Using The Media

In yesterday's post I mentioned seeing something on CNBC which opened the door to a good conversation about how much, if any, stock market television to consume or what role it should play, if any, in participating in the market. Like the portfolio itself there is no single right way to consume information. Personally I want to consume as much as possible.

One reader noted that the business model of television is to sell advertising. While that is true, news channels tend to want to report the news as well. There may be, and probably are, biases and conflicts that exist in the running of a network, conflicts and biases from some portion of the reporters and conflicts and biases from some portion of the people being interviewed but if something bad happens to Archduke Ferdinand during the day then chances are it is going to get covered.

If, as I said yesterday, you have eight tabs open on your browsers with articles to read and you do not have your TV on a news channel and something big happens then you will not know about it for a while. While knowing that something has happened may not result in a trade some people would want to know right away and some would not care. Which are you? The answer to that question contributes to whether or not your TV is likely to be tuned to a stock market channel.

Occasionally the news will trigger a trade and in those instances, timeliness matters. A few May's ago I woke up one morning, flipped on CNBC and the news of the morning was that Microsoft (MSFT) wanted to buy Yahoo (YHOO) which we owned at the time. Generally I am a seller right away if a holding catches a bid. The highs of the day were in the premarket and obviously the stock has not been that high since. It is not knowable how quickly in the day I would have stumbled across the news but by flipping on the TV first thing it was literally the first piece of news I had that day.

A different example I have used before was the GM bankruptcy. We did not own the stock or the debt but it was a big story and it was talked about to excess on CNBC whatever the biases and conflicts of anyone talking about it. This saved me time reading about something that realistically had no direct effect on the portfolio. I think that is a constructive leveraging of time.

For people reading this site who are advisors they have clients who will ask questions about newsy things that probably have no direct impact on the portfolio. In that instance "I don't know" is not an answer you want to give. Too many "I don't knows" and you probably start losing clients. For some who work in the industry there is the opportunity to talk about these things in the media. I appear on CNBC two or three times a year which at that frequency is a fun novelty and has opened the door to some experiences I would not have otherwise had. It is ok to have fun with your job.

More important to the portfolio is that if you are a top down person then the important decision of being defensive or not is based first on the big picture of the world. Being a news junkie has helped us over the years, especially with what to avoid. I've disclosed in previous posts that we sold Barclays in December 2007 and Allied Irish Bank in March 2008 in part because "how many times are you going to read that the housing market in the UK and Ireland are in serious trouble before you sell." Having CNBC Europe on for an hour every mid morning contributed to that and these turned out to be important sales.

This utility can still exist while you tune out Jim Paulsen and Thomas Lee.

Any or all of the above might sound exactly right for you or utterly ridiculous but again there is no single way right way. Media outlets are a tool to be used as much or as little as you see fit.

One add on about Twitter. I keep my feed open all day. I Tweet three or four times during market hours, usually linking to something I read and adding something that is hopefully useful (or occasionally funny) about the link--yesterday I made a joke about the recent frequency of sovereign ratings changes lately being like the speed dial episode of Seinfeld. There is a lot of useless stuff on my feed to be sure but there are also many links tweeted that are useful reads that I would not otherwise find. Again it is a tool to either use or not use.

The Red Sox hired Bobby Valentine as their new manager. Based on where the team was on Labor Day, this is a true Black Swan.
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Financial Bulls Will Be Right Eventually

The interweb had a little fun yesterday poking fun at Dick Bove, the sell side bank analyst from Rochedale Securities. It started with his mea culpa of sorts that was picked up by FT Alphaville, was contributed to by his mid-day appearance on Fast Money and was jumped on by various bloggers on Twitter. Bove gets a lot of face time on TV, his opinions get dissected in many places and he has very specific opinions several of which have been wrong in very loud fashion.

Later in the day there was another segment on CNBC not involving Bove where an analyst tried to make a bullish argument for financial stocks that with just one ear on the segment seemed to be based on valuations.

The valuation argument has been around for a while post-meltdown (Barron's seems to write this up every three weeks) but hasn't mattered yet as the sector, as measured by the Financial Sector SPDR (XLF) is still in the dumps. XLF went from $38 before the crisis to a low in March 2009 of $6.18 to a post meltdown high of $17.17 in February of this year and it closed yesterday at $12.12.

As a quick recap, I was underweight financials long before the crisis due to the sector's weight exceeding 20% in the SPX, then went more underweight when the yield curve inverted and have been very underweight and very skeptical ever since. The book value argument is sketchy as I don't think book value is reliable these days because I do not believe the banks are done writing down the crisis.

One observation that I think contributes to the conversation is that twelve years ago we had a tech bubble and many of the big surviving companies are trading at fractions of where they were 12 years ago, earning much more money than they were 12 years ago and fundamentally are much better businesses than they were 12 years ago but the market appears not to care..yet. Intel (INTC) peaked at $73 and is now at $23. Cisco peaked at $79 and is now at $18. And there are others but obviously there have been some success stories too like Amazon (AMZN).

There could be success stories with US banks too but there won't be a lot of them as I believe the financial crisis is far more serious than the tech wreck. With the tech wreck, the market took something new and overreacted sending valuations to unsustainable levels. With financials the valuations were fine but then the industry got far too aggressive on just about every front which dominoed into their blowing themselves up. If tech has not recovered after 12 years for a bubble that was not as bad as the financial bubble then how long do you think it will take for the banks to recover?

Obviously people draw their own conclusions and so you may view this much differently than I do but for now I continue to prefer banks from select foreign markets, exchange stocks (although we don't own one currently) and we also own an index provider.

The picture is of upper Wall Street in 1941 from a photo essay published at the Daily Mail.
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It's Not an Apocalypse, But In Case It Is...

Yesterday I stumbled across a couple of articles each pointed to how to invest into an economic apocalypse. This is an interesting exercise in terms of how to use volatility in constructing a portfolio. Before jumping into this let me say that economic apocalypse is not my base case. For many years I have thought that this decade will be less growth in the US than people have been accustomed to necessitating more exposure to select foreign markets ex-Western Europe and ex-Japan.

One article highlighted five stocks that per the title can survive an apocalypse with the other making a case for going heavy on dividend paying stocks at the expense of bonds. The first article was simply bad (which is why I'm not linking to it) and the second article seemed aver a strategy that I don't think is right for anyone expecting a "great deleveraging."

To the first article one of the stock picks was a heavy cyclical stock from the industrial sector that I am very fond of although we don't own the name currently. If we are to take the title literally about surviving then yes the company and its stock will survive but if we have an economic apocalypse then the stock will get crushed and contrary to the author's assertion, the 2% yield won't matter. If you really think there will be an apocalypse then you don't want to own volatile industrial stocks (see below).

To the second article it seems like we have had some measure of deleveraging already. If there is more to come (I think the author was implying it would be worse from here) then we have something of a litmus test about how to invest into this deleveraging and it seems to me that treasuries and sovereigns from select other countries are exactly what you want to own. Lower quality paper seems likely to take it on the chin. In the last two years JNK is down 4% on a price basis while TLT is up 27% and ZROZ is up 47%. YTD the respective returns are down 8%, up 28% and up 54%. The numbers for TLT and ZROZ trounce the numbers for SPY and SDY (proxies for equities and dividend paying equities respectively). And of course there have been and will be some stocks that do indeed thrive somehow in an apocalypse.

While I continue to believe buying TLT, ZROZ or individual US treasuries is buying high, I think it is reasonable to conclude that treasuries will continue to go up if the deleveraging worsens and causes or contributes to an apocalypse. Inflation is bad for bonds, deflation is not so bad (for the right type of bonds).

In building a portfolio for the apocalypse the first thing I would not do is completely ignore an asset class; what if there is no apocalypse? It might make sense to be very underweight equities versus a target weighting. If 60-65% is normal then maybe 25-35% for the person worried about an economic apocalypse makes more sense. In the equity portion it also makes to increase the yield versus the benchmark index and take a defensive tilt or own countries that you think might carry on even if there is a US economic apocalypse.

In enhancing yield, yes there would be some DZ stocks but there should always be some. It would also make sense to have a little exposure to industrial stocks like the one mentioned above, not as a way to ride out the apocalypse but in case there is no apocalypse.

In terms of countries, perhaps a small exposure to some place like Mongolia, Market Vectors should have a fund out soon, and maybe countries known for yield and low volatility.

In terms of fixed income I'll repeat that some treasury exposure makes sense if there is a dire outcome. I would also want to own foreign sovereigns from certain countries and this is become easier to do as WisdomTree came out with AUNZ and PIMCO came out with AUD and CAD. I think there will be more of these to come.

I think preferred stocks could be owned in moderation, all the better if you can find one outside the financial sector. These often have yields in the sixes and while a financial preferred might cut in half in an apocalypse a preferred from a non-financial probably will not.

The Barron's article about finding yield from a couple of weeks ago talked a lot about closed end funds. I would suggest going very small and find one that tends not to get pulverized during a crisis; many do but some do not. We have one of these that we are favorable disposed to in this light but there are several that exist.

There can also be room for some sort of product that has a high yield but again, go small. The context could be a BDC, an infrastructure trust, floating rate fund, mortgage REIT an MLP or the like but I would keep these on a short leash. Personally, we are not going to own a BDC or a mortgage REIT but I may be overly conservative on this point and this does not mean that you should not explore these spaces and decide for yourself.

Keep in mind that although I grouped these as an other category they are essentially equities and to be clear I would not own one of each, maybe one name from at most two categories. These things are unlikely to blow up but it is in the realm of possibility.

Unrelated; Bob Costas had an unusually useful nugget in his rant at halftime of the Steelers/Chiefs game. Apparently Homer Jones, who played for the Giants in the late 1960s, is the guy who came up with spiking the football after scoring a touchdown.
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Sunday Morning Coffee

Gone hiking (the picture is from the Grand Hotel in Jerome, AZ).
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The Big Picture for the Week of November 27, 2011

Yesterday, my reading took me to a revisit of a few themes that I have written about over the years which brings up a point worth mentioning that coincidentally came up during my visit to Maryland last week. The themes in question are Scandinavian banks, Mongolia and publicly traded farming/plantation stocks.

The point here is not the content of what I read, you can find news easily enough, but is the time that goes in to the initial learning and then the ongoing monitoring of these things even if you don't own them. Learning some of the basics is not that difficult and keeping tabs on some of the bigger news items like things negative affecting fish production or the price of copper or knowing who is exposed to Hungary is also doable.

In addition to the above it is important to understand the volatility characteristics of the stock you might be most interested in but also other names, if there are any, in the space. Most of the obscure things that I have found, researched and written about have very simple supply and demand characteristics but the stock trading is far more complex meaning they tend to be wildly volatile.

In exploring themes there will be some number that you buy and some number you won't out of the total number you research. In order for the theme to be investable you need to be comfortable with both the fundamentals, how the stock trades and where it is priced. Over the years I've written about the themes we own but the above are themes we don't own. I typically say that I do expect to own them at some point which is why I continue keep tabs and continue to try to learn.

The takeaway here is that for people inclined and able to spend the time at the theme level it makes sense to expect that just as much time will be spent on what not to own. I thought this was obvious but it may not be and so it worth going over. And obviously the context is for people who prefer narrow based portfolios.

Often these posts draw comments asking why this is necessary and of course for you it may not be. A huge building block is have the type of portfolio that is right for you not for someone else. Obviously I prefer a series of small exposures to countries and themes that allow for potentially subtle tweaks to the portfolio.
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Thanksgiving Morning Coffee

Yesterday we executed a trade for larger accounts in selling Pro Shares Ultra Short S&P 500 (SDS). For being a half day (mentally) I had a lot of things on my plate and I wanted to get a hike in with Joellyn and our hiking friend (plus all the dogs). Thankfully smart phones make it easier to play hooky for a couple of hours.

We met at the trail head about 50 minutes after the open and as we hiked the market deteriorated into being sort of an ugly day. We ended up placing a limit order that targeted where I thought SDS would be if the SPX hit down 2% on the day and our trade executed around 2:15 EST (it took another couple of basis points to get for limit we placed to fill so relative to the day we got a good price but not the high for the ETF.

There are a few things here. First the price looked good relative to Wednesday but of course if the market tanks on Friday it will not have been a good sale. The logic here is that I think the SPX range has moved up some, not a lot, and after six down days in a row I think the SPX is close to the bottom of the existing range. In addition to simple market action taking it lower from here, some new piece of news could also take it lower but I generally believe the above about the range having moved is my base case.

I've also been consistent in saying that I don't think a revisit of the 2009 lows is a realistic outcome become the newness of the crisis is long gone. We are more in the muddling/slogging phase and have been for a while which if correct makes SDS a little less important than it was in 2008.

We have a fair bit of cash built up as we made a few sales earlier in the year (these were disclosed as we went) so if the market does drop from here we would look to execute a couple of buys into that drop and still have cash for defensive purposes.

Zooming out a little, after period where the market goes in one direction for a week (or in this case six days) a lot of extrapolators come on TV to tell us why the trend will continue and it is fascinating how often this sort of extrapolation turns out to be incorrect. Maybe this time will be the exception that proves the rule but if we rally from here then maybe we will put SDS back on--that will depend on whether we get there and the path we take to get there.

Happy Thanksgiving!
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Newt Likes Privatized Social Security

Reuters reported that Newt (turns out they meant Gingrich not the character from Lonesome Dove) is in favor of privatized Social Security for younger workers although there was no mention of a specific age.

Gingrich would be on board with giving people a choice of whether to participate or not and if participating how to allocate between stocks and bonds which he thinks would offer a chance at 7% annual returns.

This issue makes for a great debate because it is something that people can relate to and more than other issues it really is an intersection between ideology and reality.

The ideology is the sort of Libertarian view of having less government in our lives, having the chance to succeed or fail and own the consequences. I would sign up in a heartbeat, I love the concept for top down reasons of starting to relieve the burden placed on the country and from the bottom up in the belief that I can get a better result than the government would.

The reality is the 401k litmus test. We've probably all heard about the research that concluded that (as of a few years ago) the stock market averaged 10% per year, actively managed mutual funds averaged 8% (the fees) and mutual fund holders averaged about 4% (poor decision making). I remember this coming from T Rowe Price but I believe there have been several papers concluding about the same numbers. Numbers for 401k plans are also quite poor, likely to be worse as the 401k population takes in people who would otherwise not participate and so are not likely inclined to try to learn about markets and investing.

Part of the equation here could be education of course. If it were done correctly it could be reasonably cheap and effective where the goal would be basic literacy. Unfortunately I think the lack of interest thing would be a hindrance to this working as it would take in an even larger percentage of people who are otherwise not interested. Maybe there should be a competency test to go with education although that would increase the expense and I wonder if it would be unconstitutional somehow.

As a practical matter I think this would fail on a colossal scale and would lead to even more of the "personal bailouts" I mentioned a couple of weeks ago which might be more costly than what we have know unless the country is really prepared to turn its back on someone who tried this and was wiped out.

I will repeat my idea which would address a small slice of the problem which is to remove IRA and 401k contribution limits, allow for writing off whatever amount someone contributes but still collect the full $16,000 (round number) FICA withholding and people participating would get no benefit. Yes it would benefit the well to do but this section of the population is less likely to need the money, could save more on their own but still pay in full boat. I'd do this in a heartbeat too.
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The World According To Rosie

ZeroHedge posted the following list from David Rosenberg of things that people are not talking about but should be (at least this is how ZH interprets the list):

1) Hedge funds have not piled into the equity market to play catch-up.

2) The Super Committee did not come to a compromise (and remember Moody's has the U.S. debt rating on "credit watch" and Standard & Poor's still with a "negative outlook".., shades of August).

3) The Europeans have not managed to resolve let alone contain their credit crisis.

4) Germany has not acquiesced and agreed to having poor sovereign credits ride off its AAA rating via a "Eurobond".

5) The ECB has not moved towards QE. Nor will it — have a look at today's WSJ editorial on the matter. Brilliant.

6) Mr. Market saw through the Q3 earnings season and recognized the lack of visibility in the guidance provided.

7) China did not start to ease policy just because inflation rolled off the 6%-plus peak.

8) U.S. recession risks, as per the San Francisco Fed, did not recede and actually stayed above 50% even with the better statistical tone to Q3 and Q4 GDP.

We've all heard point number one many times, often referred to as window dressing, but this is something that I have never understood how it can be pulled off. To take an extreme example, if a portfolio reports owning nothing but names that are up 20% but the actual portfolio is only up 2% then wouldn't all credibility be lost?

The apparent failure of the super committee should surprise no one. Washington has become more ineffective than I can ever remember. It starts at the top and goes all the way down to both sides of the aisle. This has no shot of changing until Obama is gone. As a side note there was a write up over the weekend in the WSJ making the case that Obama should not run in which case Hilary would, she would win (a comment on how fouled up the GOP is these days) and draw on her experience of having a front row seat (presumably) to the manner in which her husband reached across the aisle.

Points 3, 4 and 5 all underscore the extent to which Europe's fundamentals stink and are going to continue to stink for many years. Long time readers will know I have been saying this for a long time and there appears to be no visibility for substantial improvements. Actually the visibility is for things to continue to deteriorate (it looks like Belgium's temporary honcho resigned last night).

Earnings are complicated these days. As you know, companies give guidance to analysts then report their numbers shortly thereafter creating the appearance (at the very least) that things are going better when they beat their own guidance. It is true that the percentage gains in reported earnings has been good for a meaningful number of companies but Rosenberg's comments are also true.

The other complicating factor is that earnings have not mattered in the short run for quite a while as the market is being driven more by macro factors. The first time I had ever heard of 90/10 days was in 2000 or 2001 in Barron's and it was portrayed as being a very rare event. Now they happen many times in a year contributing to the real or perceived increase in correlation.

Everything about China is complicated, promising, worrisome and exciting all at the same time. The story on the ground of modernization, urban migration and middle class ascendancy is continuing to happen and I contend will continue uninterrupted. This should mean good things for the right stocks long term but there will be short term lumpiness and sometimes it will be severe.

The wrong stocks need to be avoided (obvious statement) and by wrong stocks I mean Chinese banks, real estate companies and the companies that have their primary listing in the US. This will guarantee nothing but if China really implodes then ground zero will be the banks and real estate companies. I am not in the Chanos camp in terms of magnitude but I do believe these groups are on shaky ground. As far as companies that have their primary listing in the US, this is where most of the frauds occur. You may feel that not being able to discern when a company is simply lying makes for an unacceptable risk which would be valid but there are plenty of real companies in China.

And finally about a recession in the US; during the summer I said I thought we were in a recession and I still feel that way. This call will either be right, or early, or too early to be right or simply wrong but I continue to believe that things are unhealthy fundamentally and that jobs and housing a shockingly behind where they should be by now. More important than whether we are in a recession right now or not is that we are still in the event of the financial crisis that started four years ago.

Congratulation to Justin Verlander on winning both the Cy Young Award and the MVP.
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Is The Market Frustrated?

For months now the US equity market has been churning violently in the same general range without having made much progress. This type of action can be a source of frustration for investors. Over the years the comments on this blog have been something of a sentiment gauge although not infallible.

There have been times like late 2008 and early 2009 where a lot of frustration and even hostility showed up in the comments of the blog, in the comments on my articles at Seeking Alpha or both. Lately the comments have taken a more aggressive tone than normal on the blog but interestingly not on my posts at Seeking Alpha (SA reruns the same posts).

I've generally been saying the same thing for seven years and sometimes I am a good guy for it and other times I am "deluding" myself. Sentiment is of course very volatile as fear of being broke, losing your nest egg and being out on the street is a core fear for many people and anything the makes those fears perceptually closer to reality, like a malfunctioning stock market, will evoke an emotional response.

Emotional responses can be an enemy of long term portfolio success. I repeatedly make the point about taking bits of process from many sources, including this one if you like, to create your own process. Your own process needs to be one that gives you a reasonable basis to think you are giving yourself a reasonable chance of having enough money when you need it. You also need to have a process that you can understand (as obvious as that sounds...) and one that allows you to sleep at night.

It is important to realize that success can be had with any method but failure can also be had with any method. It makes sense to work on refining what you do but contrary to what one comment said, I also think it is valid to dissect other people's mistakes to learn what not to do--this is the reason for the Bill Miller posts over the last few years.

Given how long I've been blogging and the consistency of the posting it is a good bet that I will keep at it which means that although I am deluding myself now, I will be a good guy again soon but then sometime after that I will be back to delusional (or worse to judge by some comments).

As far as commenter sentiment being an anecdotal indicator for stock prices, the comments would seem to be saying stock prices will go higher but unfortunately there is no Seeking Alpha confirmation as there was in late 2008/early 2009.
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Sunday Morning Coffee

By now you know that Bill Miller is stepping down from his role as lead manager for the Legg Mason Value Trust that he is so famous for having managed to a 15 year streak of beating the S&P 500 and then for blowing up the fund by holding on to too many stocks from the wrong sector.

Friday morning Sam Peters, Miller's replacement, was on CNBC and to the network's credit they asked a couple of reasonably difficult questions. I was surprised that Peters did not distance himself from what Miller has done over the last few years. There was talk from Peters about the legacy of Miller, of belief in the process, about the portfolio having a little higher quality these days and that while they don't think another huge decline is likely the portfolio now yields about 3% and they would view a large decline as an opportunity.

Oh boy.

As far as process they reasonably created the impression they did not understand what they owned as stock after stock dropped 90% with seemingly no room in the process for admitting they were wrong. I also wouldn't have much faith in their ability to assess the quality of the portfolio. The idea that a 3% yield could be a palliative for cutting in half seems ludicrous. That yield is only 100 basis points or so more than the SPX. The 3% in and of itself is pretty good but it means very little to just about everyone except the dividend zealots (per their comments on my posts at Seeking alpha) as "sweet, I was only down 47%" is not something too many people are likely to say. A large decline can be an opportunity but it is less of an opportunity if you don't sell anything earlier on.

There were several other shots taken at Miller later in the day on CNBC by Carl Quintanilla and Gary Kaminsky. I am probably coming across as being overly harsh here but this story is about extreme hubris. The question "what happens if I am wrong" is something I have blogged about many times, is a cornerstone to the decisions I make in client portfolios and is something that you should be cognizant of as well. This is a simple lesson that Miller appears to have never learned. Hopefully for LMVTX shareholders, Peters did.
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The Big Picture for the Week of November 20, 2011

What is the proper allocation to foreign markets? Within that decision is the question of how much should go into a single country. The catalyst for this post is the following comment I saw in an article deconstructing a thematic ETF;

Global exposure can be a great thing, but in the context of a diversified portfolio of stocks, too much of a good thing can increase risk.

There could be a couple of different ways to interpret the comment but the way I read it, the author is lumping together all foreign exposure as if it was one thing which is the wrong way to look at it. As we've talked about countless times each country has its own attributes as an investment destination. The attributes of a given country might be similar to the attributes of some other countries but it will not have the same attributes as every other investment destination.

Which countries having banking crises and which do not? Which countries have resources in the ground that the world must have and which do not? Which countries have problems with aging populations and which do not?

There are more differences of course and obviously the answers to every question are not all that cut and dried so for anyone inclined to spend the time it would be easy to construct a portfolio of different countries that takes in various types of fundamental attributes. The importance here is that countries with different attributes are likely to be at different points in their respective economic cycles which gives them a chance to be at different points in their respective stock market cycles which in turn creates the opportunity for lower long term portfolio volatility.

The best example of this is probably the fact that Brazil and Norway kept going up until June 2008 after the US peaked in October 2007. That example also makes a point about realistic expectations for this type of diversification. In the face of a short term market calamity it is not realistic to expect some market to be immune but a country that is fundamentally healthier has a decent chance of outperforming over longer periods of time. There were dozens of countries that did just that in the last decade and that will repeat again in the new decade (assuming the US turns out to be the laggard I think it will).

Contrary to the quote above I think an allocation to various countries with different fundamental attributes from each other and different from the US makes a portfolio less risky not more risky.

Generally we target 2-6% in any single country although China is more like 1% these days by virtue of its weighting in a couple of thematic ETFs we use for most clients. A 6% weighting would equate to two stocks with each one targeted at 3%.
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All ETF Portfolio? Part Two

This is a follow up to Thursday’s post that tried to offer a more constructive reply to the almost useless ETF expert portfolios from Barron’s last weekend. Thursday’s post was about building an ETF portfolio using broad based products. This will be about using sector based products or using ETFs that might serve as proxies for sectors. As a quick reminder I do not think all-anything is ideal for a portfolio. Assuming no commission constraints I would say the best way to go is to be wrapper-agnostic, to pick whatever you think is the best way to capture each thing you want exposure to.

Our method for portfolio construction at the sector level is to assess the weightings of each of the ten big SPX sectors in the index and then make decisions about whether to overweight or underweight each of the ten based on our knowledge of stock market history combined with what we think is going on now in what is hopefully a forward looking analysis.

The thing that is being managed against is buying each of the ten sectors in an index fund and buying in the same weight as the S&P 500. No one would buy the ten sector funds in the exact weighting of course but that is the benchmark. In this context we’ve talked most about underweighting financials. This was first done in 2004 due to that sector’s weight in the S&P 500 exceeding 20%; it is a sign of trouble when any sector exceeds 20% of the S&P 500.

Other sector decisions factor in cyclicality. Late in the sector it makes sense to reduce exposure to industrials and increase staples as two examples. Industrials tend to get hit harder than most and staples tend to hold up better than most in the face of an economic slowdown or bear market. These types of simple decisions, and they are simple, need to be done with each of the sectors and the process needs to be ongoing as the cycle is ongoing. This requires time spent to learn about all ten of the sectors and then have the discipline to stick to it.

Our history with Caterpillar is a great example. We sold it several years ago in the low $70s, bought it back near the market low in the $40s, sold it again in the mid $90s a few months ago thinking that chances of another recession had increased dramatically, sure enough the stock dropped into the mid $60s very quickly although we did not buy it back on the downswing unfortunately but the thought process is pretty easy to understand. We are no less fond of the name but it is one that goes down a lot when the market goes down.

Now substitute your favorite industrial sector ETF for CAT. The magnitude of the moves may be different but I think the market action is simple enough that the example stands up. XLI is probably going to drop faster than the market on the way down and snap back faster on the way up. Utilities (XLU and several others) will go down less and snap back less—although I will be curious to see if that continues to be the case if a large drop in equities coincides with a meaningful run up in interest rates.

At this point it might make sense to talk about proxies. Just about all the financial sector ETFs are dominated by exactly the banks I don’t want to own. In our case we usually use a common stock or two instead of an ETF even for mid sized accounts where a lot of individual stock positions are not ideal for whatever reason. The search for proxies can include country funds. Many of them are very heavy in financial stocks; Singapore, Colombia, Poland and Egypt come to mind as examples. Obviously you have to have researched the country, be favorably disposed to the country and like banks enough to own the fund but EWS will work for someone as a financial proxy. EWS is just an example. As much as I like the country as an investment destination for the fundamentals, when world markets go down a little it seems to go down a lot and when world markets go down a lot Singapore tends to get eviscerated.

Another type of proxy is specialty/thematic funds. For example we use the Water ETF as part of our industrial sector exposure. There are defense contractor ETFs that could also be part of the industrial sector allocation, we use an individual stock for a defense contractor. Something like the Lithium ETF (LIT) could be a proxy for materials.

Global X and EG Shares both have sector funds of varying sorts for emerging markets; for China and Brazil from Global X and more broadly emerging markets from EG Shares. There are also countless small cap funds for sectors from quite a few different providers to explore.

The idea with this post is not to hand out fish with X% in XLF, Y% in XLK and so on but as noted above in the header of the site to delve into process. Take little bits of process from various sources and create your own process.

On a related note we have filed for the ETF. The rules on what can be said or what can be linked to (nothing can be linked to apparently) are very strict. While I am very excited, the little bit I can say is all that we think I am allowed to say. Despite all the emails and comments Greasy Wool arbitrage is still off the table (humor attempt).
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All ETF Portfolio?

The other day I had some fun poking at the ETF portfolios put forth in Barron's by the experts. I thought it might be useful to go over what I would suggest makes for a more strategic approach than owning both SPY and DIA or splitting every conceivable asset class into multiple broad holdings in the context mentioned the other day.

As a matter of compliance we think there are rules against putting percentages in blog posts so I'll avoid that. Also there are commission logistics to take into account. TD Ameritrade has about 100 commission-free ETFs but only three of those are sector funds.

An account sized such that $40,000 or so is going to equities is probably better off avoiding sector funds because of commission drag but obviously if there is some platform what allows commission-free access to sector funds then there would be no economic reason to not use sectors.

In terms of a portfolio where for whatever reason broad based funds make the most sense I would say you do not need every cap size or both styles for every cap size. When I was at Fisher ten years ago they had research saying the correlation between domestic mid cap and domestic small cap was something like 90 or 95% and I would imagine that it is now higher given that "all correlations have gone to one."

I do believe that having both domestic large cap (or mega cap if you prefer) and domestic small cap in a portfolio that only uses broad based products. There is research out there that says small cap value is the best performing domestic asset class, where it is economical it makes sense to choose that over all small cap like IWM. I'm not a huge fan of trying to game value over growth in this type of portfolio as there are rules of thumb about value over growth or vice versa but of course that may not always work.

For domestic large cap it may make sense to use a dividend product. Obviously a dividend ETF will increase the yield of the mix but it should also help with smoothing out the ride a little depending on what is under the hood. When WisdomTree first hung its shingle I wrote up many of the funds for TheStreet.com but always included a bit about watching out for the financial exposure. That still applies. If you are going to use a dividend fund for domestic large cap I would tell you to avoid one that is overly heavy in financials--if any still exist.

Developed foreign becomes tricky as most broad funds are heaviest by far in Big Western Europe and Japan. There are choices that avoid these areas of course. For some accounts we use Global X Nordic (GXF), we also include iShares Canada (EWC) in some instances and while we are out of Australia now I am sure we will be back at some point. To be clear the context of our use of these funds are for accounts where individual stocks or sector funds may not be the best way to go for whatever reason.

For emerging there are broad funds to choose from like EEM, there are country funds like iShares Chile (ECH) and there are thematic funds like iShares Emerging Market Infrastructure (EMIF). We use ECH and EMIF in various way for clients. Both ECH and EMIF tend to be less volatile than EEM. If someone wanted to ratchet up the volatility they might choose one of the broad based small cap emerging market funds that trade or even one of the small cap country funds--iShares has a couple of these and Index IQ has several of them.

The idea that a small account can only use a fund like EEM is silly. For many people a broad fund will make the most sense but why can't an opinion be expressed with Index IQ Small Cap Taiwan or EG Shares India Consumer? Yes there is an added volatility element but if you understand that and what the consequence for being wrong is and you've done the research then you should own what you think is the best proxy.

I might suggest a split between something like the above and a dividend fund like the EG Shares fund with the symbol HILO. It just changed its name you can get the proper name yourself at their site but the yield seems pretty good and with a few months under its belt it seems to be delivering on its low volatility promise but you should decide for yourself.

I believe in gold exposure and use GLD for most small accounts (we use it for large accounts too). The other precious metals have more of an industrial/cyclical element to them which is why I prefer gold but you get the idea, there are also a couple of funds with access to multiple metals.

This turned out to run a little longer than I thought so I will try to get to a sector approach in the next couple of days.

As for the quick trip to Maryland, I think all I am allowed to say is it went well, that and the crab cakes were good. I'm headed back to Arizona this morning.
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Finally, Inverse JGB ETPs!

OK, so I am trying to be funny with that title. PowerShares at some point listed the Japanese Government Bond Futures ETN (JGBL) and the 3x Japanese Government Bond Futures ETN (JGBT) which both offer long exposure to the JGB market albeit in an ETN. Now PowerShares has come along with inverse versions of those same funds; the PowerShares DB Inverse Japanese Government Bond Futures ETN (JGBS) and the PowerShares DB 3x Inverse Japanese Government Bond Futures ETN (JGBD).

The already existing long versions of these funds have little to no volume so why would they come out with inverse versions that would seem to have little promise of garnering much volume?

Candidly, I don't know but I do have a theory. For a couple of funds that do not trade much, the two older long funds have a lot of assets; about $80 million each per Google Finance. Providers don't seed funds with that much money, not even close. Someone, for some reason has positions in these funds (IMO). If that is correct then it is possible, very plausible, that PowerShares knows who has these positions and whoever it is now wants exposure on the other side of the market.

Over the years I have heard of instances where a big pool of money has a direct line into a fund provider like this and when the manager asks for a particular product it happens. I think this can be a positive in that if ETFs are the democratizing force I think they are then providers creating products based on end-user demand is a positive for the people making the request but also for the fund companies because if there is demand for fund then that demand will lead to AUM.

I've disclosed a few times that I've been lead to believe that this blog has had influence on a handful of funds that have come out over the years. While I don't know if that is true, I have been asked for input on numerous occasions and so it is logical that other advisors/bloggers/both are also asked for similar input.

This blog has tried to chronicle the evolution in the space since inception in 2004 (how nutty is it that the blog is seven years old?) and will continue to do. You, as an audience of end users can have input here, and at other blogs too, to help the industry evolve. This is very democratizing only if you take advantage of it.
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Is It Really That Bad?

A friend passed along a link to an article at Smart Money called 10 Things Baby Boomers Won't Say and it was profoundly negative.

The list included

"Make room kids, we'll be living with you when we're old"

"and we blame you for that"

"We can't face reality"

"We're unhappy ..."

"... and we eat our feelings"

"We will bury you in debt"

Reading the list I am reminded of a quote from our friend Bill up here in Walker that I have mentioned before. Bill said "you can figure it out now or you can figure it out later but if you can figure it now you'll be a lot happier."

A lot of things on the list would seem to relate to how people make life choices and figure things out for themselves. Part of this might be learning from their own mistakes which can be a great way to learn. We all know people in their 20s who have a lot of things figured out and we all know people in their 50s (maybe older?) who are clueless.

The notion of multiple generations under one roof is not new, it was somewhat prevalent many decades ago and anecdotally appears to be on the rise due to the recent state of the economy. Michael Panzner used to write about this a lot and while I've never agreed with him on the magnitude of troubles he sees coming he was early to see this trend. Naturally this sort of living arrangement will create various forms of resentment because of the proximity. I remember a bit on CNBC earlier in the fall about new home construction catering to the need for multigenerational cohabitation.

Not facing reality is a big problem in terms of required savings rates, investment performance, safe withdrawal rates, reasonable lifestyles expense-wise and several other issues. This is behavioral and while retraining would be a huge obstacle it doesn't have to be impossible.

I doubt that the baby boomers have the market cornered on unhappiness and obesity. Eliminating related psychological issues and physical maladies these are tough things to overcome. I am happy and try to stay fit and I realize saying "you should do the same" is wildly empty but I think it is ok to make a priority out of trying to make improvements here.

The debt comment seems to be at the societal level as in the country's debt is huge a growing.

The list dwells on various types of short comings that people have or think they have. To the extent the list will create financial desperation on the part of some portion of the population it raises the idea of needing your portfolio to generate some amount of income--placing more of a burden on the portfolio. The greater the need the greater potential for taking reckless risks in order to generate some withdrawal rate that exceeds safe or taking reckless risks to make up for some sort of large decline.

This does happen and has tragic outcome written all over it. Obviously a big focus on related posts here has been about how to avoid being in this sort of predicament. My thoughts on the best way to do this have always included saving more, spending less, living below your means and figuring out how to monetize some activity you enjoy doing and would otherwise do for free--reducing the burden on the portfolio.

I'm headed out Maryland this morning for a quick ETF-related meeting tomorrow and returning back to Arizona on Thursday.
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Not Much In The Way Of Innovative Thinking

One of the features in this week's Barron's included an interview with three investment advisors who were billed as ETF experts using all-ETF portfolios for clients. Obviously I have no idea where Barron's found these guys but the conversation read like something you could have read four years ago at IndexUniverse (that is a compliment to IndexUniverse and a shot at the Barron's article). Each interviewee provided specifics of the mix they use with percentages; two of them seemed to be very odd in terms of specifics and one of them was actually more like a slice of a bigger pie but was more interesting than the other two.

First things first, I've often said that all-anything portfolios don't make sense to me. It is not logical that the best way to capture every part of the market that an investor would want to own could all be in the same wrapper. It seems only logical that someone with the time and inclination would own various wrappers after studying the alternatives for each desired exposure.

There are logistical considerations like it not being economically efficient for a $28,000 account to have seven ETFs and 20 individual stocks but where there are not logistical constraints going all-anything is artificial.

There was one wildly self-serving comment in there that made me literally laugh out loud;

...have convinced me more than ever that investing is not a do-it-yourself, at-home proposition.

The context was levered ETPs but as the advisor does not use levered ETPs it just struck me a very funny comment. Like all investment products, levered ETPs have pluses and minuses that people should weigh out for themselves and then either use or avoid. One point that was implied was the levered funds do progressively worse over time but that is not accurate. Some have done progressively worse over time and going forward this will be the case with some of them but the key determinant of how these particular types of funds will over periods exceeding one day is the combination of up and down says that come. This might be reason enough to avoid the funds which would be perfectly valid it but it makes sense to have accurate information about the product.

There was one interesting nugget that seemed to be behavioral in nature which is that clients of one of the advisors tend to be more critical during declines of actively managed funds than ETFs because active managers should know better about certain types of blow ups. But with ETFs, the index is what it is and his clients apparently understand the difference. This was interesting.

As mentioned, two of the portfolios seemed odd to me. One of the portfolios owns SPDR S&P 500 (SPY), Dow Diamonds (DIA), SPDR S&P Dividend (SDY) and iShares S&P 500 Value ETF (IVE) totaling 27.8% of the over all portfolio and 55% of the equity portion. All four are variations on the same thing, that being US mega caps, and the correlation between all four has been very tight. One note is that IVE may not be the correct fund, Barron's just has it listed as iShares S&P Value so it could be Small Cap Value not large cap value. Still I cannot imagine there is any need to own both SPY and DIA.

The other odd portfolio had 16 different broad based ETFs comprising 50% of the portfolio for what the manager thinks of as equity exposure (more on that in a moment). The reason to mention this is that there were two different domestic large cap growth ETFs, two different domestic mid cap growth ETFs, two different domestic mid cap value ETFs, two different domestic small cap growth ETFs, two different domestic small cap value ETFs and both EEM and VWO. In all of the listed asset classes above there is an even split between the iShares version of the fund and the Vanguard version of the fund.

Obviously the weightings are tiny. In several instances the allocation to the funds are less than 2%. This is baffling.

This same portfolio also allocates 2.5% to "equity based commodities" spread across five ETFs. The largest weightings in this little slice is 0.60% to IGE and 0.60% to VDE with 0.30% going to SLX.

The platform might be one where there is no commission for trading but even so, this seems beyond odd to me.
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Sunday Morning Coffee

Sorry for not posting for the last couple of days I've got a lot going on that I'll mention in subsequent posts. But for now there was a very instructive passage in this week's Barron's that I think underscores a point I have tried to make over the years;

Shouldn't Europe cost less [meaning have lower valuations], given the news backdrop?

Enthusiasts for the continent say no. First, because many "European" companies are really global companies that happen to have their roots and headquarters in Europe. From luxury goods to heavy machinery, pharmaceuticals to telecom equipment, iconic Europe-run corporations get most of their sales, and certainly most of their expansion, elsewhere. "The days of looking at where a company is based to assess its growth opportunities are way in the past," says George Evans, chief of equities at Oppenheimer Funds.

Obviously the context is multinational corporations based in Europe, usually conversations like this in print or on TV are about US multinationals. Many people believe that multinationals are proxies for foreign markets because they generate some portion of their revenue from foreign markets. My contention has always been that multinationals are beneficiaries of foreign markets not proxies for foreign markets.

Embedded in the passage seems to be a sense of disbelief or a feigned lack of understanding as to why European multinationals have not performed better. Obviously any stock can do any thing in any type of market but I believe it is very unlikely that a relative mega cap (so it will be a large component of the benchmark index) from some country will go up 20% in a year that the benchmark index for that country goes down 20%.

For example long time client holding Vale (VALE) has had a good year fundamentally in my opinion but the share price is down 24% which is somewhat consistent with the Bovespa. Vale is obviously a multinational company but Brazil is digesting some top down issues and Vale's share price has not been immune but I never expected it to be; it is a proxy for Brazil.

Evans from Oppco, the strategist quoted above, could be right but he is calling for an existing dynamic to change and I believe that is unlikely to happen. I've made comments about the world getting flatter in terms of being able to access more places in the world but I do not believe it is flatter in the context of the above quote.

People love to go after this idea which of course is legit but this one seems pretty obvious to me.
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A Hoax?

Paul Farrell had a post a couple of days ago noting that financial literacy is hoax. He isolated some of the human behaviors that make it impossible, in his opinion, to retrain the brain to succeed and for good measure he threw in all the reasons why Wall Street brokerage are hell bent on preventing people from being financially literate.

Farrell is correct that human behavior gets in the way of financial success with financial success being defined as proper budgeting, effective debt management, sufficient savings rates and moderately competent investment results. I don't necessarily agree with the magnitude of his sentiment about brokerage firms in that they clearly have their own interests ahead of yours in a structure where interests are not generally aligned but I don't think they are out to "get you." Putting themselves first is not the same thing as trying to hurt customers but make no mistake, they do put themselves first.

To the point of financial literacy, people can learn from their own mistakes and the mistakes of others which serves to make them more literate. This does not remove all obstacles but people can improve in certain aspects of this. Unfortunately not everyone can become more literate and not everyone can make progress on every front but how much better off would a couple around 40 making a combined $50,000 be if they figured out how to get by with never using a credit card again? Or what if this same couple figured out how to save another $2000 per year? These would be incremental improvements but still big positives.

As for the Wall Street out to get us aspect, one way to look at it is whether people are allowing themselves to be the victim or instead making use of product innovation and access to more information to achieve a moderately competent result while minimizing doing truly stupid things.

The reason I say moderately competent is that that type of result can get the job done provided there is an adequate savings rate. I'm not sure what Farrell thinks of ETFs but obviously I think they are a great democratizing force in investing and allow people willing and able to put in the time to build an effective investment portfolio and bypass the wire houses (if Farrell is actually correct about them).

Farrell's articles are often interesting to read but I don't think they do anything to help people solve the problem. People can learn to think ahead to remember that occasionally markets panic lower, this has always happened and will happen again. People can learn to have parameters in place ahead of time to take defensive action or to get more invested. People can learn to pre-plan for when they realize they were wrong about something and need to make a change. People can learn to avoid big bets in their portfolios. This list is endless, or people can say "woe is me" and play the victim.
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An Explanation?

The chart to the left captures today's market action pretty succinctly.

A prominent blogger tweeted out right before the close that bloggers should put up a good post tonight because investors will be looking for answers.

I come at this much differently. Having an explanation for every big move in the market might be nice but in reality most explanations are simply guesses and not very productive.

More constructive for investors as opposed to traders, in my opinion, is to understand what the market cares about most right now and understand the fundamental backdrop. Right now the market cares about Europe and the fundamentals in Europe stink. They are trying to figure out which desperate plan of action might work best.

The best plan of action for your portfolio is to stick to whatever strategy you laid out before things got ugly.

One final note for the one reader who does not understand my humor and thinks I panic after declines and get excited after rallies; I use pictures like the dancing lemurs from the movie Madagascar when the market rallies to make fun of the ebullient sentiment that always shows up in print and on TV. I use pictures like the one on this post to make fun of the panic that sets in after days like today. In reality not much has changed. The market is still afraid of the same things, the fundamentals of Europe and the US still stink, this is still a bear market (IMO) and all of this has us back to where we were a week ago.
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Something Is Going To Give

There was a write up in the WSJ about a particular type of pension called a voluntary employee beneficiary association or VEBA. You can read the article for the particulars of this type of pension but the bigger point is that like other pensions, one element that will determine the future is stock market performance and the realization that the VEBAs mentioned can't count on the expected returns built into the plan.

The general take is that one way or another, retirees and future retirees are going to be adversely affected. There will be benefit cuts and current workers will need to pay in more and more.

One point I have made over the years is that if there is not enough money saved then something will have to give; either lifestyle, working longer or saving more before retiring. This pertains to defined benefit plans too.

All manner of retirement plans are facing some serious headwinds. The viability of social security and medicare as we know them has come into question, pensions are underfunded and savings rates and average 401k balances are generally much lower than they need to be.

I've also made clear the extent to which I think sole reliance on something like a pension or social security is destined to end badly for a lot of people. The reality that I think is coming down the road is various forms of "bailouts" for people who are not otherwise prepared for their financial futures and if you are somewhat prepared, or in even a better position than that, then you will not think the bailouts (there will be some other word) are fair because you won't benefit.

The benefit though is the psychic value of your own self-sufficiency and not having to fret over whether you will get one of these retirement bailouts. Self sufficiency is very empowering and not to be minimized. As far as not having to fret over the bailouts, financial stresses are very bad for us so the extent which we can have one less source of financial stress or mute the impact of a stresser offers the opportunity for being healthier. This always draws disagreement which is good but this is a philosophical point of not wanting to be at the mercy of something that is both beyond your control and on very shaky ground.
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Odd & Ends

Felix Salmon revisited an idea from a few years ago whereby foreclosed homeowners are allowed to rent the house they used to own at whatever the prevailing rent market is for the respective area.

One positive of this would be that it would be less of a life disruption for families who actually live in the house that was foreclosed upon. Very few people like to move and any children affected would not have to change schools. Another positive is that the houses in question would not be destroyed or otherwise vandalized on the way out. We all know it has been very common for people to cause a lot of damage, steal copper and whatever else. This would not happen if the family was going to stay, it would simply be a change in the title and a change in the occupants' relationship with the house.

The obstacle here would seem to be how many instances that the now-renter would not be able to afford fair market rent. Obviously there was some sort of problem with the mortgage payment and rents are now generally high relative to mortgages so the idea may not be able to work (if ever gets implemented) for logistical reasons. Fortunately I can't relate to this but the idea is innovative and we could use more legitimate innovation.

Barry Ritholtz had an interesting post about the history of the four secular bear markets of the last 100 years. Based on the limited sample size Barry says that we are probably a little more than halfway through and precedent says the low from March 2009 will be the low and unlikely to be revisited although he does not advise anyone hang their hat on those observations.

Of particular interest was the extent to which the "roller coaster ride leaves investors psychologically exhausted." It is reasonable and obvious that investors would be exhausted or some other word like maybe impatient or frustrated. Equity markets will start "working" again (although some foreign markets never stopped working) but in the mean time focus on what is in your control; saving money, having the proper asset allocation and planning ahead for the next market freak out so that you don't freak out with it.

John Hussman had the following nugget this week;

In our view, investors should presently hold risky assets only in the amount they would be willing to hold through the duration of significant downturn, without abandoning them in the interim. For buy-and-hold investors, that amount may be exactly the same as they are holding at present, but the choice should be a conscious and deliberate one.

The focus for me is not whether he is correct about what awaits the market on whatever timeline he has in mind but what the comment says about asset allocation. An important building block for asset allocation is having some idea of what the portion of your portfolio that is in risk assets could do to your bottom line and your psyche in some sort of March 2009 decline.

For example you utilities and staples stocks are unlikely to go down as much as the market in a serious decline. However things like mining companies and many types of tech stocks probably will go down more than the market in a serious decline. There will be certain environments where junk bonds will get pasted. The point is not that these types of things should not be held but to understand their dynamics relative to the markets. If most of your holdings have the volatility characteristics of a small cap coal company then you will go down more than the market. If all of your holdings have the volatility characteristics of Proctor & Gamble (PG) then you will lag the rallies. A blend between the two extremes can be constructed such that the portfolio is generally predictable.
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The One Missing ETF

For ages I have wondered why there is no ETF or ETN for publicly traded exchanges. Occasionally I bend an ear or two from this blog and maybe that can be repeated by laying out what such a fund could look like.

Some of the names will be obvious and chances are there will be a couple that you did not know traded publicly. Not all of them have pink sheet ticker symbols for US trading.

Chicago Mercantile Exchange (CME)

NYSE Euronext (NYX)

Intercontinental Exchange (ICE)

CBOE Holdings (CBOE)

NASDAQ (NDAQ)

Deutsche Boerse (DBOEY)

Bolsa Mexicana (BOMXF)

TMX Group (TMXGF) Toronto

London Stock Exchange (LDNFX)

NZX Limited (NZSTF) New Zealand

ASX Limited (ASXFY) Australia

Singapore Exchange (SPXCF)

JSE Limited (JSEJF) South Africa

BM&F Bovespa no US symbol Brazil

Osaka Securities Exchange (OSCUF) Tokyo is not public

Hong Kong Exchanges & Clearing (HKXCY)

Bursa Malaysia Berhad (BSAMF)

Oslo Bors (OSBHF)

Bolsas y Mercados Espanoles (BOLYY) Spain

Warsaw Stock Exchange no US symbol

Bulgarian Stock Exchange no US symbol

Mercado de Valores de Buenos Aires no US symbol

The soon to be merged markets of Peru, Chile and Colombia which for now all trade on their own.

There are others. One word of caution, just because some of the stocks have five letter designators for US trading does not mean they are easily traded. This listing is reasonably diverse from the country level, and for certain countries they obviously play into the ascending middle class and I would contend are a form of financial infrastructure.

This seems fairly obvious to me but it hasn't happened and so maybe it won't but I believe this line of business is on firmer ground than banks in many countries.
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Sunday Morning Coffee

Some odds and ends.

My buddy Art, whom I used to work, with posted this picture on Facebook from his stroll past Occupy San Francisco. While I still think this movement is trying to figure out exactly what it wants to say, they clearly are not fond of capital markets and many market participants.

Just as no one knew what a CDS was five years ago, (almost) no one knew the extreme relative disparity between the wealthiest people and the rest of the population. Now we all know multiple stats about the wealth gap.

The path that has always seemed logical to me was for each person to figure out how to make their way in the world they live in. They might have success or they may not.

While I can't be sure, this seems to be a missing component in what the protesters are talking about. Whether that is correct or not, I think the protests are going to last for a while and more people are going to be attracted to what they are trying to say.

On a related note, when Art posted his picture it drew a lot of comments including a couple of his friends asking for his opinion on a couple of market related topics. Like many of us, Art is very interested in the markets, he worked in the industry for a long time and still trades. The comments reinforced something I've mentioned before which that like Art, many of you are the go to person for investing questions/advice for your respective circles of friends and colleagues. Pretty neat that you might help prevent someone from doing something truly stupid.

Barron's had a recap of the latest implosion with solar stocks, specifically First Solar (FSLR). I've never been a fan of this theme as an equity investment. I got flamed for an article I wrote for theStreet.com in 2008 where I was negative on the group which lead to a CNBC visit where I said essentially the same thing. It would be great if it made economic sense either on everyone's roof, building massive farms here in Arizona and in Nevada or both. It didn't take much work, from the top down, to realize the extent to which subsidies were needed to make this work (at least for now) and now subsidies are disappearing--although maybe they will come back again. The foundation has just been too shaky.

Barron's also had a two-article special report on Brazil. The market is down a fair bit this year lagging behind the US by a meaningful amount. The threats to the story have not changed much over the years but the market seems to care more now as China may or may not be looking at a slowdown, GDP growth in Brazil this year is very low and inflation while a far cry from Brazil's past is a pretty big number these days.

This period of lagging will end, hopefully soon, but the threats will be the same it is just that the market will care a little less, that and GDP will start going up again. The big thing here is that the story, in my opinion, has not changed making this year more of a cyclical event. It is very interesting that the EG Shares Brazil Infrastructure ETF (BRXX) is only down 9% versus a 19% drop for the broader iShares Brazil ETF (EWZ).
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The Big Picture for the Week of November 6, 2011

A reader left what I took to be a very cynical comment yesterday;

What is your main goal in trying to bring an ETF to market? Altruism? Extra personal income? Both?

First, my use of the word trying in this context is that as matter of philosophy I take nothing in life for granted. There are a lot of steps to be completed and there is no fund until there is a fund as far as how I view things. Even in the ninth inning of game four of both Red Sox World Series wins last decade (they swept the Cardinals in 2004 and the Rockies in 2007) there was no joy of winning until they won.

Part of the equation is definitely expanding our business. There is some number of people who read my content in the various places it is published. If somehow they all wanted to hire us we would not be able to accommodate the interest. A lot of people have hung with the blog for many years and while they would never hire an investment manager they might have some interest in participating anonymously through a fund at least that is part of the equation.

On a personal note I have been very fortunate in terms of the writing opening doors to some very fun things I would not have otherwise been able to do and meeting some interesting people I would have never otherwise been able to meet. I think this will be a very neat thing to do, if I thought otherwise there would be no fund.

As for any personal financial gain, an ETF needs a certain amount of assets to be viable and while I have unyielding faith in the viability I take nothing for granted. Should it be successful it would simply be another income stream which is something I have written about many times.

As far as the crack about altruism, we are not doing this for free but I think seven years of blogging almost every day for more than seven years averaging a few hundred dollar/month in ad revenue might give me some credibility to say money is not my top priority in life. Ditto my involvement with the fire department except for the add revenue and I've been doing that a little longer than I've been blogging. And if you were to ask me, I would tell you that a big part of my job description is to help clients protect and grow their assets. I also believe the writing helps some people who for whatever reason would never otherwise hire an investment manager.
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Wait, Was This My Idea?

Not really but iShares filed for an ETF that is along the lines of a concept I've written about many times. The fund, if it ever lists, will be the iShares MSCI All Country Asia Information Technology Index Fund. This is similar to the Scandinavian Bank ETF idea that I've been writing about for quite a while now.

The various contract manufacturers in Asia and OEMs are a valid way to incorporate the tech sector into narrow based portfolio, indeed many of these names are very active on the local markets and weighted heavily in their respective country funds. Not all specialized funds have an audience of course but some have meaningful volume due in my opinion to the realization that broad indexing has not "worked"in many years and may not work for a while to come requiring people to go narrower and be more tactical.

Country funds are democratizing to a point as are sector funds, I think funds that combine sector and country or region enhance that all the more. I also think the various emerging market sector ETFs have long term utility as well.

As a quick update, the ETF that our firm will be managing is coming along. There are various tasks that need to be completed before the actual filing and those are getting done and it appears to be on track time-wise in terms of the expectation set out at the start of the process. Unfortunately, focusing the fund on greasy wool arbitrage won't work out as we had hoped (humor attempt). I will try to update as the process moves along.
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Replacement Rate; Hokum and Hooey

The WSJ's Total Return Blog shared some of the conclusion about magic retirement numbers from a report by the Boston College Center for Retirement Research. The key takeaway from the WSJ's viewpoint was people need 80% of their preretirement income and that socking away that much requires an 18% savings rate assuming 4% total annual return (there were other assumptions behind the numbers).

I like the idea of a very conservative estimated return but beyond that I think the entire framing is incorrect. As we've gone over quite a few times before, the thing that matters is expenses not income. Taking this perspective allows for more control in terms of planning to reduce expenses and hopefully being being less susceptible to the vagaries of the market.

If global stock markets generally do not double in the next 7.2 years (rule of 72) then it is probably not realistic to expect your portfolio to double in that time.

Some expenses have reasonable visibility like utilities and so could be cut if needed. For example we have two phone lines, a very robust programming package from Directv and we have two smart phones. We could literally cut those expenses in half if we needed to.

Some expenses may not have great visibility like various insurances, home heating costs, groceries and prescriptions. We talked about health insurance the other day and maybe we should count on 15% increases per year? There is obviously volatility in heating but sometimes that might work in the favor of consumers. With some coupon diligence grocery expense can be helped a little and prescriptions; some may go down for going generic and some may go up for who knows what reason.

Then there are one-offs like home repairs, car repairs, vet bills and all the other things like this I've brought up in the past. Add to this list for some people is adult children moving back in due to their own hardship. Someone we know up here had their 40-ish year old son move back in. This could be a net gain if the son pays rent but depending on the situation it could also be a net expense of course.

This also leads to a conversation about living in less house than you can afford, driving less car than you can afford and holding on to that vehicle a little longer and when you make discretionary purchases not doing so on credit (other than a rewards card you pay off immediately).

Over the years I have tried to convey that there are many expenses that come out of nowhere and this seems to be corroborated by reader input. To me this places the emphasis on reducing expenses that can be controlled (somewhat).

If you live a $90,000 lifestyle because your gross income is $140,000 then by using the BC report as a guide your portfolio needs to be $1.2 million to maintain the lifestyle. I get there by taking 80% of the $90,000 which is $72,000, I subtract $24,000 from that for social security (which might not be a correct figure) to get $48,000 and then divide by 0.04 to use the 4% rule.

Fill in your own numbers and decide whether you want to plan on social security (despite the above I don't plan on getting it). What number do you need? Where are you now? How much time do have to make up the difference (by both growth and additional savings)? Do you even want to retire?

Maybe you can save the 18% but what if you can't or what if a 4% total return is actually unrealistic (that would certainly be brutal)? Based on what we know about savings rates and 401k balances saving 18% seems very unrealistic for the general public and even then 18% may not be enough.

If, I say if, 18% is unrealistic yet that is the required savings rate then conceivably this invalidates the entire concept of a magic number. I contend that getting expenses down is a bigger priority because it is more within peoples control. Further, whatever your magic number supposedly is, it has no meaning when you actually retire. Whatever you have on that day is what has meaning. If it is not "enough" then you have adapt one way or the other.

I am all for saving as much as possible but the idea of a magic number is on shaky ground because even if you do get that number something could go wrong and derail the plan. It boils down to save more, spend less and I will add be ready to adapt.
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Bonds Over Stocks

There was an article from Bloomberg that got a lot of attention the other day. The article itself was not earthshaking but it seemed like many people around the blogosphere weighed in on it. Such a broad topic "bonds outperformed stocks for a 30 year period for the first time since 1861" lends itself to a discussion that goes wherever you want it to go.

The last 30 years have had a couple of anomalies that played a role here. First is that interest rates went from the mid teens to the low single digits. Gains can still be had with bonds for people willing to buy here but yields would need to go back to the mid teens again before repeating the result of the last 30 years. The other anomaly is the (more than) decade long round trip to nowhere for US equities.

It certainly is possible that ten years from now we will be fiddling with SPX 1200-1300 although I do believe the market will grow but will lag many other markets and lag what we today think of as being normal returns.

This general topic has been one of the cornerstones of this blog since I started it in 2004 and my answer has always been to have more foreign equity exposure. This has been pretty simple in that from the broadest viewpoint possible the economic fundamentals and some of the excesses from the 1990s built a case early in the last decade for US equities being relatively less attractive than many other countries. There was also a similar story for Western Europe and Japan.

Just from a casual observation "hey, things don't look so hot." As we sit here today late in 2011 I would again conclude that "things don't look so hot" for the US, Western Europe and Japan. That does not preclude those countries from having stock market rallies or even having seemingly prosperous decades.

It also doesn't take too much effort to figure out that for certain countries "hey, things look pretty good." It is fairly simple to understand if a country has something the world needs. Digging in a little more I think understanding some of the basic dynamics of an economy are pretty simple as well.

This obviously is the top down process. It starts very simply and get move involved the deeper you go but figuring out the dynamics and prospects at the country level is in the wheelhouse of most people interested enough in the market to read stock market blogs. Investing in countries can be as simple as country funds but obviously big bets must be avoided and it would be wise to own countries with different attributes.

You can go deeper into individual stocks of course if you have the time and inclination but as we know from the the research done by Bespoke Investment Group we know that many markets had normal decades from 2000-2010 and that even if the US flounders again in the new decade there will again be plenty of markets that have normal decades.

As I wrote starting back in 2004 this type of work merely puts the odds in your favor. Long time readers will know the countries I've favored over the years and the ones I've avoided and the logic was simple then as it can be now.
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What The MF?

The big story yesterday was the bankruptcy filing of MF Global. The news angles to this story include Corzine's reputation, possible disruptions in trading, other firms with possible counter party risk to MF, the bonds the company floated during the summer and a bad trade.

There is no shortage of coverage of all aspects of the news but of most interest to me is the trade made by going long, in some form, debt from several of the PIIGS and Belgium. As I write this there appears to be some question as to the leverage to put the trades on but the notional exposure appears to be $6.3 billion.

The reason the trade is interesting is because of the repeat of one of the most common behaviors that does people in time and again which not simply being wrong but being wrong combined with a grossly oversized bet.

This is something I've written about many times over the years and I always include the fact that this will continue to happen forever. I don't know exactly why participants take on deathblow risk with their trades but they do and every so often it ends very loudly as is the case now with MF.

Zooming out a little bit, an actively managed portfolio is a combination of decisions. No one gets every decision correct. No matter the investor, some number of decisions will be incorrect--this is guaranteed. If you know as a fact that some of your decisions will be wrong and there is no escaping this. And if you know ahead of time you will be wrong some times and obviously you can't know ahead of time which decisions will be wrong then the important thing becomes not letting one of these incorrect decisions sink you.

As obvious as this sounds Corzine is evidence that these types of bets still get made. The trade itself could have worked (per one CNBC report the trade might end up working but on someone else's P&L) it just so happens it didn't which didn't have to be a big deal but for the leverage and what appears to be an unwillingness to take a loss earlier on.

Several years ago a reader was kind enough to share his having put 25% of his portfolio into a biotech stock that went on to have deathblow news from the FDA. This anecdote is much closer to the type of damage someone can inflict on themselves as opposed to levering up several times their equity (there are some exceptions) and then wiping out completely.

This type of wipeout is unnecessary but it happens every so often and will happen again. It is a great example to learn from.
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