200 DMA. The thinking was if the market continues higher on Wednesday I can always sell it then as missing by one day would not be a crisis and if it goes lower then the chance for whipsaw has been reduced.

As a practical matter if an individual waits until one minute before the close to place a trade they may not get it in on time to be executed due to the vagaries of the internet and online brokerages. I am quite confident I could get a trade completed for a liquid vehicle like DXD if entered no later than 3:55 but I am not sure where that line in the sand is and don't want to find out first hand.

In the time I have been relying on the 200 DMA in this manner I cannot recall another instance where the market hopped around the 200 DMA on either side of it so closely as it did yesterday. As the SPX closed below the 200 DMA yesterday (1113.84 for the cash index versus 1113.93 for the 200 DMA) I will wait to sell DXD until there is another two day series of closes above the 200 DMA.
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More Lists

Yesterday was a day for blog lists. In addition to the investing essentials list I posted, Brett Arends post a list of investing cliches that he debunked and Tech Ticker re-ran a list of 23 stats that "prove" the middle class is "being systematically wiped out of existence in America." Brett's article was a little more useful so I'll give that one a little more attention.

Brett debunked ten truisms, as opposed to "myths" suggested in the title of the article. His number 2 was interesting to me; Stocks on average make you about 10% a year.

He picked 10% apart pretty well but I think there is a more useful point to be made with this one. No matter what the real average annual return over some reasonably longer period of time the returns year by year will be very lumpy. In 2008 the S&P 500 was down 38% and in 2009 it was up 25%. That sort of one year to the next difference is probably a very rare thing but given the debunked assumption of the average being 9-10% per year take a look back at the number of years where it was that number plus or minus a couple of percent. It is a very rare thing. The point here is that over a normal bull market cycle (1995-1999 inclusive may not have been normal) most of the return will come from just one year or maybe a little but longer. Check a Trader's Almanac to see for yourself.

Another interesting one was "If you want to earn higher returns, you have to take more risk." There are two things here. One is that in a way this is about confusing beta with alpha. In past posts I've commented that it is pretty easy to make a portfolio more volatile than the broad market. Done even just semi-intelligently should result in going up more in an up market and going down more in a down market. With just this information it is unlikely that true alpha is being generated however knowing when to make the portfolio more volatile than the market and knowing when to ratchet the vol down could be thought of alpha generators.

The other point in debunking this one is the concept of risk adjusted return. I've written a lot of posts on this as it is how I try to manage portfolios. In a typical stock market cycle there might be one year that the market is up a lot, one year it is down a lot and several others that are up or down just a little. In thinking about the entire cycle I've outlined a strategy of not missing the big up year even if you lag it, adding value with dividends in the up a little and down a little years and taking defensive action in the down a lot years by heeding any breach of the 200 DMA by the S&P 500.

One last one I'll mention is that "You can't time the market." Brett says that you don't have to ignore valuations. I believe valuation is a very difficult way to time the market or otherwise assess the market. If you take a look you will see long periods of time where stocks are "cheap" and other long stretches where stocks are "expensive." The predictive value is pretty weak and I would also note that a diversified portfolio would own some cheap stocks and some that are expensive. Certainly any broad based index fund is a mix of cheap and expensive stocks. Favoring cheap over expensive is certainly valid but if every name in a portfolio has a single digit PE it is difficult for me to believe that portfolio could be properly diversified.

As for the article about the middle class I will preface by saying the conclusion might be correct, that the middle class is being "wiped out of existence" but the stats cited are far from compelling or more correctly some of them simply don't support the argument and some other need more context in order to be relevant.

One example of having nothing to do with the point was "In the United States, the average federal worker now earns 60% MORE than the average worker in the private sector." This being true is clearly seven different kinds of FUBAR but has nothing to do with the middle class. As I understand it the vast majority of the salaries in question are between $100,000 and $200,000 which is right in the wheelhouse of middle class in the Washington DC area and other expensive places and upper middle class in less expensive places so if anything increases the middle class albeit in an unhealthy way.

A couple that need more context to add any value are "36 percent of Americans say that they don't contribute anything to retirement savings" and "a staggering 43 percent of Americans have less than $10,000 saved up for retirement." Both numbers are grim but we aren't told how they compare to other years like 1980 or 1990 or some other year deemed relevant.

There has always been some number of Americans not contributing to retirement savings and does 36% include people who are counting on a pension (if so they are taking a gamble but still). If in 1997 there were 35% not saving then today's 36% would seem to be irrelevant. Ditto the 43%. To reiterate, the numbers are bad and obviously it is no secret that a lot of people are looking at huge problems with their retirement plans but the connection has not been made and there are a bunch of other numbers cited that lack context and so don't make a logical connection.

One more non-nonsensical one was "average Wall Street bonuses for 2009 were up 17 percent when compared with 2008." I won't defend bonuses but they were not outlawed so it is not shocking that bonuses went up 17% in a year where most asset classes went up a lot (US equities up 25%) and I would add this has nothing to do with the middle class question because any bonus money not paid out as bonuses would have either been retained by the company, paid to share holders one way or another or repaid to the government (depending on the company) none of which impacts middle class middle class in a meaningful or even noticeable way.

Perhaps selfishly and with a hint of Ayn Rand influence I think the best thing here is for people to pull themselves up by their own bootstraps and get their own affairs in order which would require a willingness to learn by many people and then try to contribute the societal solution if possible (this could mean time volunteering not donating money).
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Ten Essentials

This weekend I stumbled across a hiking term that I'd never heard before; the Ten Essentials. The Ten Essentials are a suggested list of what everyone who goes hiking should have with them just in case.

The ten per Wikipedia;

* Map
* Compass
* Sunglasses & Sunscreen
* Extra Food & Water
* Extra Clothes
* Headlamp or Flashlight
* First Aid Kit
* Fire Starter
* Matches
* Knife

There are other things suggested in the body of the Wikipedia article including a cellphone and duct tape. While I've never heard of the list I have used most of the things on it during recreational hikes or wildfires I've worked on.

It might be worthwhile to make an essential ten for investing. I think of this as a mix of investment products and strategies to help endure the vagaries of market cyclicality. This post is not a personal finance essential ten which would probably not even be ten; save more, live below your means and don't use credit cards unless you are doing so for points or cash back and pay them off each month but feel free to comment with personal finance essentials.

Ten Essentials of Investing (or maybe it should be portfolio construction) in no particular order;

* Trader's Almanac which is more about learning some market history to help have an understanding how the market works. Many of the market's reactions are not that different from previous events even if the details causing the reactions are different.

* Trigger point for defensive action to protect assets. I use a simple breach of the 200 DMA for the SPX but there are several others and none can be the best for all occasions but they can all be effective for asset protection during a large decline with the proper expectation of not being able to hedge away every negative basis point.

* Internet resource for analyzing sector weightings, country weightings and the like for anyone using funds. I pay for Morningstar's premium service. As lousy as their content the application for portfolio analysis is very good. ETFreplay.com as a free resource is also becoming handier with more tools as time goes on. Avoiding unintended overweights is very important and these sorts of things help.

* Being open to the idea that investing evolves. This pertains to strategy and investment products. Buying and holding on no matter what worked very well from 1982 until 2000 but it has not worked since, at least not for broad domestic indexes or broad global indexes. There will be another period where buying and holding on no matter what will work again and that of course will be another evolutionary step. My answer to this has been to go narrow in terms of countries, sectors and themes with a little bit of stock picking.

* Time to devote to minding your own store or if not finding someone you trust to do it for you. I am a big believer that people can succeed with investing provided they spend the necessary time. The amount of time may vary from person to person and while no one will correct with every decision this is not an impossible task. Additionally some self-training about how to avoid emotional reactions to market behavior also makes sense.

* A good sense of moderation. This is a repeat theme but a little can go a long way. As a bit of a building block think about one stock in a portfolio of 40 stocks. In a year where the stock market were to go up that average 10% then you can generally bet that all the sectors are doing well and that most individual stocks went up by some amount. In that scenario for the market it would be very reasonable that at least one stock out of the 40 held would be up 100% (guessing which one that might be ahead of time would be a much more difficult bet). One stock at a 3% weight that doubled would add 300 basis points of return versus the 1000 basis points in the market. Then add 250 basis points for dividends and the portfolio only needs 450 basis points from the rest of the 39 holdings to keep up with the market. Obviously some holdings would lag but this is the line of thinking that leads me to a little going a long way.

* Inverse index funds. If you don't like them then don't use them but I have found the broad based funds to work very well in hedging large downside moves. The inverse sector have been less predictable than the broad funds and so I don't say the same about those. Again the key here is moderation. A small position will grow to hedge more of the portfolio as the market goes down more.

* Absolute return funds but again only in moderation. Right here the market is up 65% from the March 2009 low so it is very unlikely that return for many absolute return funds will look too hot. This is something that should never go down a lot so it stands to reason it will never go up a lot. Anyone interested in using these types of funds should not want them to be the best performing thing they own.

* Introspection. Knowing our own weaknesses and vulnerabilities goes a long way toward avoiding ever being in situations that could cause a panicked sale or purchase. This can pertain to analytical skills, tolerance for volatility, knowing what you don't know and many others. For example I know I am a sucker for a good story. I get captivated far more often than I take actually action otherwise everyone would own a Chinese toll road, Norwegian fishery, Ukrainian farm and Indonesian plantation that I would never be able to get everyone out of if I had to (this is a slight exaggeration might you get the point).

* What would you add to the list for number 10? What would you remove?

The picture is from a hike on Molokai.
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Sunday Morning Coffee

The Barron's interview and the Up and Down Wall Street column each covered some similar ground this weekend. The interview was with Lou Harvey from research firm Dalbar Associates and focused some behavioral issues and voiced some concerns about Modern Portfolio Theory. The end of the Abelson column had some interesting thoughts from Jeremy Grantham.

First the Grantham money quote in opining why "blue chip" stocks might be lagging he notes what he calls the "let's all look like Yale syndrome." This is a very funny quote and something we've talked about here frequently over the years. The title for the interview was What Did Investors Learn From the 2008 Stock Market Crash. I jokingly tweeted "probably not enough."

Personally I think any article I can find on the endowments is fascinating reading although new articles are harder to come by since the tide went out on a few of them--so to speak. The people running these funds are very smart, despite the tide going out, have very useful things to say about asset allocation but (repeat theme coming) trying to emulate them is a very bad idea especially using exchange traded vehicles to build large weightings to things trying offer "private equity" exposure. As discussed yesterday large exposures to commodities can be problematic in terms of exchange traded products "not working" the way they are supposed to and more volatility than originally bargained for.

The interview with Harvey seemed to be saying that MPT works except for when it doesn't. He specifically talks about the need for some sort of back up when it doesn't work. I know people love to believe the market is at all times efficient or rational but that is difficult to buy into given that the market is people and people are not collectively rational. If they were then behavioral finance wouldn't exist, there would be less of a death of equities sentiment and I think this list could be endless. However I do concede that some people believe in efficiency and rational behavior wholeheartedly so ultimately you can decide for yourself.

In the last couple of years we have all learned a lot more about the 1930s and 1970s than we used to know. Given what we all know now and what we have recently been going through the conclusion I draw is that occasionally for very long periods of time the equity market does not get the benefit of the doubt and effort should be made to neutralize the downside which can be done with moderate exposures to things like inverse funds, certain commodities, absolute return funds and maybe you have other ideas you can share. And to repeat all of these things can be done in moderation. If you think of yourself as an investor then you need to accept that the market goes down every now and then and you don't need to hedge away every last negative basis point.
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The Big Picture for the Week of July 25, 2010

Businessweek posted a lengthy article called Amber Waves of Pain which is about the extent to which investors are not getting what they expected from commodity based ETFs. Obviously the US Oil Fund (USO) and US Natural Gas (UNG) have gotten the most attention for "not working" but there are more funds that have been impaired by roll issues meaning that the funds have to replace expiring contracts with further contracts that are more expensive--this is known as contango.

The article has all sort of examples of the underlying going up X% while the tracking fund goes down X%. There are many stories like this which is the entire point of the article as a sort of buyer beware.

Slightly bigger picture there are a lot of issues here that have repeated over and over and will do so in the future. I have tried to make the following points before and will do so again.

The general appeal of commodities coming into the last few years was the low correlation to equities. Additionally there are some fundamentals regarding middle class ascendancy an infrastructure build out that stand to put upward price pressure on various food stuffs and natural resources. As investor awareness of this idea grew so too did demand for access to these commodities and as the demand increased so did the prices and this continued for a while as more and more ETPs providing access were built and listed. Demand causing investment product proliferation is an old story--think internet stocks.

The existence of the products creates access for people who would not otherwise have ever had commodities in their portfolio. How many articles have you read that talked about commodities as a new asset class? So it turns out that with this "new" asset class there are a few more moving parts that not everyone took the time to learn about. When USO came out I underestimated the impact of contango in an interview and it turned out to be an issue almost immediately out of the starting gate.

A lot of the article is devoted to John Hyland who is one of the honchos behind USO and UNG. I participated in a lengthy four-way conversation with him where I said almost nothing and neither did anyone else. He also is on TV every now and then talking about why the funds are doing exactly what they are supposed to do. He knows more than you or I do on this subject and has a way of talking where the points he is making are obvious and everyone should know better however, clearly with his funds they do not know better. The end users don't know better, some professionals don't know better, a lot of people do not know better or at least they didn't.

For anyone interested in buying a single commodity it is important to look at a futures chain, which can be done on the exchange websites, to see if a particular commodity is in contango or backwardation. This will impact futures based funds like USO but not the funds backed by precious metals like the various ones for gold and the few for silver, platinum or palladium.

My take all along has been the same which is to maintain exposure but to do so in moderation. The most we've ever had was mid single digits (we targeted a combined 5% at one point with gold and agricultural commodities, sold off some of the ag position at a high price and the rest after something of a drop). Our only exposure of late has been one of the gold ETFs. There have been many articles suggesting 10-20% in commodities which I have always disagreed with. Here there is a repeated behavior at work which is something new comes along and people get very excited, over commit and get blind sided by something they never saw coming. In the time since this site started we've similar things with emerging markets and Canadian trusts and there will be others. Getting blindsided in a 5% exposure is not a financial deathblow, 20% might be.

I do believe in the diversification benefits when looked at over a long period of time. Look at gold for the last ten years versus equities or look at GLD, which is a client holding, since it debuted versus equities. In ten years it is up four or five fold versus a decline for equities. Whatever the reason, when looked at over a long period of time it did deliver. Over the course of a few months anything goes but the context here is longer term.

To repeat from many past posts, moderation is key. Any segment can blow up and if a blow up in some narrow segment would cause you to have an emotional response then you have too much in that narrow segment. Finding out the hard way you have too much is not good but that is exactly what happened to people with these commodity funds.
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The Book Of Eli

Yesterday I watched the movie The Book of Eli (hat tip Paul). It is a post apocalyptic flick about a guy who really knows how to handle himself. Without giving the movie away, as you can imagine resources are quite scarce--I winced a little when I threw away the rice out of the rice cooker that we did not eat.

As I was watching the movie this article popped up on one of my news feeds about employment benefits being extended to last a total of 99 weeks.

I have opinions but do not necessarily know what the best thing to do here is. Many things that the government spends money on sound important, like helping people who are out of work due to no fault of their own (man do I hate that phrase) but to the extent we have to do everything (not my belief) it reiterates the lack of political will to ever fix anything. One byproduct of kicking the can down the road is that it makes today's problems worse in the future.

Does anyone think that solving our problems does not mean some serious bullet biting at some point? If we do have to collectively bite the bullet then can delaying that reckoning do anything but make the ultimate bullet bigger?

To read some of the commentaries from a couple of years ago there were quite a few people expecting a Book of Eli outcome from the financial crisis. I've never been in the total tearing of the social fabric camp but I do believe things will be more difficult for more people. The follow up question to that vague statement of course is how difficult and for how many?

In a lot of posts I've quickly referenced my belief that social security and medicare as we know it will not exist. Often there will be a mix of comments agreeing or disagreeing but no entitlements would have dire consequences for a lot of people and while many might say not no entitlements just reduced entitlements-- either way this is a tough decision affecting incomes for a lot of people where the average 401k balance is below $100,000 (the number varies depending on the study you look at).

The implications are that people will be forced to work longer as opposed to deciding to work longer which potentially dominoes to fewer jobs available to people coming out of college which seems like could occur in what continues to be a "jobless recovery." This, IMO, would create serious headwinds but not The Book of Eli.

The personal solution, which will be crucial, has to include getting fixed expenses down and saving more money. I say this a lot but I think it is important to repeat certain things. My thought before about social security letting people down was along the lines of well that will be rough for a lot of people but as I think about it more the proper magnitude needs to be stronger as it will really hurt a lot of people, I mean really hurt them.
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ETF Goings On

AdvisorShares is back with its second actively managed ETF. Recently it launched a long short fund which you can read about here and yesterday came the WCM/BNY Mellon Focused Growth ADR ETF (AADR). If it is not clear it will only invest in ADRs be they NYSE listed or pinksheet traded.

The fund is concentrated in 25 ADRs along with a little bit of cash. It looks as though the intention is to always have a small number of holdings. The largest holdings currently are Baidu (BIDU), Walmart de Mexico (WMMVY), Li and Fung (LFUGY), client holding Teva (TEVA) and Nestle (NSRGY). Each of those five have weightings in the 5% range so while it is concentrated the single stock risk is not huge.

Based on the current holdings, which can change at any time, the fund is not well diversified at the sector level. There appears to be no utilities, telecom or energy holdings but large weightings to growth areas like tech, healthcare and consumer stocks. This is not a negative per se as anyone buying this fund is buying the decisions of the managers.

The difficulty in owning a fund like this is that the current holdings might fit in with someone's portfolio today but as there is no way to know what the fund will own in the future there is no way to know how it would fit in to a portfolio in the future but this is true of all actively managed funds.

The one space where I think an actively managed ETF would be a boon to investors is in the financial sector. That may seem surprising given how down I am on the sector and how down I've been on it since before this site started but that is exactly the reason why an active ETF could make a lot of sense. If you look under the hood of just about any financial sector ETF and what do you see? If it is a domestic fund you see JP Morgan (JPM), Bank of America (BAC) and Citigroup. If it is a foreign sector fund you see HSBC (HBC), Banco Santander (STD)--the one from Spain-- and a French bank or two. Further down the list you'd probably see some UK banks.

People have made great trades on a lot of these names but in terms of investing I want no part of them. There is no convincing me there are not more shoes to drop (something I have been saying all along). An actively manage financial sector ETF could potentially bypass or at least underweight US and European banks.

Looking over longer periods of time there have been foreign banks that have had relatively little attention paid to them, that is they have not been in the news much, that have done quite well in what has been a down market.

We have owned the same Australian bank since before this site started and for the last five years it is up 22% versus the Financial Sector SPDR (XLF) which is down 53% in five years. We have had the same Canadian bank since before this site started and for five years it is up 37% and our Chilean bank we probably first added in late 2004 but were out of it for a short period of time and it is up 127% for five years. Additionally all three pay very large dividends. We also own a publicly traded exchange and an index provider.

The catalyst for looking for these banks way back when was, this will be a repeat for long time readers, that the financial sector's weight in the S&P 500 exceeded 20% which I take as a warning of trouble. This is not intended to be a brag after the fact as I've been writing essentially the same thing since the start of this site in 2004. I've also been been saying that this sort of analysis and then finding stocks that fit the bill is not terribly difficult.

Anyone willing to do some stock picking, there you go, but I realize many people are not comfortable with stock picking but are comfortable investing at the sector level which given the landscape of financial sector ETFs this would be a great spot for an active product. Unlike the AADR mentioned above you know that six months from now it would own financial stocks. It may or may not own the right ones but it would always be a proxy for the sector.

For what its worth I think the best areas in the sector continue to be banks from countries that no one talks about and certain publicly traded exchanges. Obviously there are other areas where the fundamentals are sound too.

One other little ETF item is that the Lithium ETF is planned for Friday and should have symbol LIT. Amusingly Quimica Minera (SQM) will be the largest holding but only 20% of the fund not the 100% I've been joking about. Half the fund will be lithium miners and the other half will be lithium users (think batteries) so the fund will be heavier in the US than I was expecting. I plan to do a write up for theStreet.com that should run next week.
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New Paragidm? No Investor Confidence? Is It Really That Bad?

I don't know. Ok everybody, thanks for coming by!

Just kidding. Yesterday I found a triple play of especially provocative woe is the investing world articles. Some of these articles are blatant marketing ploys while some, IMO the three yesterday, ask good questions and create a catalyst for exploration.

As opposed to woe is the investment world I view this as a problem (in the challenge sense of the word) to be solved and personally I enjoy pondering the possibilities, it contributes to the love of my job.

Pragmatic Capitalism had a post called Will The Cult Of Equities Die? which talked first about "our excesses" have contributed to where we, the US, are now. Reading between the lines there seemed to be blame a little more narrowly on society having tried to take short cuts, IE get rich quick. Also noted was that "we have spent more than we have and lived well beyond our means."

To the extent this is true it pertains not only to individuals but also to the federal and state governments. All of these things and related points create obstacles to "normal" equity market performance. The US market will either overcome these obstacles or it won't. The theme on this site for years has been to try to avoid the obstacles altogether.

Long time readers will know that living within ones means, below ones means actually, has been a major talking point of mine. Given that it can be very difficult to have your money grow into what you need it to be to cover retirement it makes a lot of sense to stop worrying about the neighbors, get the monthly overhead down and save more each month.

This article from Mohamed El-Erian aimed at investment advisors addresses more of the evolution of investing. He says "investing for the world of tomorrow means paying closer attention to the faster-growing and more fiscally stable emerging economies." I believe this is consistent with my thoughts on avoiding or at least underweighting the countries with most obvious problems (hey, I've never claimed originality).

El-Erian and his colleagues at PIMCO have been referring to this as the new normal. It may not be truly new as the US has faced this sort of thing, at least in terms of equity market behavior, before and obviously we are seeing something similar play out in Japan although some of the details are different and Japan is further along than the US is.

The common thread is countries on the decline or at the very least struggling mightily to run in place. Both countries have demographic issues and debt problems. Their problems quite simply are bigger than in many other countries. Have you ever made the decision to avoid a country because the fundamentals did not look good to you? If you can say no to Argentina then why not the US?

The final article was from Wall Street Cheat Sheet and highlighted a potential loss in confidence on the part of US investors in the US stock market. Things like the flash crash, the article reasonably contends, have contributed to disillusionment with investing and retirement.

So there is a fair bit of negativism there. This line of thinking of draws criticism but it is not my job to try to solve the world's problems. My job is to try to give clients the best chance possible of having enough money when they need it. This means giving money the chance to grow at certain times and trying to protect it at other times. Other people might describe it putting money where it will be treated the best.

iShares has 31 single country funds (also several regional funds and other specialized foreign funds), Market Vectors has seven single country funds, additionally EG Shares, GlobalX, IndexIQ and WisdomTree also have single country funds. There are also countless other niche funds that provide heavy foreign exposure. The above might be the problem but if it is then the access available is where the solution lies for many do-it-yourselfers.

If the problem is definable, even if not solvable, and we know where the work-around lies and that the only thing between us and the work-around is time spent then I would say this is reasonably encouraging. People just need to save properly and do the work.
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Tuesday Tidbits

A little while back I mentioned a large filing from GlobalX of resource oriented niche ETFs and it looks like the first one might be coming as soon as this week. The WSJ reported that the GlobalX Lithium ETF could list as soon as this week. Also in that filing were uranium and fishing ETFs among others.

In that post I joked about the lithium fund only holding Sociedad Quimica y Minera (SQM) so we could know as soon as this week what it actually will hold. The largest lithium deposits are in south and central America, specifically Bolivia, although a big one apparently exists in Afghanistan as well.

You may have heard that China now consumes more oil than the United States. This is something I have been writing about for years. I first heard this from Puru Saxena on CNBC Asia. Back then, maybe 2003 or 2004, the US was using 25 barrels of oil per capita compared to a little over one barrel for China and about 0.75 barrels in India.

It was obvious that those numbers, while unlikely to ever get close to the US number were going to move up and it wouldn't take much for increased demand to impact oil prices. This played out for a while on the way up to $147 WTI but obviously at some point that run stopped being about the fundamentals. Oil is something China needs and is going to use more of. While we do not currently have exposure to China or Chinese oil stocks this continues, IMO, to be one of the better way to access China. There are several NYSE ADRs and GlobalX has a China Energy Sector Fund for people who do not want to pick stocks but one thing to keep in mind is that that fund, symbol CHIE, also has a fair bit of solar stock exposure too.

iPath launched Barclays ETN+ Inverse S&P 500 VIX Short-Term Futures ETN (XXV)--that's an inverse VIX fund. The hat tip on this one, as usual goes to IndexUniverse. This will surely be a very popular product. Although not my type of trade one thing that I think this fund can do is allow people to not just play a decline in the VIX but on a deeper level, game changes in the roll yield of the VIX futures curve. The curve these days is apparently steep, in a state of contango, so people who believe it will stay steep can trade it one way and people who think the curve will flatten can trade it another.

That I used the words "play" and "game" in the preceding paragraph should underscore the extent to which this is not my trade. The VIX has far more moving parts (IE influencing factors) than gets discussed on stock market television. Take this as my knowing what I don't know, no one has to be an expert in everything.

The last item is this from the WSJ noting that Temasek, one of the Singaporean SWFs, will be issuing "sterling-denominated bonds: £700 million ($1.07 billion) of debt in a mix of 12-year and 30-year paper." Perhaps there is demand in the UK for Singaporean paper and also Temasek isn't selling this debt because they think the GBP will skyrocket higher against the SGD.

Generically speaking, I'll repeat, generically speaking too much issuance of debt in other currencies can cause serious problems. Taken to an extreme, an extreme we have seen play out a few times in the last few years, if the home currency were to go down a lot versus the currency where the debt is being issued it would create substantial problems for the borrowers. This was problematic people in Iceland and Hungary who took out mortgages in euros and Swiss francs and it has also been very bad for various countries in years past.

Of all the pictures we have ever taken at the Grand Canyon, this one might be my favorite.
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iShares Rolls Out A Suite of Foreign Sector ETFs

iShares very quietly rolled rolled out nine foreign sector ETFs on Friday although IndexUniverse did notice the rollout. iShares was early to market with sector funds that combine both foreign and domestic stock in one fund but these are foreign only. The reason that Friday's rollout only had nine funds is that the tenth one, the iShares MSCI ACWI ex US Financials Sector Index Fund (AXFN), was actually the first one and came out in January.

The new nine funds;

* iShares MSCI ACWI ex US Consumer Discretionary Sector Index Fund (AXDI)
* iShares MSCI ACWI ex US Consumer Staples Sector Index Fund (AXSL)
* iShares MSCI ACWI ex US Energy Sector Index Fund (AXEN)
* iShares MSCI ACWI ex US Health Care Sector Index Fund (AXHE)
* iShares MSCI ACWI ex US Industrials Sector Index Fund (AXID)
* iShares MSCI ACWI ex US Information Technology Sector Index Fund (AXIT)
* iShares MSCI ACWI ex US Materials Sector Index Fund (AXMT)
* iShares MSCI ACWI ex US Telecommunication Services Sector Index Fund (AXTE)
* iShares MSCI ACWI ex US Utilities Sector Index Fund (NYSEArca: AXUT)

In looking under the hood of all nine funds they are all quite heavy in big Western Europe and Japan. This is not a surprise given that the funds are cap weighted and it is those countries where the largest stocks are. SPDR has a similar line of ETFs that have not seemed to gain a lot of traction. It would be very unlikely that the new iShares funds will trade much differently than those SPDR funds and maybe not much differently than the global sector funds (foreign plus domestic) that iShares already had.

One of the first thoughts I had was that WisdomTree got out of the foreign sector fund business too soon. It came out with a full suite of foreign sector funds weighted by dividends. It then closed most of them leaving only energy (client holding), utilities and materials. Also listed in with the sector funds is a REIT fund. Generally speaking Japanese companies are not big dividend payers so most of the funds had relatively little exposure which IMO made them a better choice for many sectors. Unfortunately this little point was not enough to attract enough assets to make the funds viable for WisdomTree.

iShares also has a couple of emerging market sector ETFs including the iShares MSCI Emerging Markets Materials Sector Index Fund (EMMT). The materials sector is an easy place to add foreign exposure because many of the companies are quite large in their respective home markets and might have an NYSE listing or at least a pinksheet ADR which makes them easy to follow. For anyone who would rather use an ETF for materials exposure, iShares now provides three different funds with foreign exposure.

The oldest of the three is the iShares S&P Global Materials Index Fund (MXI) which I use for some client accounts. It combines US and foreign with names like BHP Billiton, Rio Tinto and Monsanto but there is very little emerging market exposure. The new AXMT is obviously all foreign, also heavy in BHP Billiton and Rio Tinto but has a larger, 20%, allocation to emerging markets. EMMT is obviously all emerging markets, it has 20% in Vale (VALE)--a lot of iShares funds double up on stocks like VALE, BHP and RTP because of multiple listings and preferred shares)--which is also well represented in the other two funds. EMMT has a few other very large companies that will be familiar to many investors. VALE is a long time client holding.

For some standard boilerplate, anyone interested in buying MXI would be well advised to learn a little about BHP as two of its listings (Australia and UK) add up to about 12% of the fund.

The choice available, and I would extend this to include funds like the GlobalX Copper Miners ETF (COPX), the Jefferies CRB Global Agriculture Equity Fund (CRBA) and the First Trust ISE Global Platinum Index Fund (PLTM), means that investors willing and able to spend the time can capture some very specific things in terms of segments within the sector and also manage the volatility of the portfolio. EMMT should be more volatile than MXI most of the time.

In the raging bull market of the 1990s these concepts were less important because everything went up a lot. Ten years past those good times and there are still a lot of people who do not yet understand the need for a more tactical approach. I believe this has been important for the last ten years and more importantly will continue to be important.

Our new shed is just about complete. Above is the inside still looking a little sparse. I have a place to sit, a phone, a couple of lights, a picture of Fenway Park and CNBC.

The second picture is obviously the outside. There are three windows plus the glass door so plenty of light can get in. The little white thing next to the front door is a dog door. We need to do something for steps and we'll call the gutter guy today. Not too shabby.
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The Big Picture for the Week of July 18, 2010

A popular topic of conversation nowadays is whether or not there will be a double dip recession. Supporting the "no" camp is the rarity of such a thing pointing out that it has only happened one time in modern history in the early 1980s (I read one thing that said despite what people say, that double dip was recorded as two separate recessions).

Supporting the "yes" camp is the employment situation and lately Edward Harrison has been very interested in the ECRI Weekly Leading Index which, if I am reading him correctly, are almost saying double dip.

Recessions are typically very bad for equity markets, averaging a 40% decline if memory serves. I've been asked a couple of times in different contexts whether I thought there would be a double dip but really I'm not sure this is the best question. Whether there is technically a double dip or not we have problems with indebtedness, jobs, the banks are still in trouble (I've never thought they were fundamentally sound since this all started) and all the other things you know about and of course this is the "worst financial crisis in 80 years."

Double dip or not these are formidable obstacles that US equities need to overcome and thinking it will take more than two years (my opinion) is quite reasonable. I would again point out that there are quite a few foreign markets that simply do not have these obstacles in front of them. I've been talking about Chile almost since the start of this site. Since the peak of the US market in October 2007 the S&P 500 is down 30% while the IPSA is up 25%. It went down plenty, dropping almost in lockstep with the S&P 500 for about a year to a 30% decline but has been mostly working higher since.

If this has been a time to focus on protecting assets, and I believe it has, then certainly one way to protect assets would be to invest in countries with relatively little fundamental connection to the US' obstacles. The other day I made a comment about avoidance as a valid protection strategy so here the point is avoiding a systemically vulnerable economy.

I'm glad to let other people devote time to assess the reality of double dip or any other economic event. There are times to let assets grow and a time to protect assets and this continues to be a time to favor protection.
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Does Morningstar Finally Understand ETFs? No They Don't

Morningstar has tried to be a content provider of consequence for ETFs yet somehow after years of trying they still appear to be clueless. The latest piece of work is this post that Seeking Alpha titled Sizing Up the Industrials ETF Landscape.

The article makes two main points, neither of which are very helpful. The first point can be dissected quickly which was that "for most investors, such niche funds are rarely an appropriate choice." Anyone using an S&P 500 Index fund has about 10% in industrials. Any broad based, actively managed mutual fund anyone might be using benchmarks against some index that probably has a similar industrial sector weighting so there is a good chance of that actively managed fund having something like 10% in industrial stocks.

So if instead, someone puts that 10% into and industrial sector fund it is far from inappropriate. Further, the ETFs focused on in the article were all the big cap sector funds which are heavy in names like General Electric (GE), Minnie Mining (MMM) and UPS. People could easily make mistakes with these but "rarely appropriate" strikes me as a CYA comment which if true why even write the article?

Even less helpful was the bigger point that "industrials-sector ETF offerings remain remarkably scarce relative to other sectors." This point is so ignorant that I wanted to quote it so as not to muddle the meaning. The author would like to see a machinery ETF and a railway ETF and he thinks that the iShares Transportation ETF (IYT) provides a good alternative.

Conversely, long time readers of this blog might be used to hearing me say that the industrial sector offers more choice than quite a few other sectors--far from "remarkably scarce." I've been saying for years that client holding PowerShares Water Portfolio (PHO) is a proxy for small cap industrial exposure; the current weight to that sector is 77%. Staying at the PowerShares site the PowerShares Aerospace & Defense Portfolio (PPA) is 78% industrial stocks. There are several other funds from PowerShares with 40-50% in industrial stocks.

Then there is the iShares Dow Jones U.S. Aerospace & Defense Index Fund (ITA) which is 99% industrials. The iShares S&P Global Infrastructure Index Fund (IGF) which some clients own is about 40% industrials. The Market Vectors Global Alternative Energy ETF (GEX) has 70% in Alternative Energy Sources and 19% in Environmental Efficiency which if you look includes heavy exposure to turbine makers like Vestas Wind (VWDRY), meter makers like Itron (ITRI) and water treatment like Kurita Water Industries (KTWIY). One client gave us a mandate to buy GEX--not sure if that requires disclosure.

Moving on to First Trust the First Trust ISE Global Engineering and Construction Index Fund (FLM) is 93% industrials, the First Trust ISE Global Wind Energy Index Fund (FAN) is 44% industrials but is heavier in utilities, the First Trust ISE Water Index Fund is 51% industrials, the First Trust NASDAQ® Clean Edge® Smart Grid Infrastructure Index Fund (GRID) is 78% industrials.

The Global X China Industrial Fund (CHII) is, um, all industrials. Claymore has a solar ETF (KWT) with 84% industrials, airlines (FAA) 100% and water (CGW) 43%.

There are probably others as well. While the 40-50% funds are in the eye of the beholder the article misses the concept entirely of specialized funds as proxies for sector exposure. Just as ABB (ABB) is an infrastructure stock so too is it an industrial proxy, same as that First Trust Engineering and Construction ETF above. In addition to the concept not being understood I believe it is reasonable to conclude the article was poorly researched given there are some funds with 80-100% exposure to the sector not mentioned.

Neat looking fire trucks are part of the industrial sector, aren't they?
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Should Individuals Try To Hedge Tail Risk?

Felix Salmon had a post up the other day asking if it is possible to hedge tail risk. For purposes of this post tail risk refers to very extreme outlying events that cause meaningful disruptions in capital markets. Felix also provided a link to this article with detail about a manager just coming out with a hedge fund aimed at hedging tail risk. Per the second link the fund will not charge an incentive fee because the fund's objective is not to generate alpha. Not trying to generate alpha is a fascinating concept.

The question of whether or not individuals need this sort of thing or what the realistic objective should be makes for good contemplation. This is the sort of thing where there is no single correct answer that can work for everyone.

I believe the concept of trying to avoid the full brunt of down a lot is related to hedging tail risk. When framed as hedging tail risk is seems as though there is an attempt to try to assess what the risk might be (my perception, there are many correct answers). It probably makes more sense to think in terms of simply protecting against some extreme event that you accept you cannot predict.

There are all sorts of different types of assets or segments that do provide some measure of protection many of which I've written about before. Obviously an inverse index fund will help when a disruption causes the stock market to go down a lot and obviously they are accessible.

As you can see from the table that Felix provided, managed commodity futures offer a port in the storm and there are a lot of funds out there that target this space. We've had good luck with the Rydex Managed Futures Fund (RYMFX) but to the extent any of this interests you, you should do your own work.

A little more broadly speaking there are a lot of absolute return mutual funds out there, some did well in 2008 and some did not and there is no way to be certain that a fund that did do well in 2008 will do well the next time.

Commodities generally did not hold up but gold did. It is not perfect and it did not go straight up and obviously cannot be counted upon to do so but take a look at a chart of the SPDR Gold Trust (GLD) which we own for clients. Gold attracts buying interest in times of fear and this is true of quite few different types of fear; this is the reason I own it.

Despite all of the apparent problems in the US with debt levels, unemployment and all the rest the US dollar and US treasuries continue to attract frightened money. Treasuries could continue to do well and do well in the next tail event but that does not change the fact that buying treasuries here is buying high.

I do think that certain equity exposures can offer some protection but it takes some legwork and the proper expectations. The context of many of my blog posts in this regard has been that foreign markets will still go down in the event of some big disruption but that some can go down less and recover sooner and this is exactly what happened with some countries. I've talked about these places has having cyclical events compared to the US and Europe's possible structural or secular events.

Some of the quirky stocks I've mentioned over the years ended up delivering this sort of low correlation, or tail risk protection but of course others did not. This is another area where everyone should really do their own work but these types of names are out there, if I can find a couple you can too and couple is all you need.

The last point here is one of proportion. This boils down to tolerances. I believe down a little goes with the territory but you may not or maybe my idea of a little is different than your idea of a little. There is a reference in the article linked above about one tail risk strategy spending 6.7% of the account to protect it against meaningful disruption. As I understood it, this would provide a lot of protection below a certain point.

Anyone wanting a lot of protection could buy a lot of puts. My preference is simple avoidance, it is cheaper. Inverse funds don't expire and it doesn't take much exposure in one to neutralize some of the downsize. Add in selling a couple of things and prudent exposure to some of the things mentioned above and I think you can protect against down a lot regardless of whether you hedged tail risk.
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Debunking The Numbers?

Yahoo reran an article from theStreet.com that attempted to debunk some of the magic numbers of retirement planning. Debunking is a constructive exercise as I believe the last twenty years show that all sorts of assumptions will not work.

In the 1990s equity returns were unsustainably high and in the oughts they were (hopefully) unsustainably low. Additionally, there are far too many variables to construct a plan that does not leave a healthy amount of wiggle room.

The first number debunked was planning to "spend 70% of your current income in retirement." People should be able to do a simple inventory of fixed expenses to figure out what expenses might reasonably go down after retirement and what expenses might reasonably go up after retirement to see what their own reality might be. Surely some people can get way below 70% if there is no longer any installment debt.

The article did not really get into any of the obstacles that I think exist here. There are often one-off expenses that come along like car repairs, vet bills, a serious repair to the house and anything else you can come up with. This, more than anything else, cries for wiggle room.

For example a retired couple needing $3000 per month from their portfolio where that $36,000 equals 5% of the portfolio, not the 4% that gets debunked later, who then needs $15,000 for something major on their house after last month shelling out $1200 for a crown at the dentist who next month was finally going to take a long planned trip to some interesting destination in a year that the stock market happens to go down 20% could have a serious problem.

The next number debunked was the 4%. A big problem that far too many people have is simply spending way beyond 4%. I know people of do this, have seen the impact on people when this has gone wrong and many who are guilty of this know they are taking the risk but don't seem to care (or maybe I am misreading the lack of regard?).

The way I think of it is whatever you got, 4%. More specifically 1% per quarter. If you can get by on a lower number then all the better. This is where the consequence of not having saved enough should come home to roost. Assuming 4% a $600,000 portfolio generates $24,000 "safely." That is a very low number for someone living a $100,000 lifestyle. Someone in this boat could easily take out $50,000 a year early all the while telling themselves they will take out less when they're older. This is very common and very likely to result in something drastic and forced in a few years or so.

The next number was the age of 62 for collecting social security. Obviously the longer you wait, up to a point, the more you get. One of the big things that will have to change, I've been writing about this forever, is people will need to work longer to compensate for inadequate savings. As I have also said this does not have to mean making top dollar, relative to your earning power, in a job you hate. Be creative and figure out a way you can make some sort of income that is sufficient to relieve some of the burden from your portfolio or in the context of this post, sufficient enough to leave some wiggle room.

The final number debunked (although it probably was debunked long before this article) was $1 million in savings to fund a comfortable retirement. 4% is obviously $40,000. How much do you make now? How much do you want to live on for the rest of your life? And relative to those numbers what does $40,000 do for your plan? If that does a lot for you (it would for us) then you are all set if not then something else has to be done or something will have to give.

There is nothing that seemed factually incorrect in the article but I do believe a different focus is warranted. To paraphrase a Woody Allen quote I've used before; there is no retirement planning issue that was made worse by saving more money. Unexpected stuff comes up for everyone all the time. Take a look at your Quicken file, how many "unexpected" items are in there that were more than $500 (or any number significant to you)? These things are rarely accounted for in planning but will not stop when you retire.

The other thing is living below your means. The stock market is not really in our control but living below our means is. That might be difficult for some people to do right now but over time this can be brought under control. Things like driving a car for five years (or longer) past when the loan is paid, staying in $150 (or less) hotels on vacation instead of $300 hotels, buying some of your clothes as Costco (nothing wrong with their $14 jeans); the list is endless.

The above are obviously how I come at this. The bigger macro is that this is a problem to be solved and the hopefully innovative solution is unique to everyone's lifestyle and interests. This is why I so frequently mentioned my now-79 year old neighbor and his backhoe and occasionally write about some other very quirky ideas.
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Global Debt Picture

From Economic Forecast & Opinions
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True Diversification

James Picerno had an interesting post about hedge funds with the following quote really catching my eye;

Hedge funds are supposed to be the ultimate diversification tool. The idea is that the returns post low/negative correlation with broad measures of conventional investing strategies and yet somehow manage to deliver positive returns when the standard strategies tumble.

He goes on to note that some hedge fund managers do deliver but not enough of them do. The other day I had a post about 18 year cycles. If you believe in that concept then you should think we have eight-ish more years of round trip to nowhere and should be ready to quickly lighten up if whatever indicators you look at flash a warning.

In the last few years there have been very few things that have truly offered a low or negative correlation to the large declines of equities. US treasury paper has done so along with gold, inverse index funds, some absolute return fund and one other that I can think of; cash.

At some point markets will have another up cycle like 1982-2000 (even if the magnitude is not the same and even if the US lags other markets) and when that time comes risk will be rewarded and "diversification" will go back to meaning picking the stocks, sectors, countries, whatever that go up the most as opposed to what diversification means now which is trying to protect assets.

When the market warns there might be a problem with demand I want to protect assets, period. I thought of a slightly different way to frame this concept. In past posts I have often talked about avoiding the full brunt of down a lot and my belief that down a little goes with the territory of investing (trading may be a different matter). In that context the search and use of lowly correlated assets like the ones mentioned above could be thought of as keeping down a little, in the portfolio, from turning into down a lot as the market goes from down a little to down a lot.

Obviously not everyone views it this way, and short term emotions often impede long term logic but the ultimate goal of investing (and maybe trading too) is to have enough money when you need it.
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Ouch!

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Emerging Markets Dialogue

One recurring theme here over the years has been the increasing importance of emerging market investing and the extent to which access has evolved, mostly with ETFs. This weekend's interview in Barron's was more like a roundtable on emerging market investing--it was not that easy to find as they put in with the mutual fund quarterly report.

There were a couple of very useful comments along with the stock pick commentary.

From Rajiv Jain;

Two-thirds of emerging-markets companies are leveraged to global growth. When the average investor makes a call on an emerging-markets index, you aren't really buying emerging markets. You are making a call on global growth. The problem is that global growth is floundering...So are we buying emerging markets or not?

To put this comment in the jargon of this blog I might say that some emerging market stocks capture a country's rise in the world economic order while others capture the story on the ground and in a diversified portfolio exposure to both types of stocks has merit. An example of a world economic order stock could be Vale (VALE) which is a long time client holding. The big driver for Brazil is resource exports. VALE is at the core of that and is owned in just about every Brazil index fund there is.

One example of a stock that captures the story on the ground could be Zhejiang Expressway (ZHEXY) which is a Chinese toll road stock, another would be Cementos Argos (CMTOY) a Colombian cement company. There are also quite a few specialized ETFs that come closer to capturing the story on the ground than the broadest index funds like the iShares MSCI Emerging Market Index Fund (EEM) or the Vanguard equivalent.

There was also a comment in the article about correlations between emerging markets and US stocks having gone up in recent years. There are at least a couple of reasons for this including the $36 billion that as gone into EEM; the easier the access and the hotter the excitement about returns the more money that flows in, to the broad indexes, which causes the correlation to go up. Obviously if the correlation goes up then the diversification offered diminishes. Not that there is no benefit just less benefit.

This makes the case for more specialized exposure, a repeat theme here, than buying a bunch of EEM. This does not have to mean going exclusively small cap, VALE is not exactly an under followed stock. Eyeballing a five year chart from BigCharts, VALE has had a more volatile ride to a 200% gain versus about 65% for EEM.

If individual stocks will never be your thing there are of course plenty of ETFs that fit the bill with more on the way. And, repeat concept, if stocks are your thing then looking under the hood of ETFs is a useful place to begin a search. For example a look at the cap weighted SPDR S&P China ETF (GXC) down to the middle of the holdings as listed on the SPDR website and you'll find Tsingtao Brewery (TSGTY). Tsingtao is profitable, has a HKD50 billion market cap, is listed in Hong Kong and Shanghai in addition to the ADRs, pays a very small dividend and is a beer you have had before.

I have no idea whether anyone should buy Tsingtao or not but there is not much reasonable risk that this thing is fraud that goes to zero one weekend.

The picture is our new back gate that Joellyn designed and put together (our friend Bill helped with the welding). We've been doing some DIY lately.
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Sunday Morning Coffee

About a week ago as you probably are aware the 50 DMA of the S&P 500 crossed below the 200 DMA. While the importance of this has been debated, if the market is on its way to down a lot then the crossover serves as a confirmation of the 200 DMA breach from a couple of weeks ago.

As of Friday's close Stockcharts.com has the 50 DMA at 1100.30 and the 200 DMA at 1111.58.

We sold Walgreen (WAG) as a result of the crossover.

I mentioned to a client that during the last go around the small position in SDS grew to hedge a much larger portion of the portfolio as the market kept going down. That combined with only a few sales went a long way to achieving the objective which as stated many times before is to avoid the brunt of down a lot.

Down a lot does not result every time the S&P 500 goes below its 200 DMA but for every down a lot there was a breach early on. The current breach will result in down a lot or it won't. As this is unknowable ahead of time the ultimate knowledge of whether another large decline is coming or not means this trade was either the correct thing to do from the top down or it was an error on the side of caution.

One other related point is, and this is a repeat theme, that the panic is over and at this point for now I think is more about the reckoning of all of the problems, excesses and so on. To the extent the newness and unknown are less than before then I think that argues for any subsequent decline to be less than going back down to SPX 666, which was the March 2009 low, regardless of whether it scares the hell out of anyone or not.
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The Big Picture for the Week of July 11, 2010

Just a few odds and ends as this will be a busy weekend for me with the Fire Department.

This picture is a sort of updated Ring of Fire that Felix Salmon posted. This has fewer countries on it that Bill Gross' original but it is still interesting.

Over the last couple of days I have been having an email conversation with a friend from high school that has included my best attempt at a politically unbiased explanation of what is going on in the economy to someone whose job does not require them to sift through and decipher things like job reports and earnings releases.

As I wrote my most recent reply I had the thought that from 60,000 feet things are really a mess and no one knows what to do.

AdvisorShares has a new long short ETF out. It is the Mars Hill Global Relative Value Fund (GRV). It goes long and short ETFs to "target absolute returns (consistently positive) that outperform the total return of the MSCI World Index over complete market cycles." I'm doing a write up for theStreet.com that will have a closer look.

On a related note WisdomTree is moving closer to a commodity currency ETF and an actively managed emerging market bond ETF with bonds denominated in the local currencies as opposed to US dollars. There are some of these currency and bond ETFs that don't move much, pay a little interest and are good holds in case the dollar ever actually does implode.

One reader has asked that I not give updates of the Tour de France so he can watch after his work day. While I will honor that request I have a couple of observations with one week in the books. Does anyone know what team is wearing the black and flesh colored uniforms? They are beyond creepy. I am thrilled that they are not beating us over the head with Jonathan Vaughters as they have the last couple of years. Most of the little segments they shoot are worthless and I do fast forward but either way I'm glad there is less of this guy. If you are a fan and have forgotten you are better off recording the live show than watching the prime time coverage that is almost entirely Craig Hummer and Bob Roll. One last point, there is no rivalry, try as they might, between Mark Cavendish and Tyler Farrar. Assuming Cavendish doesn't get hurt he will beat Farrar every time and if Cavendish goes down then Alessandro Petacchi and Tom Boonen will beat Farrar. I may be wrong but I even think Farrar's own teammate Robbie Hunter could beat him if they let him. I'd like to see Robbie McEwen win a stage one more time but that may be a tall order.
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Is There Anything to the 18 Year Theory?

Yesterday there was an article on Seeking Alpha with a fantastic title; With 3, 5, and 10 Year Stock Returns Negative, Why Are Pension Funds Assuming 8% Returns? I tweeted because they have to.

A chart of the US stock market for last 100 years shows that for big chunks of time the market goes up a lot and then there are big chunks of time where it takes a very bumpy ride to nowhere.

For people who don't want to be very active with their investing but who take the time to develop a basic understanding of this the task can be made a little easier. Some people like to hone in on these cycles lasting 18 years and while that might be a little simplistic going forward the nature of the past cycles combined with the current fundamental backdrop argues for more bumpy round trip to nowhere trading for a few years.

The chart comes from Cam Hui who writes the Humble Student of the Market blog. I have unyielding faith there will be some sort of repeat of what the market did from 1944 until 1962 and then again from 1982 until 2000. Maybe it will start in 2018 and maybe it won't be as much is those two other periods but something similar will come.

The ideal way to navigate this would be some sort of strategy that deemphasizes equities in a period like 1966-1982. This could mean relatively heavy doses of ETFs like iShares COMEX Gold Trust (IAU), inflation protected products like the SPDR Barclays TIPS ETF (IPE) if things look inflationary or regular bond funds like the iShares Barclays 10-20 Year Treasury Bond Fund (TLH) in an environment that appears to be deflationary, like now. In addition to that some sort of absolute return product like the IndexIQ Hedge Macro Tracker ETF (MCRO). The big idea is to protect assets in an environment where equities do not do well.

Then after 18 years one would ideally rotate into some sort of aggressive equity exposure to capture a likely five-bagger, or more, in the market.

I use the word "ideal" because perfect execution would require perfect information and that is of course unlikely. This could be partially mitigated by simply reducing equity exposure after 15-20 years of raging bull market as opposed to eliminating it. Something like the PowerShares Buy Write Portfolio (PBP) which some clients own could be one way to do this. I would also add that after 15-20 years of bumpy round trip to nowhere anyone on this sort of path should start increasing equity exposure.

This is a vague but evolving thought but I believe it is best suited to people who are willing to spend only some time on their investments as opposed to no time or a lot of time. As I have pointed out numerous times despite the fact that the S&P 500 was down 24% price-wise in the recently ended decade many easily accessible countries thrived. Mexico was up 345%, Brazil up 301%, India up 243%, Norway up 121% and Israel up 109% as some examples.

This is not to say that those countries will continue to perform like that if the cycle continues in the US until 2018 but some countries will (maybe those, maybe others) and for people willing to do a lot of work the notion of hiding as outlined above becomes less relevant.

The relevance of the first line of the post is that as a do it yourselfer, if you save properly make the access a lot easier. , you are better positioned to take what the market gives. Many pensions obviously were not able to average 8% per year in the last decade and some did far worse by chasing heat or putting too much in private investments that blew up. If markets can recover from the Great Depression it can recover from the current event. The only variable will be time. You can hide out, which is perfectly valid, or you can take the time to find healthier countries to own and obviously ETFs.
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Cement ETF?

A while back there was someone at Seeking Alpha who wrote a lot posts with proposed indexes for ETFs. I haven't seen posts along these lines in a while and while I won't be doing this often it might be interesting to do this one time or maybe a second time in the future.

As you know EG Shares has come out with country funds for infrastructure with another possibly on the way and some of the larger ETF providers have broader infrastructure funds that trade. I am a big believer in this theme and we have exposure for clients.

I've been friends/acquaintances with a couple of the guys running EG Shares from before the company existed and at one point I jokingly asked if their proposed India Infrastructure ETF should be called the India Cement Fund. In doing some research for this post I would tell my friends at EG Shares (not that they don't know this) that if they branched out to have infrastructure funds for Egypt, Vietnam or Saudi Arabia, for as many cement stocks in those countries they could be the respective Cement Funds of those countries.

It seems as though many countries have at least one big cement company. The first place I looked for names was in single country ETFs and then I just typed cement into Google Finance (not the Google home page) and trolled through the listings.

Cement is obviously a sub-set of the infrastructure theme. You probably know this but cement needs to be made locally. Due to the weight it can't really be shipped that far. There are quite a few cement companies in the materials-heavy PowerShares Emerging Markets Infrastructure ETF (PXR) but not in the utility-heavy iShares Emerging Markets Infrastructure Fund (EMIF) which is a client holding.

Below is a list of 20 names I found with the symbol, if applicable, and the country that it is from. I would not be surprised if one or two were not trading for whatever reason but that doesn't necessarily detract from the idea.

Siam Cement (SCVPF)-- Thailand; and in the iShares Thailand ETF (THD)

Cemex (CX)-- Mexico; and in the iShares Mexico (EWW)

Anhui Conch Cement (AHCHY)-- China; and in many China ETFs

Lafarge (LFRGY)-- France; and in the iShares France ETF (EWQ)

Akcansa Cimento (ACKMF)-- Turkey; and in the iShares Turkey ETF (TUR)

Orascom Construction Industries-- Egypt; and in the Market Vectors Egypt ETF (EGPT)

Indocement Tunggal (PITPF)-- Indonesia; and in the iShares Indonesia ETF (EIDO)

Lafarge Malayan Cement-- Malaysia; and in the iShares Malaysia ETF

Cementos Pacasmayo-- Peru; and in the iShares Peru ETF (EPU) client holding

Cementos Argos (CMTOY)-- Colombia; and in the GlobalX Colombia 20 ETF (GXG)

James Hardie Industries (JHX)-- Australia; and in the iShares Australia ETF (EWA) client holding

Heidelberg Cement-- Germany

Saudi Cement-- Saudi Arabia; I don't think Saudi markets are open to foreigners but there are many names from Kuwait to add instead

Ultratech Cement UCLQF-- India; and in the WisdomTree India Earnings Fund (EPI)

Taiheiyo Cement THYCY-- Japan; has to be in iShares Japan (EWJ) but there are many names to look at in that fund

Raysut Cement Co--Oman; in the WisdomTree Middle East Dividend Fund (GULF)

Lucky Cement-- Pakistan; there will be a Pakistan ETF one day

Holcim Cement (HCMLY)-- Switzerland; and in the iShares Switzerland ETF (EWL)

Cimentos de Portugal (CDPGF)-- Portugal

Bim Son Cement-- Vietnam

The index could equalweight all 20 names or perhaps favor the stocks from the developed countries with smaller weightings for the emerging names.

Any ETF providers interested? Give me a call, we can work something outXD
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Is There Any Utility Left In Buying Timber Equities?

The catalyst for this post was an article at Hard Assets Investor comparing the Claymore/Clear Global Timber Index (CUT) to the iShares S&P Global Timber & Forestry Index Fund (WOOD). I wrote about CUT for TSCM in 2007 but have not written about WOOD before.

I have written many posts about investing in timber assets one way or another with the inspiration having come from former Harvard Management Company CEO Jack Meyer. There have been other luminary investors also known to invest in the space including Julian Robertson.

The big idea as you may well know is that timber assets tend to offer a steadier return than broad equity indexes and a low correlation to broad equity indexes.

Stocks like Plum Creek Timber (PCL) have long been popular as offering the potential diversification benefit mentioned above along with an above market dividend yield.

The correlation of these stocks and ETFs ebbs and flows of course but are not that low. According to ETFreplay.com CUT's correlation to SPY is currently 0.96 and while that site did not seem to know WOOD, the correlation between the ETFs is very high.

Since the inception of WOOD in July 2008 that ETF is down 20% and CUT is down 7% compared to a drop of 18% for the S&P 500. However from that inception date to the low in March 2009 both WOOD and CUT dropped 60% (July 2008-March 2009) versus a 40% drop for the S&P 500.

I believe the drop ties into both the sector makeup of the funds being very heavy in materials stocks (with kind of an industrial twist if you look at some of the companies) which got hit harder than the market and that the nature of the panic in the market was that there were almost no themes or market segments that did what they were "supposed" to do.

Given that cyclical makeup of the ETFs I'm not sure they can offer much in the way of zig zag as the market appears to be rolling over again--and if it is not rolling over now then apply the comment to whenever the next bear market comes.

That there may not be much in the way of diversification benefit does not invalidate the theme or the funds. The need for timber would seem poised to trend higher over the coming years, some of the companies in the funds do indeed own a lot of timberland around the world, some of the stocks do have very attractive yields and offer foreign exposure with almost nothing allocated to big western Europe, especially CUT which is 61% in foreign stocks.

A little more specifically some of the names in the fund could be a starting point for picking stocks to serve as proxies for certain countries. Finland figures prominently in both funds with exposure to UPM Kymmene (UPMKY) and Stora Enso (SEOAY).

I believe Finland would benefit in the unlikely event of a breakup of the euro and to a lesser extent if there were to be a dramatic change in the composition of the euro.

Is UPM Kymmene a good company and/or a good proxy? You can decide that for yourself but the bigger picture idea of looking under the hood of an ETF as a starting point for seeking out ways into a country that interests you is a valid approach.
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