Trade Executed

Yesterday we executed a trade that might be a surprise but was telegraphed once or twice. We bought a small cap domestic bank. As it is a small cap I am going to refrain from mentioning the name at the point as I don't want to evolve into a small cap tout. Anyone interested in knowing the name can probably find out around July 11 if you take my meaning. If it immediately blows up I will be forthcoming about it.

I still believe the big banks are toxic for various reasons including the issue that JP Morgan (JPM) has been enduring for the last month or so and I believe the large banks will continue to struggle. If there is any area that can do well in the domestic banking group I believe it is with smaller cap companies.

The name we bought did not take TARP funds, appears to have very good loan quality and its balance sheet appears to be very healthy. Interestingly from June 1st, 2007 into the March 2009 low it only fell 32% (so it held up better than the S&P 500) as the Financial Sector SPDR (XLF) was falling 83%. I found a couple of different numbers for its beta but they were all below 1.00 and I expect it will continue to be a low beta hold which combined with a dividend yield in the high threes seems to make it the right type of hold if the market is done going up meaningfully for a while.

At the portfolio level our recent trades have reduced the volatility a little and increased the yield. At the sector level we have been very underweight financials and so now we are less so. Additionally we are now four to six years from the start of the crisis (depending on how you count) which is a long time. The worst crisis in 80 years will still take a while to sort out but a 2% exposure to a bank that appears to have managed around the full brunt of the event would seem to be a reasonable top down choice.

Another layer is deploying cash as the market generally has been working lower. We recently bought Kinder Morgan (KMP) when the market had dropped 4-5% from the recent high followed by yesterday's trade. Any sales we might make to take defensive action due to a 200 DMA breach would be to remove high beta and these recent names are low beta.
Read more!

Of Austerity & Depressions

Paul Farrell has an article up at Marketwatch about austerity in the US and depressions. Early on in the financial crisis I made comments that I did not believe we were in a depression and laid out some reasons why. At some point well into the crisis I began to think of it differently. In saying no depression I was thinking in terms of a 1930s type of event but there is no reason a modern depression has to look like the 1930s.

At some point I came to the opinion that history would look back on this period starting in the early 2000s and label it a depression. As a note I have a specific recollection of mentioning this a couple of times but I had trouble finding it in the archives (here is one post that comes close) which now consists of 4500 posts; today is post 4501.

This is not a call for apocalypse but in looking at the last dozen years, equity prices are 165 SPX points below the 2000 high, the employment situation has deteriorated badly. the housing market has deteriorated badly, we are debating the viability of programs like social security in a way that we have not done before, the country has taken on a debt load that would seem to be very problematic and we still have desperate and unprecedented policies in place trying to stimulate demand that is not really working. The divide between the haves and have nots seems to be the widest it has ever been.

As noted countless times before, the last 12 years has not prevented many markets from having normal or better than normal stock market results.  In thinking about longer chunks of time I continue to believe that healthy markets/economies can still do well. Short term of course and anything goes.

Any economy can reward innovation and resourcefulness be it on a grand scale like founding a social media company that goes public all the way down to monetizing a hobby. The extent we cannot rely on working for the same employer until we retire creates a crucial need for people to take a more proactive role in shaping their financial future.

Going along with that thought is personal austerity which addresses spending decisions and realistic attitudes about the lifestyle that be afforded. The recurring theme here is trying to avoid having your financial circumstance dictated by something other than your own work, habits and luck.

I draw an analogy to our recent scare with the Gladiator Fire in that I was very motivated to try to make sure our one road out of here would not turn into a parking lot. This was easy to foresee and so it was easy to get the word out about the potential. Similarly with what austerity in the US could turn out to be in terms of impacting social security and medicare, if you can envision cuts then you can try to take action that would minimize the consequence; save more and spend less.

If we turn into Greece at some point you might still want to go riot in the streets to have your political voice heard but it would be better if you didn't have to riot in the street.

As a quick note the US' fate could be terrible or great but would be different from Greece mainly because we can print our own currency. 
Read more!

A Not So Lazy Portfolio

Hopefully we are now back to regular blogging after the Gladiator Fire.

The lazy portfolio concept is intriguing on different levels. The blending of assets is interesting as is the idea of getting from here to there with the least amount of work possible. The opposite of a lazy portfolio might be some sort of frenetic day trading procedure. That leaves a lot of room in the middle for all sorts of strategies.

Personally I am not a fan of a truly lazy portfolio for my money but there is merit. I thought it would be fun to put together a not so lazy portfolio of individual stocks with a defensive overlay. We don't own any of these stocks but we do own some names that are similar. The idea with these stocks is there is very little likelihood of a blowup, they are generally well run not that there aren't occasional problems but of course the fortunes of any company can change at any time for any reason which is where the defensive overlay will come in.

I dug up one name for each of the ten sectors, tilted to yield and with plenty of foreign. Only one stock for each sector makes for a poorly diversified portfolio but can still be an interesting blog post (hopefully).

Tech--Seagate Technology (STX)

Seagate has been around for a long time and has matured into a low debt high yielding stock. It currently yields 3.8% and has a mid single digit PE ratio. Certain parts of tech have become sources of serious yield in the last few years. Seagate popped up a few weeks ago in a favorable Barron's piece. Despite the yield the name is still fairly volatile. It was having a great 2012 but then started selling of aggressively as the market has been rolling over in the last month

Financials--Westpack Banking (WBK)

This is one of the four big Aussie banks. We sold our Aussie bank about a year ago on concerns over an overheated housing market. As a trade it looks ok as both it (ANZ) and Westpack are down 15% but I would not say the housing market has had serious trouble. WBK focuses much more on the domestic Aussie market than ANZ. A big near term risk is the extent to which Australia has become a magnet for recession expectations--its yield curve is inverted which is a warning sign. At this point WBK is down 17% from its recent high and has a trailing yield of 8.2%. WBK has a good track record of raising dividends but if earnings drop then so will the dividend.

Healthcare--Abbot Labs (ABT)

ABT is a big diversified health company that everyone has heard of. It is usually very popular with dividend investors for growth but the yield isn't that high at 3.28%. At times ABT is a top performer and sometimes it lags which is similar to most of the big cap US pharma stocks. The company has six disparate business segments that you can learn about here. The cash flow multiple is good and the debt is low. I prefer other names but there are no obvious red flags that I can see.

Staples--Altria (MO)

This might be the easiest one to come up with for this sort of exercise. The longer term risk is declining smoking rates in the US. For now though, the stock does well and yields 5.1%. The company does have a fair bit of debt but not enough to choke on in my opinion. Growth is still positive but is modest. At some point growth could stop but I don't believe that will be the case for quite a few more years but whenever growth stops the name would become a sell.

Discretionary--McDonald's (MCD)

This is also a fairly easy one. It yields 3.1%, the balance sheet is is good shape but it is a little expensive. MCD is interesting because like some mega cap tech companies it has evolved into being a dividend payer. Everyone knows the extent to which a lot of the menu has been unhealthy but also the extent to which parts of the menu continues to evolve to meet demand for some healthier choices. Menu evolution will have some hits and some misses but makes the case that the company can continue to do well. Obviously it has an ever increasing global footprint as well.

Energy--Petrochina (PTR)

China is tough to own via a broad ETF because quite a few of the sectors, like financials, are better to be avoided. Energy is one that I believe can be owned. Similar to other segments, the Chinese majors seem to take turns being the top performer; the other two being CNOOC (CEO) and Sinopec (SNP). This might be a good time to buy the name as it is down 14% from its February peak probably due to concerns about a hard landing. If a hard landing comes then it will go down more and the current 3.6% yield won't help much. It is cheap; trading below its revenue and with a mid single digit PE ratio.

Industrials--Lockheed Martin (LMT)

This name seems easy to forget about but it has a single digit PE, a low net debt load, yields 4.8% but growth for the time being is estimated to be middling at best. This is one of the big American defense contractors. The entire group will always face political threats but the primary products will always be needed and there must always be innovation with these companies. We own another defense contractor and it seems like they all take turns being the top performer.  

Utilities--Utilities Sector SPDR (XLU)

Why not use at least one ETF for this post. XLU is domestic large cap oriented. It has a trailing yield of 3.88%. XLU represents the utilities stocks in the S&P 500, it is generally going to be a defensive position so it will probably lag when the market is doing well and be a top performer in a downturn. The biggest risk looking forward would be higher interest rates. Interest rates are at about all time lows and whenever they turn up it will be a drag on this sector.

Materials--BHP Billiton (BBL)

BBL is the ticker for the UK ADR not the Australian ADR. BBL yields 4.1% versus 3.5% for BHP. Over the last year BBL has outperformed by 2.4%. The trailing 12 months has been bad with a 32% decline but it has been rough going for the much of the mining group. This is obviously a mature company and when things are going well for miners then BBL (and BHP) will do well without being the best and when things are going poorly it will also do poorly although probably won't be the worst. Growth estimates are pretty good and the PE is a little over six. Six is low but not out of line low compared to other big miners.

Telecom--Telenor (TELNY)

Telecom is probably the easiest to add a foreign stock because so many countries have a large company in the sector. Telenor is from Norway, it has low debt compared to the big three US telecoms. It yields 5.6%, has a decent global footprint, good growth estimates but the name is volatile. It has dropped recently by a noticeable amount and it would probably continue down more if the recent selloff continues. Some of its foreign dealings are complicated, especially with Vimpelcom (VIP).

The above mix is obviously a large cap combo but as noted the objective was managerial track records with a skew toward dividends. These traits are harder to find with small cap stocks. The lazy aspect is that the companies are fairly steady even if the stock prices can be volatile. Anyone able to think long term can probably hold onto these names. ride out the occasional storm and be ok.

As also noted above, one objective is a defensive overlay. I've written a lot about defensive action when the S&P 500 goes below its 200 DMA but of course another version is heeding the 200 DMA for each individual holding. This won't get you out at the top but I believe would be very effective on the way toward cutting in half. Someone wanting to be more tactical could also sell when a stock gets too far above the 200 DMA and buy when it gets too far below the 200 DMA as an add on strategy.

One obvious caveat is alluded to with Altria which is any long term story can end. The story for MO ending seems to have the most visibility now but that could change at any time for any name. A mix like the one above which is a large cap dividend oriented combo is very unlikely to ever be up 20% in an up 5% or up 10% world but the extra yield and the quality of the companies (if they are quality) could compound over time to outperform as could effective use of a defensive strategy.

In the real world an entire portfolio of companies with the same attributes does not make for the best diversification in my opinion but it still can work, especially for people who save adequately.
Read more!

Barron's Ranks Annuities

Barron's had an odd cover story this week which ranked the top 50 annuities. I have never been a fan of annuities because they are usually very expensive and I do not like the idea of relying on an insurance company to stay in business.

My mother had an insurance company fail on her (I had nothing to do with her buying an annuity) which contributes to my sentiment. There are of course some that are not that expensive.

One observation that I have shared in the past is that anecdotally I know a few people up here who have annuities and they absolutely love them. I have no idea whether they paid a fortune to get into them, I have no idea if they really understand what they own but they do understand the income stream and they do provide comfort without the worry of being in the stock market (talking end user perception).

To the extent any of these folks were with insurance companies that were on the brink in 2008 I don't know whether they knew they were on the brink or not but this is a big part of why I personally want no part of them. I do acknowledge the comfort they appear to provide.

Last night I started working on a regular post for today but got called out on a lengthy medical call so hopefully regular blogging will resume tomorrow but in the mean time please weigh in with what you think about annuities.
Read more!

The Big Picture for the Week of May 27, 2012

It looks like the ordeal with the Gladiator Fire is over (it would not be a Black Swan if something did happen). A week ago there was no certainty about any aspect of the fire but the uncertainty seemed to fade slowly over the course of the week--thankfully.

This was the first Type One Incident to threaten our area so obviously it was my first Type One Incident. There was another large fire in 1972 that I believe predates the current typing system. I made certain decisions on preparing for just in case based on trying to avoid Walker Rd turning into a parking lot under a get out now type of evacuation.

Going in it was obvious that not everyone would be happy regardless of the outcome--this is true of every decision made by any fire chief on any topic. We've had very little push back but there was a little which again is to be expected.

The interesting thing is how some of the biases and fallacies we talk about with investing came out during this event, an event that would seem to be much different than the process of managing an investment portfolio. This isn't necessarily a shock but it is interesting to see these sorts of behaviors exhibited in a completely different context.

One final note (hopefully) on the fire is the extent which I learned a lot, was able to get a structure protection plan devised by people with far more experience and (hopefully) raised the profile of our department made this a net positive despite some serious uncertainty early on. Unfortunately fires this big usually start in June in Arizona so it stands to be a long fire season.

Thanks for your patience with the sporadic blog posts.
Read more!

Monetizing What You Love Doing

For the last few days I have been writing a little about the Gladiator Fire which threatens the little community where my wife and I live. Fires are categorized into types with a Type 1 incident being the most serious and so garnering the most resources (financial and man-power).

The Gladiator Fire is a Type 1 incident and there are a lot of people doing all sorts work that most people would never even think of. Walker (where we live) is the the big "value at risk" and so we are a center of attention of sorts for the incident and I have been very engaged in several aspects of the fire which has allowed me to learn a lot about how these types of incidents are managed. I've also gotten to know quite a few people who might be involved should we ever have one of these closer to home.

In the past I've made vague references to doing certain types of tasks on these incidents as a post retirement income income stream. For example large incidents have a finance division which lends itself to people with flexible enough schedules to take the occasional, seasonal gig.

I have a more tangible example of this. Last night on my way into the planning meeting I ran into a (retired) friend I've known through fire service for many years now and he was working for the fire in a similar capacity as one of the finance jobs.

My friend had to go through some serious paperwork hoops but he contracts on a per incident basis to shuttle supplies from the camp around the Incident Command Post (ICP) to various points out on the fire (from top to bottom the fire is about six miles long, the base camp is about 20 miles from the anchor of the fire appears to be 22 miles around). He uses his truck so there is serious wear and tear on the vehicle. The pay is a little over $300 per day plus mileage and he can eat the food provided at the fire camp (that might seem like a joke but assuming the food is good, and it is, that is one less expense as he goes). He said the mileage about covers the fuel expense for his vehicle.

The trade off is the wear and tear on his truck and driving all day, every day for what will probably be 14 days (more on that in a moment) so this is not easy work. The upside to the work is any involvement with a big fire--people who do this stuff love it and often want to stay involved in some capacity for as long as possible.

He can be called to any type of incident anywhere but realistically there might be 3-5 times a year that he will work a fire in this capacity. People on the fire in typical roles (firefighters, members of the incident management team and so on) have a 14 day time limit but I don't know if that applies to someone in my friend's capacity or not. Assuming it does he'll make a little over $4200 and if he does that four times this year then it is almost $17,000.

In terms of monetizing a hobby or finding a unique solution tailored to your own situation and interests this example epitomizes exactly what I had in mind. There won't be too many people who want to do this which of course does not matter; he does, he loves it and the money is meaningful.

For someone living a modest lifestyle $17,000 could easily cover three or four months of basic expenses--maybe even a little more? Make no mistake this is hard work he's doing but if you love it, it isn't necessarily "work."

As for the picture, someone is leasing the hand washing station to the fire.
Read more!

The Facebook Goatrodeo Continues

A reader left a link to a Yahoo video discussing the revelation that Morgan Stanley allegedly was going to cut earnings on Facebook (FB) and then gave that info to select clients. This comes on top of what has been a very loud failure of sorts of the actual offering. 

The sell side of the industry has evolved a lot but is still rife with conflict. The action that Morgan Stanley supposedly took with this (and for that matter there are now questions as to what their position in the stock actually is) may or may not be illegal, I don't precisely know but as I said  in the comments yesterday it is unethical if true. It is also not new behavior if it is true.

We seem to be in an era where this sort of thing can no longer be hidden as well as it used to be which a positive but it will still go on. This is not something I spend much time on as we've never tried to access an IPO and we don't do business with these types of firms. As we move forward with our ETF we will be doing business with several trading firms which creates the potential for "getting our face ripped off" but obviously we believe the firms we'll work with will treat us in an ethical fashion as there is a competitive element that doesn't necessarily exist when someone opens an account at a sell side brokerage firm.

As far as Facebook's stock, most people knew it came to market with a very high valuation. I tweeted that I wasn't sure how to value the stock (reason enough to stay away). Barry Ritholtz replied "earnings and revenues?" to which I said I did not think that would matter for some short period of time. Generically speaking a stock at 100 times revenue does not have to be an avoid but something will have to give. Walmart was very expensive for years and the thing that gave was the stock price didn't really go up but the earnings did.

A different outcome for Facebook could have the stock goes up a little and the earnings and revenue go up a lot or the IPO turns into a goatrodeo.

Fire related, I spent a chunk of yesterday with the structure protection division supe yesterday going over the map of our area and then taking him on a drive around to see what it actually looks like here. It is possible that the fire gets here but it is not probable. Hopefully the work done Tuesday will be helpful for any future incidents we might have. The wind on Tuesday did pick up as they predicted so I will find out at the Tuesday night planning meeting if there was any consequence to the increased winds--I have been attending the planning briefing every night which will continue for quite a while and I wrote this post Tuesday afternoon before the meeting.
Read more!

Phew! Stock Market Correction is Over!

Actually I have no idea if the correction but it truly amazes when the market goes down for a stretch the extent to which pundits all pile on that it is going lower then the market has a day like yesterday and we hear about earnings growth and stronger economy.

However bad or good things were on Friday, it is no different after yesterday. This would again seem to be a good time to talk about remaining disciplined to whatever strategy was laid out before the market started selling off and when there was no emotion involved--if you even believe in a defensive strategy.

It is always worth repeating; when the market is doing well, everyone will tell you that of course the market goes down every so often but that is no problem. Then the market starts going down many of those same people will have a serious problem.

The market will have ups and downs and no one will get all of them right. But you can use a strategy that you have some reasonable basis to expect will work more often than not which combined with an adequate savings rate can give leave you with enough money when you need it.

Monday had calmer winds at the Gladiator Fire which is a positive but winds are expected to increase for the rest of the week. The work done on the fireline that is the most obvious threat to Walker has been fantastic but the concern would be if winds do pick up and launch embers out past the fireline such that it torches up and makes a run in our direction.

For now the work on our end remains going to meetings, putting out a lot of emails and answering a lot of phone calls. We are trying to discourage people from coming up here later in the week in case there is an evacuation notice issued at that time. Our best estimate is that the population doubles for the typical Memorial Day because of the holiday and the annual meetings in Walker and the adjoining community. For now an evacuation is absolutely possible but remains improbable. Lets hope that stays the case.
Read more!

Facebook Goat Rodeo

The price of Facebook (FB) stock is well below the $38.00 offering price in the pre-market unofficially making it a goat rodeo. Apparently syndicate bids aren't what they used to be.

Facebook is clearly a life improving service for people interested in catching up with people they lost touch with decades ago, it is a game changer for things like non-profits to create awareness and even for large businesses.

Just as the internet exceeded the hype so too might Facebook be more than we thought but that does not have to mean the stock is a game changer. It might turn out to be, I don't know but this is part of a fad of recent social media names to IPO. Maybe someone can refresh my memory but I don't recall too many internet IPOs around the time Google (GOOG) IPO'd thus GOOG was not part of a fad.

Yesterday was a good day weather-wise at the Gladiator Fire which made for effective fire suppression but today the wind is due to increase and keep increasing for the next couple of days at least.
Read more!

Sunday Morning Coffee

Some of you may know about a fire near Prescott called the Gladiator Fire. It started last Sunday as a structure fire that got into the forest. This fire is now close enough to Walker that we need start preparing to evacuate and as fire chief I am obviously in the middle of this. My phone has been blowing up, I am in contact with a lot of people, attending a lot of meetings and managing a lot of different things.

For the first week, the fire burned up a lot of empty USFS land but as it moves closer to Walker and Potato Patch (just south of Walker) there are now a lot structures at risk (only four have burned so far) which makes Walker the center of attention unless they can stop the fire in its tracks. It is about six or seven miles from top to bottom of the fire and the head of the fire is about 8 miles from Walker as of Saturday night.

The neat part of this is all there is to be learned and of course the downside is the threat to the community. Long story short, it is not probable that the fire gets all the way here but it is possible.

On Saturday Joellyn and I prepared to evacuate. We packed up a lot of clothes and a lot of stuff and took it to a friend's house in Prescott Valley. We actually don't have a lot of either but if there is a worst case outcome we won't have to start from scratch. There won't be much to take other than the dogs so no last minute scramble. Long time readers may notice similarities with things I've written over the years about navigating cycles with an investment portfolio.

One thing we did not take out of the house was any of our books. It's not like we have 1000 books or anything but in looking at them and deciding not necessary I thought about the story of Umberto Eco, as told in the Black Swan, who said something like it is not important what books you have read, but the books that you haven't read that are important.

This will be a very busy week around here. We should know whether we need to evacuate or not by mid-week (they will have either succeeded or failed at stopping the fire by then) but through the magic of spreadsheets we will be able to start defensive action on time if necessary.

For now Walker Fire's role is phone calls and meetings. If the fire gets here then we should be integrating with the outside crews that come through and stay for as long as it is safe or the incident ends.

Of course any of the above is subject to change at anytime.

The picture is from the Incident Command Post (ICP) at Mayer High School on Saturday morning.
Read more!

The Big Picture for the Week of May 20, 2012

A reader asks;

What percentage of your client's equities do you sell if the 200-day is breached?

There is no specific answer. Part of the process as mentioned in past posts is having an understanding of market history and combining that with what appears to be going on now to hopefully make a forward looking analysis.

The stock market cycle and economic cycle are both somewhat long in the tooth but there is a relatively low probability of the market cutting half because it did so quite recently.  Late 2007 and early 2008 was a little easier than now because the yield curve was inverted and the 2% rule was in play (2% decline three months in a row is a good indication that a bear market has started and the market doesn't drop 2% three months in a row very often). The current decline is a little over a month old which makes it more of a fast decline for now than a slow rolling over.

The 200 DMA is only 17 points away but the moving average is still sloping upwards ever so slightly. That is not a reason to change strategy but to be a little less aggressive. A couple of years ago the SPX danced around the 200 DMA without ever really going down a lot and that was as the moving average was sloping upwards.

If the 200 DMA slopes down and the 2% rule comes into play then our defensive action will be more aggressive, if those things do not come into play then we would be a little less aggressive in taking defensive action. 

I have been very consistent over the years in saying the discipline is in taking action upon a breach but that the action taken does vary depending on the situation. Being aggressive early in the financial crisis helped returns (this was all blogged as we went along) but a couple of summers ago the defensive action was drag. It was fortunate that we were not more aggressive then as the drag would have been bigger.
Read more!

Check Yourself

Yesterday I was asked a question about preemptively taking defensive action before a breach of the 200 DMA in what has obviously been a poor tape for the last couple of weeks or so. Weeks like this is exactly what all those posts about discipline and avoiding emotion are all about.

The market has backed off enough to apparently make people nervous. Getting nervous or even scared is perfectly valid but what matters is what you do in the face of being scared or nervous.The reason to put some sort of objective trigger point in place at a time when emotions are not involved is so that there is no need to guess about what might happen at a time when you might be clouded by emotion.

For anyone feeling emotion right now all that needs to be done is to remain disciplined. We may have opinions about what comes next and while those opinions may or may not be correct no one actually knows what comes next. It is possible that any sort of strategy you might use (including my preference for a simple breach of the 200 DMA) will turn out to work very well on this go around or maybe not so well but if you use some sort of strategy like this then you must have some basis to believe it works more often than not even if it is not the single best on this go around. No defensive strategy can be the best every time but it still can be very effective.

My hope for the 200 DMA strategy is simply that it allows us to miss the full brunt of the next large decline whenever that comes. Going down a little, for investors, just goes with the territory. Traders may view that one a little differently.

I have unyielding faith in our strategy in terms of getting us to our long term objective but a part of that equation is that there will be periods where clients will be uncomfortable. It would be great if that were not the case but it is and does not have to disrupt achieving the long term goal unless someone succumbs to their emotion. Anyone really freaked out by the current decline probably has a short memory and probably has too much equity exposure.
Read more!

Trade Executed

If you watch any of the shows on stock market television with real traders then you have heard them say on more than one occasion something like "we bought at the low in the after hours yesterday" or "we sold at the high two days ago." Well this isn't one of those stories.

In past posts I've talked about one reason for selling being you are simply wrong. Maybe wrong about just one thing or maybe several but turning out to be wrong one way or another is one reason to sell. It is not possible to be correct on every position. Everyone will get some number of decisions wrong, this turned out to be wrong for us and we will be wrong on other things in the future.

A while back we bought the Market Vectors Coal ETF (KOL). The basic idea was an expected long term increase in global coal demand and to add some volatility to the portfolio. I was also favorably disposed to the country make up of the fund.

While demand is likely to increase over the long term that was never going to be a one way trade of course but I believe I underestimated the extent to which short term visibility for lower demand would pulverize the stocks in the group. In a similar vein I believe I also underestimated the extent to which the group would go down in the face of signs of an economic slowdown. 

The general path of the fund since we bought it was that at first it went up nicely (that is good), then it backed off a little in line with the market last year (this is not necessarily bad) and then it mostly kept going down as the market went up earlier this year.

Recently I laid out an argument for 2013 being a down year based on how long GDP has been positive and how long the stock market has been going up. In the last few weeks the market has come back down some and so if my 2013 thesis turns out to be correct but is actually starting early and we go on to breach the 200 DMA then KOL would have been the first thing sold. Given what appears to be a murky short term outlook for coal I think that if a 200 DMA breach is coming then we'd just end up selling KOL five points lower than where we actually sold it yesterday. Of course in hindsight it would have been preferable to have drawn the same conclusion two weeks ago and for all we know maybe the next five points will be back up.

As I said above this one just turned out to be wrong and it won't be the last one in my career. Generally it should be easier manage holding that turn out to be bad holds when you realize ahead of time that this will happen now and then; it simply goes with the territory. This is also a reason to talk about position sizing. We can't know what we will be wrong about otherwise we would never buy. So if you know the occasional position will be wrong and you don't know which one it will be then you have to be very mindful of position size and the potential consequence of being wrong. 
Read more!

Black Swan Alert--Financial Stocks Still Stink

Before anyone gets worked up, the title of this post is meant to be sarcastic, I realize a decline in bank stocks is not a black swan. If anything it is a white swan as I have been saying from the time we knew it was a crisis that there would continue to be shoes to drop for a long time; the worst financial crisis in 80 years will take a while to sort out. Any black swan nazis can instead think of the title as "I want to show you something, it's my shocked face."

Part of the equation for my belief of this taking many years to get healthy again is how long it took the Great Depression to sort itself out. It is probably now generally accepted that the crisis of 2008 did not have anywhere near the societal consequence as the Great Depression but one point just as true but getting less attention is that the crisis of 2008 was/is far more complicated than the Great Depression.

The complexities of the businesses of investment banks and derivatives were/are monumental and I believe the totality of the recent event is far less likely to be fully understood by the people who lived through it than with the Great Depression. If this line of thinking resonates with you then you might agree about it taking years to sort out, correct and fundamentally recover.

I found a very interesting commentary via Barry Ritholtz about how the mentality of picking up nickels in front of steamrollers is alive and well and will destroy Wall Street firms. While it is less clear that Wall Street firms will be destroyed the business with the Whale of JP Morgan losing $2 billion on a hedge creates doubt about what was actually learned from crisis about thinks like risk limits, VaR and other aspects of running a prop desk.

Legislating this would not be the right thing to do for at least two reasons. As a practical matter these institutions always figure out what restrictions will allow them to do an then pile it on. From a philosophical standpoint the only ones that should be protected are the depositors; let equity holders and bond holders eat it if it gets to that point. Having a suitable framework is appropriate but changing that framework in reaction to every big news story that comes along will have very poor results with many unintended outcomes. The financial system is smarter than those who will try to legislate it.

The investment implication here should be to tread very lightly in this sector. We continue to use an individual bank stock from Canada and Chile, the Australian Stock Exchange (ASXFF) and an index provider. The broad sector ETFs are generally heavy in Citigroup (C), Bank of America (BAC) and JP Morgan (JPM) all of which we prefer to avoid. There is a bullish case to be made for JPM that I concede is plausible but we prefer to avoid it. I have been working on finding a couple of very small domestic banks to buy and I think I have found a couple that appear to be very well capitalized, have very good (sustainable) dividends and relatively few moving parts. If I add this type of exposure in I will disclose the name we buy.

One point about the JP Morgan loss to clear up is the notion of losing money on  a hedge. Many have noted that if the hedge failed then the underlying asset must have done well so how could it be a net loss. This is pretty easy to explain with an admittedly simplistic example. Let's say you load up on some stock and you hedge the entire position with puts that are 10% out of the money at a cost of 2% of the long position. The stock then drops 8% and the puts are allowed to expire worthless. Money was lost on the hedge and the position is now down 8%.
Read more!

Sunday Morning Coffee

Just a brief comment or two about the upcoming Facebook (FB) IPO. According to Barron's, FB has a "user base of 901 million, or 58% of the globe's Internet users (not including China, where the site is restricted)." Barron's quoted company filings as follows "we do not currently directly generate any meaningful revenue from the use of Facebook mobile products, and our ability to do so successfully is unproven." 

My first thought is it does not seem like there can be much user growth unless the restrictions in China come off. There was no mention of any expectation about growth in Africa, which has one billion people but would seem to be a ways from embracing social media. If this is correct then they need get growth from further monetization of the user base which might be difficult in the short term if more of the growth in usage is coming from mobile which is a weak spot for them.

It is not unreasonable to expect FB to overcome this weak spot but this appears to be what the thesis will rely on.

I haven't written much, if at all. about the FB IPO. Sometimes I get a sense of how these things will go (not to imply I am always correct) but I have no sense of how this one will go. It probably doesn't matter in that I've never tried to game an IPO with client money.

Zooming out a little, social media stocks are a fad. The fad may last for quite a while (or not) and some folks will do quite well but it could easily be that the thing (the utility gained from what these companies do) is far more important than the stocks as was the case in more instances than not 12 years ago. If you get involved, do so in a reasonable proportion so that a blow up does send you back to the financial planning drawing board.
Read more!

The Big Picture for the Week of May 13

The other day I stumbled across an article about the dividend yields for four gold mining stocks including Anglo Gold Ashanti (AU). Before the SPDR Gold Trust (GLD) came along we used AU for our gold exposure. It did ok and then starting in late 2005 in started skyrocketing and we sold it in February 2006 and swapped it share for share into GLD which we've held ever since (we did sell a chunk of GLD last August).

Historically there have been times where the metal outperforms the miners and vice versa. There were rotations between the metal and the miners and back again for this particular trade and every so often you would hear or read someone explaining how this worked. The sale of AU came after a period of miner outperformance and the swap at the time seemed obvious but I had no real expectation of being able to time it again.

Since early 2006 though this relationship seems to no longer exist. Since we sold AU it is down 38% and GLD is up 181%. Newmont Mining (NEM) has done a little better than AU dropping only 18%. The Market Vectors Gold Miner ETF (GDX) started trading a couple of months after selling AU and since its inception it is only up 11%.

Either the relationship between the miners and the metal has actually changed or this is a prolonged period were the miners are lagging (the YTD numbers are not good for the miners either). It also appears as though AU is a completely different type of stock than it used to be. Google Finance reports its beta at 0.61 and the yield at 3.1%. The above linked article quotes the yield at 3.27% but dividend.com says 1.44%. As I look at the historical price page on Yahoo Finance and applying the dividends only sort I see three dividends in the trailing 12 months adding up to $0.495 consistent with the yield quoted at dividend.com.

If it really yields 3% then that really is a big change from when we owned it and just looking at a long term chart leads me to think the beta is correct. While I am not certain what the beta was six years ago it was well above 1.00. In past posts I've talked about stocks' attributes changing as a reason to consider selling and although this was not a reason for selling AU when we did it is a good example of what appears to have been a meaningful transformation.

Generically speaking there is of course room for a low beta, high yielding stock in a portfolio but expecting high octane and getting something else can work to a portfolio's detriment.
Read more!

Individuals Have No Business Picking Stocks? Really?

Yesterday on CNBC Steven Rattner made a lot of noise by noting that individuals have no business picking stocks, that they should instead only use index funds. Later in the day the network picked up the ball to try to extend that conversation in a segment with Thomas Lee from JP Morgan and Roger Crandall from Mass Mutual. The segment was a dud due to the guests; I believe the right questions were asked but the answers offered no real help to individual investors.

Crandall kind of agreed with Rattner but also kind of disagreed (please leave a comment if you heard it differently) noting that 70-80% of the people they talk to want professional help. That is of course a useless stat, you would think a firm whose business it is to provide investment advice would not spend a lot of time talking to people with no interest in investment advice.

In terms of thinking about the entire US population, which is where the conversation started, it is a small percentage of people who are attached to the market enough for this to be relevant. The closest many people will ever get is a 401k that hopefully accumulates into something meaningful but the statistics on this tend to be grim.

So really this is a conversation about a subset of the US population and I think it is reasonable to conclude that this subset has more money on average than the rest of the population. If they have more money for what ever reason then they might be inclined to have more interest in what to do with that money including being involved with capital markets. Obviously someone with this interest might be more inclined to spend a reasonable amount of their time on the stock market.

There is some percentage of this subset that should not have much involvement with picking individual stocks. Hopefully that percentage is small but it exists. Everyone has things they simply should not do and for some folks it is picking individual stocks. For most other members of this subset the suitability for including individual stocks in their investment portfolios boils down to the amount of time they are willing and able to spend on investing and of course their investment philosophy--someone could spend 80 hours a week studying markets but not believe in picking stocks. 

Although some of the tweets solicited for the segment touched on this, for many people the answer is likely to involve a combination of funds and individual stocks. It is reasonable that someone who is very interested but not able to devote a full work week to the task could pick stocks for some portion of his portfolio even if not the entire portfolio. Even with the time to spend, there are still segments where a fund will be the better investment choice.

For example someone might want to use the Global X Norway ETF (NORW) for some or all of the energy exposure. The fund is 50% energy with much smaller weightings in the other sectors. If the investor is comfortable with stock picking in this sector then maybe they could combine NORW, or some other ETF with a stock or two; maybe one stock for yield like some sort of pipeline company and maybe some sort of niche play like a Bakken name or oil sands or something else.

With a sector that the investor is not comfortable with picking stocks then just using a single ETF for that sector can work. Maybe the investor doesn't know a lot (relatively) about utilities then something like the Utilities SPDR (XLU) can work.

Another approach is using a broad based fund, or maybe several to cover a lot of asset class ground and then layering on a few stocks as a version of core and explore. I would be wary of this as I think it increases the chances of owning too much of the wrong sector at the wrong time--think owning SPY 12 years ago with four tech stocks like Juniper (JNPR), Commerce One, Exodus and Akamai (AKAM). That type of mix back then was quite plausible. SPY had 30% in tech plus however much of the portfolio was devoted to explore with names like this and the tech wreck was made much worse.

This is just one of several reasons why I prefer looking at each sector and making a decision about weighting versus the benchmark.

I would close out with one final, related point. I write a lot of posts that are more about lifestyle issues and thoughts about trying to understand what is really important. Bigger picture this is about getting to know yourself because if you understand what you are really about (many people do not) then you have a better chance of figuring out what type of investor you should be which should better orient your portfolio toward meeting a more properly defined objective.
Read more!

How Bad Is Europe?

The chart tracks the S&P 500 SPDR (SPY) against what I believe are all of the Eurozone ETFs; iShares France (EWQ), iShares Spain (EWP), iShares Germany (EWG), iShares Italy (EWI), iShares Belgium, iShares Netherlands (EWN), iShares Finland (EFNL) and Global X Greece (GREK).

The YTD returns;
SPY +7.63%
EWQ +1.23%
EWP -18.50%
EWG +10.30%
EWI -7.67%
EWK +9.14%
EWN +1.57%
EFNL -7.76% (this fund started trading January 26)
GREK -10.15%

There really is a wide range of returns here. Germany and Belgium certainly are surprises as is Finland. Despite it going deathstar, Nokia (NOK) is still the largest holding in EFNL and no doubt contributes to that fund's poor showing (the next three largest holdings have all fared a little better than the fund).

For some reason Bob Pisani was on a jag yesterday about decoupling, saying no one likes it when he talks about decoupling but he said we're decoupling (except for Germany and The Netherlands). My thoughts on decoupling have been pretty consistent which is that any reasonable expectation should be for long term outperformance like Brazil being up 300% in the last decade versus a 24% decline for the S&P 500 (not including dividends). Over the course of a year anything can happen but expecting some equity market to go up 20% when the rest of the world is unraveling is not realistic.

The big macro for Europe has been the same for many years and will be the same into the future which is the demographics stink, the economic stats mostly stink, most countries are over indebted and desperate policy measures are not working as hoped for in terms of effect or time needed to have an impact. Over the years there have been comments generally disagreeing with my lumping Germany in with this avoid Europe theme although looking at a five year chart this has been correct more often than not. 

Looking forward and thinking about Europe we will probably hear and read a lot of comments from various professionals about how they are investing in Europe. Some will be able to avoid but some cannot because of various mandates/constraints they must operate under. If you agree with the points made above about Europe, then how soon do yo think any or all of them will change for the better? How you answer that question probably determines when you might want to get back into Europe. I don't think there is any visibility for meaningful improvement so we will continue to avoid the region.

Prescott had some very big local news on Tuesday night as there was a fire on Whiskey Row that took out three businesses. Whiskey Row burned completely in 1900 but fortunately for the town this fire was contained. It was reported as a three alarm incident and frankly I've never heard that term used for a structure fire here (obviously I am familiar with the term) so this was a serious incident. We went out on Whiskey Row the night before our wedding in 1993 and stayed at the St. Michael Hotel on the Row on our wedding night.

We have a group of firefighters who are young, just out of the fire academy who volunteer with as a stepping stone to a career with a paid department and one them went down there and took some pictures including the one above. Walker Fire was not called for the incident. Volunteer-only departments don't usually get called to these types of incidents.

Final item; as I watched the Red Sox struggle in Kansas City for the last three days I was amused to see an ad behind hoe plate for Kansas based BATS Global Markets which of course made a lot of noise with its failed IPO.
Read more!

What Does Long Term Actually Mean?

There was a post at Seeking Alpha about client holding Johnson & Johnson (JNJ) with the title JNJ Is Not A Good Long Term Investment For 2012. This was a pretty funny headline. The author made a bearish case mostly noting the lawsuits and image problem. The author went on to suggest a debit put spread on the stock (a bearish strategy).

The conclusion he drew and the trade he suggested will  either turn out to be right or wrong but more interesting is the question of what long term actually means. If the author of the above article is an options trader then the rest of 2012 could easily be long term. I've owned JNJ for clients since I started this phase of my career in 2004 and hope to hold it forever.

This is a recurring theme here. For most market participants, picking good stocks or suitable funds to be held for the long term is better than a lot of short term trading. Clearly plenty of people have success with shorter term trading strategies but that does not make it ideal for most participants.

Holding forever is more of a goal than anything else. Long time readers might recall past posts about Bank of America (BAC) which was bought in 2004 with the hope of being a forever hold and back then this was plausible.Not everything that happened with BAC was ideal (talking before the crisis) and this is true of all holdings but right or wrong the name was not necessarily a sell... until the Lehman weekend. Hold forever became an immediate sell overnight, literally.

Some of the benefits of holding forever, or hoping to can be read here but basically there is long term compounding in terms of the growth of stocks and funds that turn out to be good choices and also dividends. You've probably heard that people who bought what is now Altria (MO) in the mid 1980s (and held) now collect a dividend that is greater than their cost basis--their yield is more than 100%. I don't actually look at it that way; there is a dividend that right now is 5.1% of the value of the stock but some folks do, it has clearly compounded out over time into a monstrous winner.

This sort of thing can make investing a little easier and of course cannot be captured if the typical holding period is 6-24 months. When the time frame is that short then performance relies far more short term market signals and correct assessment of short term trends/momentum. If that sounds difficult then your time frame should probably be longer than that.
Read more!

Social Security Statements Now Online

Smart Money mentioned that Social Security statements are now online. The statements always make for interesting viewing so I took a look at mine. My benefit at 67 is slated to be $2459 per month and at 70 it would go up to $3103. My wife will get 50% of my payout.

So at some point we could be getting $4600/month in today's dollars which sounds great; this is way more than we need to spend to get by every month, way more. Of course this will change depending on how much our health insurance goes up in the future, but I don't think it will go from the current $330 up to $2000 in today's dollars (insert nervous grin).

Obviously benefits vary and only a smallish slice of the population gets the maximum benefit but in thinking about $4600, the question arises; how in the hell can the government afford to pay every eligible household between $1500 and $4600 per month for the rest of their lives? As a note, I don't know what the minimum benefit is, I just made that number up. Forgetting any research you've done on this for just a moment, thinking of it in this way makes it seem like an even larger problem, speaking unscientifically.

Another interesting number on the website (even if not new information) is how much has been paid in on my behalf which is $150,000. If I am lucky enough to stay at the same income level until I am 70 and the max tax stays about where it is then I will pay in another $312,000 (24 years times $13,000) which would bring the total paid in to Social Security up to $462,000. If I make it another 100 months past past age 70 (God willing) then I become a money loser for the program. Yes I realize this ignores any sort compounding that might happen somewhere along the way but it also ignores any COLA adjustments too.

If I make it to 90 (my dad will be 86 in July and is remarkably healthy and fit) then that is another 140 months at $4600 which adds up to $644,000. So we might collect more than twice what we put in which seems like a flawed strategy and of course not the duration of payout they had in mind when the program was started. Chances are you have heard the stat that notes when Social Security started the payer to payee ratio was at 25-1, has gone to three to one and is on its way to two to one.

This line of thinking leads me to the simplest conclusion about the future of the program which to repeat from many past posts is that it will be subject to very aggressive means testing that will come further down the wealth scale than most people think (yes there are logistical obstacles to this) and it will become a welfare program (if you think it already is a welfare program then it will become more so).

If I am wrong, then 100 years from now my wife will be sitting around like Granny with money to burn. As a note I have wanted to get a picture from this cartoon and use it on the blog for ages and finally did. I had to grab a still shot from You Tube.
Read more!

Sunday Morning Coffee

A client asked what I thought was coming next for the stock market as we had a bad week and there is some level of concern over the election in France.

The market has had relatively mild declines over the last couple of summer and that it should happen again seems plausible especially how much ground was gained from November into the start of the second quarter. A hideous decline like in 2008 seems very unlikely because the market has only cut in half a handful of times over the last 80 years and a second time in four years and a third time in 12 years seems very unlikely.

As far as the election in France. It will not be a surprise in Francois Hollande wins. Markets tend to fear surprises and tend to react to surprises more so than to what is widely expected. Certainly a Hollande win could knock the market lower for a few days but that seems like it would be more of a fast decline and fast declines are better to buy--as opposed to a slow rolling over.

No matter our opinion we will heed the 200 DMA. If the SPX goes below its 200 DMA we will take defensive action. It would not be aggressive to start because down a lot seems like a low probability but again we will heed the market as we have before (as disclosed in past posts).

The big macro here is avoiding the full brunt of down a lot. Down a little goes with the territory of participating in the stock market and so we are less intent on trying to outmaneuver a 5-10% decline (unless a move of that magnitude would cause a 200 DMA breach).

We are not at a point right here were defensive action is called for but in most past large declines (it wouldn't have to be a 50% decline to still be big), reducing small cap exposure or industrial sector exposure (depending on the type of account you have) has been a good way to go.

The picture; no we are not modernizing our fleet but one of our brush trucks is number 81.
Read more!

The Big Picture for the Week of May 6, 2012

One of my favorite blog posts was from 2009 and titled The Five Best Places To Retire. It was a tongue in cheek post about what long time reader SD later dubbed as tax arbitrage. The basic concept was to live in a state with no income tax that was also next to a state with no sales tax. You'd pay not income tax and buy whatever you need in the state with no sales tax (this doesn't work for automobiles).

A not so exhaustive search lead to finding five border towns that meet the above criteria;

• Ranchester, WY which is very close to sales tax-free Montana

• Spearfish, SD close to Montana but actually an empty part of Montana

• Walla Walla, WA which is near sales tax-free Oregon

• Homer, AK there is no sales tax or income tax in Alaska

• Denio, NV which is near Denio, Oregon actually neither Denio appears to have anything

The reason to circle back to this is that Yahoo had an article about US tax havens and number one on their list was Wyoming. The other tax havens merely have low taxes as opposed to choosing states with no taxes one way or another. In addition to no income tax Wyoming also has low property taxes, sales tax and gas tax. There were comments on the original post from three years ago asking why anyone would want to live in Wyoming. In some parts of the state the scenery is stunning and for outdoorsy people there is a lot to do.

It is also bitterly cold for a portion of the year. With all the money saved on taxes, a condo could be rented in San Diego for a couple of months during the winter or for a cheaper winter renting an RV and staying in Quartzsite, AZ is another option.

Speaking of Alaska it pays out a dividend to all of its residents from oil that moves through the states. One year it was over $2000 but most of the time it has been below $1000 and in 2011 it was $1174. The fund has had issues over the years with poor performance and changing benchmarks but an extra $1000 per person for people living a modest lifestyle is enough money to be useful.

There is a new reason to consider retiring in Alaska in addition to the tax arbitrage and the Permanent Fund dividend--although you'd probably need that RV in Quartzsite for at least three months. With the debut of the show Goldfathers last night , a show about families in Alaska mining for gold, one in three Alaskans now star in a TV reality show and these people get paid. They don't get paid a lot, certainly not in the first season. I found some unsubstantiated numbers to suggest $1000-$2000each per episode which is small by TV standards but for a $3000-$4000 monthly lifestyle it sounds pretty good. The key though is getting a second season.

The Osbournes (not Alaskans) reportedly made $5000 each per episode in the first season but in the second season got bumped to $1 million-$5 million per episode (different sources have different numbers). While that won't happen for your reality show in Alaska maybe $15,000 per person for a 12 episode season is plausible which is very significant for the people who have saved $600,000-$800,000 or less. Apparently the Roloffs all made $75,000 per episode toward the end of their run.

To increase the odds of getting a reality TV show in Alaska I suggest opening a cake shop. All of the other cake shows are in the lower 48.

Again, the above is tongue in cheek but someone has already done this or will do it although maybe not in retirement age. I've never watched an entire episode of Deadliest Catch but it has been on for years and I'm thinking at least one of the deckhands moved up there for the work, was popular one way or another and made a little bit of money from it--not life changing money but maybe good head-start money. If not Deadliest Catch than maybe one of the other long running shows about Alaska.

As crazy as the above might sound we each have something like this in us, at least I believe we do, and it can absolutely be driven by our interests. As stated many times before this requires a huge investment of time and planning. The case has been made here many times that some of the things that people have always relied on may not be as reliable as they once were but the need to get by financially in retirement or later in life has not changed. As one comment in the post from three years ago pointed, in 2006 Walla Walla made a real best places to retire list.
Read more!

A Followup To The CNBC Freakout

A couple of days ago I wrote about whether or not CNBC was freaking out about ratings and what the ratings may or may not say about the sentiment of Americans toward capital markets. The original Daily News article has drawn attention from MarketWatch and Zerohedge.

The Zerohedge angle is a little more interesting. Zerohedge believes that the CNBC personalities (notably Bob Pisani and Steve Liesman) root for Fed central planning. They link to a report that shows volume going down when the Fed intervenes and so the more they root for Fed intervention the more volume will decrease so Zerohedge concludes that CNBC is unknowingly rooting for their own demise--or maybe they do realize they are rooting for their own demise, the article seems to be saying both.

Zerohedge is a very useful outlet. They are very quick to tweet any sort of news and most of it relevant. Their own content reads well and seems to understand the subject very well and they re-run a lot of useful content from other sources. That being said they appear to be overtly rooting for the end of the world. We can learn from what they write about even if we don't draw the same conclusion.

While I am not certain what the exact outcome would be from the "central planning" they wrote about in this post it is clear that the outcome would be very bad. It is not logical to think that the Fed, the media or anyone else is proactively seeking out this outcome. Stumbling into a bad outcome because of poor decisions or poor execution is a different matter.

It seems pretty clear that interest in markets was fallen precipitously. Twelve years ago day trading was very popular as were markets in general. Do you remember the first season of the show Survivor? The episode where a couple of relatives stayed with the survivors for the night and truck driver Sue Hawk asked how the Nasdaq was doing; ding.

Layer on top of that the recognition on the part of baby boomers that retirement was coming fairly soon and the interest that created followed by the disillusionment stemming from the S&P 500 being below where it was 12 years ago. Yet one more layer is the 20-somethings and 30-somethings who appear to have no faith in the stock market and depending on what you read no hope for a comfortable retirement due to poor market returns their entire adult life and a government facing fiscal threats that appear to be unprecedented.

Where too many people were interested in markets in 2000 perhaps the pendulum of excess as swung in the other direction now? Clearly a lot of people have given up (for now?) on markets because of the above and there are probably other contributing factors as well.

Hopefully I am not perceived as the cheerleader type but capital markets will continue to function. Whatever is bad about them will continue to be bad, whatever is good will continue to be good, people participating in markets will continue to succumb to emotion at the wrong time and while not all investment products are bad; scrutiny will always be required.  

Tobacco companies will continue to profitably sell cigarettes and pay out dividends. Kids in foreign countries will continue to want to emulate NBA stars and buy Nike shoes (we've owned NKE for clients since 2006) and if you take medicine you are very likely to continue taking it which is of course good for drug companies. There are countless other examples too.

What might change is the number of people who remain active in the markets. The numbers seem to be going down but that won't prevent some stocks and markets from flourishing and others from floundering. This is one element to my long running thesis about average annual returns in the US markets being less than what they used to be (this is a theme going back to the start of this site in 2004). At the same time though many foreign markets will go on without the US (another very long running theme) as has been the case over the last ten years.

A successful financial plan typically requires contributions and some amount of growth. If the growth component is removed (for choosing to avoid capital markets) then more must be contributed and this can work but market will continue to grow even if that means the US is not one of them. In that light it makes sense to spend the time learning which markets have the best chance of "normal" growth (or better than normal) and not give up.

A related personal item; yesterday we met with a couple of people with AdvisorShares who are in town for a conference. The conversation was very productive and the timeline for moving the relationship forward is in track for early July which we are thrilled with. 
Read more!

How To Minimize Fixed Income Portfolio Risks

A reader left the following questions;

At this point in the cycle, when everyone is hammering that bonds are expensive, if one's stock/bond allocation is tilted too highly towards stocks due to the recent uptrend, how should new money be allocated? Is holding cash appropriate?

The first thing to note is that this was an anonymous comment so obviously there is no way an RIA can give specific advice to an anonymous commenter on a website.

As for holding cash. If someone can afford it then I do believe in some sort of cash cushion as an emergency fund. Some would tell you this should be the priority over having an investment portfolio, some would suggest an emergency cash fund should be the secondary priority to an investment portfolio. I don't have one answer here which is why I say if you can afford it.

The other aspect to cash is holding some cash tactically in an investment portfolio which I think is fine and we often do have some cash in the portfolio. With where interest rates are, cash that is in an emergency fund will not grow, which is obviously a tradeoff for the peace of mind the someone might get from having a sum of money for the unexpected. Cash waiting to be deployed in an investment portfolio will also not grow which is a tradeoff for the ability to be opportunistic.

As far as bonds being expensive that is generically the case but not universally true and investors need to decide what it is they are trying to do with the bond portion of the portfolio. Longer term treasuries have been dangerously expensive for a while but have continued to climb in price. Why can't the ten year US treasury yield go down to 1.5%? Japan's did. If it does go to 1.5% then some people will have had a very good trade. There is obviously some percentage of the time where buying at the all time high (or close to it) works out to be a great trade.

Great trades are not the primary objective for how we manage fixed income portfolios for clients. The very low interest rates that exist in most segments of the bond market creates interest rate risk. As a general rule for each 100 basis point increase in the interest rate the price of a ten year bond will drop about 8%. The price drop for a longer dated bond under the same circumstance will drop even further in price. With an individual bond you will get your principal back (assumes no default) but waiting for eight or nine years while collecting below market interest is not ideal. Of course bond funds have no par value to revert back to. If/when interest rates normalize (think 5-6% for high quality ten year paper) there will be some bond funds (both indexed ETFs and actively managed funds) that will get decimated. A couple of Sundays ago I mentioned TLT dropping 6% when the ten year yield went up just a few basis points.

As disclosed in previous blog posts our path has been to minimize exposure to what appears to be the most obvious risk facing the bond market which is interest rate risk. We have a large portion of our fixed income exposure in short dated, investment grade corporates (individual issues). If rates skyrocket starting today the price of these short term issues will not tank because of how close they are to maturity. We might be collecting below market interest (that is if rates do go up a lot) for 18-24 months as opposed to eight or nine years as mentioned above.

We also have a large portion in individual foreign sovereign debt that is also short dated. In some cases the yield is pretty close to normal like Australia and in other cases the idea is owning very fiscally sound economies like with Norway.  We also use an emerging market debt ETF to round out our foreign exposure.

We take a little bit of interest rate risk with a couple of funds (one CEF and one traditional mutual fund). The yields are pretty good but they are funds so there would be no par value for them to return to. Another good source of yield are individual preferred stocks. We own one from a bank and one from a REIT. Again the yields are good; high fives, low sixes. I am not a fan of the preferred stock ETFs, all the ones I've ever looked at are heavy in financial companies that I want no part of.

The last segment we have exposure to is inflation protected. The percentage allocated depends on the age of the client. Someone who is 50 will generally have more exposure here than someone who is 70. I think ETFs can be used in this space. We own the iShares TIP ETF (TIP) and while it is not up as much as TLT since we bought TIP it has done well with very little relative volatility.

For a couple of the segments above, as noted, I prefer individual issues but that may not be ideal for individual investors managing their own portfolios but there are ETF solutions that I think can work. For corporate bonds I would look to the BulletShares product line from Guggenheim and I think iShares is on to something with the recently launched corporate sector ETFs.

You need to look under the hood of anything but with the BulletShares you have to know how they work. The 2016 fund, symbol BSCG, isn't really a 2016 fund. There are issues in there that start maturing in February of that year and the proceeds will be held as cash until the fund terminates. I didn't take a complete inventory but at some point in the middle of the year the fund might be 50% cash. Maybe it is better to think of the 2016 fund as more of a 2015 fund but either way I think they can be very useful for individual investors who have taken the time to look under the hood.

There is also utility with the foreign bond ETFs too. iShares and SPDR have some funds here but PIMCO and WisdomTree seem to be doing more interesting things here. The broader funds tend to be heavy in Japan and Europe which are not great places to be. Our emerging market bond fund is the PowerShares fund with symbol PCY--obviously we think that is good fund to hold.

This was a long post but hopefully creates some understanding of spreading things across many different segments of the bond market as a way to reduce certain types of risks. Risk can't be eliminated of course but the potential impact can be minimized somewhat. The other observation is that I am not a fan of broad based funds as a first choice for accounts large enough for it to make economic sense to have many exposures. A $100,000 account for a younger person with a 25% allocation bonds probably can't take on eight different fixed income positions so something like the iShares Aggregate (AGG) does make sense.

Read more!

Freaking Out Because There's Nothing to Freak Out About

Barry Ritholtz linked to an article with a sensationalized headline that CNBC is "freaking out" over a decline in ratings. No doubt that a TV network would be concerned over a drop in ratings but who knows if anyone at the network is actually freaking out or not. Over the last few months page views on this blog have gone down.

One observation made in the past is that bull markets are bad for blogging business and probably also stock market television too. There are always threats to the market and now is no exception; Europe is quite obviously deteriorating, jobs in the US might be rolling over a little and the bull run that started three years ago could easily be starting to get long in the tooth. Again these are risk factors (there are others as well) that may or may not matter.

Ok so isolating those risk factors or any others important to you and things really aren't that bad right now and haven't been for a while. Please note this is not a discussion about the social disillusionment toward the stock market, simply an observation that the stock market has gone up far more often than not in the last 38 months more than doubling and people still involved with markets might be feeling pretty good.

If people are feeling pretty good or maybe less worried is better, then they might feel they don't need to spend as much time following markets and news related to markets. The housing market has not healed and probably is not healthy but it is not imploding (for now?). You are no longer spending time trying to learn about SIVs, CDOs, CDOs Squared, CoCos, PIKs or any other gimmickry from 2007.

If there were a lot more reasons to worry now or if the current magnitude of worry ramped up then chances are ratings and page views would be much higher but when you're not worrying about the end of the world financial system then you probably have a little less work to do.

The reason to discount stock market social disillusionment for a decline in stock market TV ratings and page views is that it seems more likely that the people (permanently?) turned off by the markets were probably not the ones spending hours on dozens of websites trying learn about all the gimmickry listed in the previous paragraph, more likely these folks were marginally attached through their 401ks and more likely only kept tabs on big headlines. That is not a shot, most people have very little interest in following markets closely and someone not that interested whose 401k cut in half again could easily throw their hands up and be done. But again, this group was probably not inclined to seek out stock market content on a blog or watch CNBC before going to work.

The above reasonably paints a picture of complacency for those still in markets. Now is the time to remember that there will be a bear market again and some sort of trigger point for defensive action will be essential for some folks and those folks should mentally prepare to be disciplined to their trigger point and have some idea of what specific action they might take if market circumstances dictate.   
Read more!