Random Roger

These Are Good For Investing Too

2012-02-02T06:05:00.004-07:00

A friend posted a link on Facebook from MSN titled 11 Health Habits That Will Help You Live to 100. Quite a few of them can apply to investing as well. An ongoing theme on this site has been that it is guaranteed that there will be years that the stock market will go down. Based on history this will happen 25-30% of the time but either way, in the future there will be down years.

It is also guaranteed that there will be years that we will lag behind whatever the market does. Both of these are guaranteed and if you have any time behind you investing you have already gone through both of these and you've lived to tell the tale.

The tie in to the article is point number 7 which is to be less neurotic. Right here, right now while it is easy to be rational if you know head of time that the market is going to have a down year occasionally and that you will not always beat the market and both have happened to you before then there should be less of an emotional reaction when it happens. This should also make it easier to stay disciplined to whatever your strategy is.

The other point that can tie in directly was point number 1 which was don't retire. The connection made in the article is the observed tendency for people to become less active once they do retire. This is well covered ground here for several different reasons with the most practical reason being that for many people stopping work altogether will not be an option for financial reasons. Working less is very plausible and I think my belief in spending time figuring a way to monetize something you love doing is also plausible.

Obviously a thread like this on a blog is going to be greatly influenced by the blogger's priorities in life. Anyone reading this site for a while probably has a sense of what my priorities are and things in the article relate for the most part. Portfolio success and financial success is much easier to achieve when you have your priorities sorted out. When your life priorities are sorted out then you have a better chance of managing your portfolio for what you actually need not what you think you need.

Managing Sector Volatility

2012-02-01T06:04:00.003-07:00

One part of how I manage the portfolio is monitoring and changing the volatility profile of each sector based on what I think is going on now and what I think comes next based on what is going on now. I mention this in passing far more than I actually spell out what this looks like.

Yesterday on Fast Money Halftime they put a chart on the screen of Under Armor (UA) and client holding Nike (NKE) that serves as a very good way to illustrate this. I grabbed the same chart from BigCharts below.

For my money UA and NKE are proxies for the same thing. Each stock has different trading characteristics but it makes sense that the correlation should be high even if the magnitude of the moves is noticeably different.

Someone who holds NKE is favorably disposed to the demand for athletic apparel and equipment and the willingness for disposable income to continue to go toward the products--probably.

At that level the story at UA is very similar. The two are a little different when you go more in depth. In an environment where the portfolio manager wanted to increase the volatility of the portfolio (presumably because the market was going to move higher) he could sell NKE and swap into UA. If correct about the market in this case then UA should go up more than NKE.

As a practical matter NKE has enough volatility for me for being a discretionary stock so I don't think I would do this exact swap but have done similar ones before. Part of our defensive strategy in 2008 was to shift most of our energy exposure into what was then the WisdomTree International Energy ETF (DKA). Then as we started to get less defensive we came out of DKA into an oil sands stock, a coal ETF and a Colombian oil stock (not all at the same time). We also increased our position in Statoil (STO). To be clear these trades go back quite a ways now.

This portion of the strategy seems like an obvious type of trading and I know that plenty of people do this, anecdotally I also know this is new for some folks.

Finally, last night we had a skunk wrangle. We knew we've had a critter since Sunday morning. He woke us up early Monday morning so I borrowed a trap Monday afternoon from a neighbor but did not set it. We heard nothing Monday night into Tuesday morning but then Roscoe let us know he was back yesterday afternoon so I set the trap and checked it after dinner and that is what we found. He has white stripes all over and actually it took a minute, at a distance, for me to figure what he was. He sprayed once but I was far enough back that he didn't get me.

I approached with a big towel covered the trap, took it out to the pick up truck and drove it out to the forest to let him go. Funny thing is he wouldn't leave, maybe because I was too close so I pried it open with a rock, backed up and it still took him about five minutes to finally leave.

A Reader Asks, I Answer

2012-01-31T06:31:00.001-07:00

A reader asks;

The comment stream is asking you to elaborate as to that portion of your statement wherein you said owning 'dividend growers exclusively' is risky or not advisable...exactly what are the dangers of having an income stream as a primary goal instead of capital appreciation?

My answer;

I have tried to address this before. This is in part a philosophical issue. My first hand experience with capital markets goes back to 1984 (worked in the industry for a year before starting college) and I have tried to learn about stock market history from before 1984.

In my time I have seen plenty of things that could never blowup or otherwise hurt people in fact go on to blowup and otherwise hurt people. I believe you are around 70 but I do not know how long you have been a market participant but you have probably seen more of this first hand than I have.

For whatever reason I have a pretty good memory for how the psychology around these things has worked and I believe I see a lot of the same behavior repeating in many of the comments.

It may be difficult to believe but the can't go wrong idea was also applied to the Nifty 50 and Junk Bonds--yes, you can say it was different for this or that but the behavior is not different. In the 1990s Fannie and Freddie were must holds because of how incredibly safe they were.

It is simply a matter of philosophy based on personal observation that too much of anything, ANYTHING, increases the risk taken. The debate that we all have is actually not whether the risk is greater (IMO) but whether or not there will ever be a consequence for that risk and for that, I have no idea. I do know that some event that I can't imagine that somehow does blow up whatever segment of dividend stocks you care about won't blow up our clients.

Frankly I would be more concerned about the blowup I CAN'T envision as opposed to the one I can envision.

My own preference is to be segment agnostic (so dividend stocks would be one segment, for example). There are many segments in the market, they all rotate in and out of favor and occasionally something truly awful happens to some stray market segment. Something truly awful could happen to any segment. This is of course improbable but it is not impossible. The individual consequence of "truly awful" depends on the amount of exposure in the portfolio.

I don't think you all see it this way but I think my comments in this thread over the last couple of years have been ones of moderation.

More On "Just Don't Lose It"

2012-01-30T06:12:00.001-07:00

I wanted to delve a little further into the Just Don't Lose It cover story from this week's Barron's. The article included some sort of model portfolio that US Trust is apparently recommending to its clients. There were a couple of different things in there so this will focus on the "long term benchmark" which was as follows;

Cash 0%
US Large Cap 16%
US Mid Cap 7%
US Small Cap 4%
Developed Foreign 9%
Emerging Market 6%
US Investment Grade Debt 25%
Foreign Developed 2%
US High Yield 3%
Hedge Fund 12%
Private Equity 4%
Real Estate 6%
Tangible Assets 6%

Again the above is put forth by US Trust not me or my firm.

First is that there are a couple of things I would do differently. The way the numbers work out, US Trust is suggesting a little over 1/3 of the equity allocation go into foreign. In thinking about the long term and how things are evolving I would want more exposure to foreign equities (we have more exposure than this) and I would reiterate that the terms developed and emerging have become meaningless as many so called developed nations have banana republic-like debt loads.

I would also want more foreign exposure in the fixed income allocation, without going nuts. Some foreign exposure can help increase the yield of the portfolio. We love Aussie debt but we have a small allocation which does help the yield but we do not own so much that we are chasing yield. While I do not think the US Trust portfolio does chase yield, a lot of investors do and this usually ends badly for not having understood the risk taken ahead of time.

US Trust is suggesting more than 1/4 of the portfolio go into alternatives (it may not be right to characterize the RE that way, but the article did not clarify what they had in mind) which I think is way too much. US Trust caters to seriously wealthy people. I don't know if they have proprietary products in the above alternative category that they sell to clients or if they bring in outside products for clients but most of us will never have access to the next hedge fund that goes up 450% in one year because it shorted the right thing right before a panic of some sort. It is also unlikely that any of us will have access to the private equity fund that makes billions on, and sells just in the nick of time, the next bubble.

That is a long winded way of saying most people should be wary about these types of funds. On the other hand we can access plenty of exchange traded vehicles that effectively capture an absolute return result and offer a place to hide with part of the portfolio during bear market phases.

Just because I would want to do a couple of things differently than what US Trust offers above does not mean it is not a sophisticated portfolio (it might be or might not, you can decide for yourself). Anyone thinking it is sophisticated and wanting something very similar can get most of the way there with exchange traded products which supports the idea that ETPs are democratizing to a point. I would mention that Barron's also had an article which noted that hedge fund replicators don't really deliver hedge fund results--they can be good but hedge fund-like is probably unrealistic.

One last point is that the idea that the above is a "long term benchmark" is flawed in my opinion. I was taught that changing benchmarks is likely to result in chasing a previous winner. By having a long term benchmark with specific targets for different segments of the market sets a stage for impatience which ultimately leads to chasing heat. I think benchmarks should be very simple and easy to follow. The idea that mid caps should always be targeted at 7% seems ridiculous. I think someone may have used the word benchmark incorrectly. I think the above is a portfolio or maybe an asset allocation but not a benchmark.

As for the pictures; my brother got us courtside seats to the Washington State/Arizona State basketball game on Saturday afternoon. The seats were great and the game was exciting.

Sunday Morning Coffee

2012-01-29T06:41:00.005-07:00

The Barron's cover story was titled Just Don't Lose It and it tried to explore the extent to which investor psychology has shifted to being more skeptical or distrusting and the article also tried to offer some solutions. Candidly the article was a little thin but the questions raised are interesting as is the pursuit for a solution.

There was an interesting stat about how many Gen Ys don't trust stocks and so have a high portion in cash. Also mentioned was how well dividend payers did in 2011 which is supporting evidence of people eschewing growth in favor of something more predictable; the dividends.

My take on these issues has been the same for a while. I do believe stocks and markets still work but there has been an evolution. Plenty of markets and plenty of individual stocks have carried on even as the SPX has floundered and there will continue to be plenty of markets and individual stocks that carry on if the SPX continues to flounder.

Certainly this means the task is more difficult and it is reasonable that people don't want to spend more time on their savings and their investing than they used to but success probably means just that; spending more time than they did 15 years ago. Fortunately the tradeoff is very simple to understand even if not easy to pull off. If 2-3% annually is a more likely outcome then more needs to be saved or you need to work longer or spend less or any combo of the three.

As far as the actual title of the article; people feel losses far more than they feel gains. This is no doubt something you've heard before but probably pertains more to specific holdings but another aspect if just don't lose it is the permanent impairment of capital (I know this as being James Montier's term) which is where people are forced to go back to the drawing board with their financial plan which is a bigger deal than buying a few shares of Netflix (NFLX) at a bad price.

The article notes the extent to which this has happened to people and the extent to which people are now more aware of this possibility and fear of it is keeping them out of stocks. This is where the work needs to come. Obviously I am biased toward a defensive trigger point (the 200 DMA) and avoiding big bets within the portfolio by staying diversified. One thing that I think helps me do my job is that I have respect for whatever clients did to get their money and take the regard for their money very seriously.

It is much easier for an advisor to explain why we didn't make more than it is to explain why we lost it all. This applies to people managing their own money too.

The Big Picture for the Week of January 29, 2012

2012-01-28T06:41:00.004-07:00

A friend posted this on Facebook and I thought it was a very useful quote. As a matter of personal philosophy I believe that investors have a much better chance of portfolio success once they figured out what makes them tick, what is really important to them.

We all know people like whom the Dalai Lama is referring to or maybe we have been that person or maybe we still are that person. Often in this context I have quoted our friend Bill from here in Walker (Bill is not my neighbor with the backhoe, that is someone else) in saying that you can figure it out now, or you can figure it out later but you'll be much happier if you can figure it out now.

One simple example of this might be figuring out that instead of an $8000 (net) monthly lifestyle happiness and fulfillment can be had for $4000-$5000 per month instead. There is nothing that says an $8000 income (just an example) must result in an $8000 lifestyle.

This can lead to a readjustment of how much risk needs to be taken in the portfolio while still accumulating and then in retirement. Using the 4% withdrawal rule as a benchmark a $1 million portfolio should be able to generate $40,000 but if a $1 million portfolio only needs to generate $30,000 then perhaps fewer chances need to be taken. Contrast the $30,000 to $50,000 coming out of a $1 million portfolio which probably means having to take more chances with the portfolio. If possible I'd rather take fewer chances (obvious statement).

On an unrelated note I found a curiously titled post at Seeking Alpha; How I Morphed Into A Dividend Zealot. It captures how one investor started out seeking capital gains. He then went on to describe his transformation--his word. To read the congratulatory comments I think the idea of a religious type of devotion stands up--I believe it is correct that I am the one who coined the term dividend zealot. My own preference is to avoid that sort of devotion.

MarketWatch Says Retirement is Endangered

2012-01-27T06:09:00.002-07:00

Robert Powell from MarketWatch posted a reasonably thorough assessment as to why retirement in the US is "endangered" with topics ranging from Social Security not being able to meet its obligation to why various demographic segments should expect a higher retirement age, smaller payouts and means testing.

This has been a popular topic here and from 50,000 feet something is going to have to have, actually a whole lot of somethings will have to give. From 30,000 feet a solution is probably going to include some combination of the above three ideas (higher retirement age, reduced payouts and means testing).

On the ground this means we all need to be out in front of this threat as part of our own solution. We all have our own emotional vulnerabilities and one of mine is being dependent on someone else or more precisely a bureaucracy that most people believe is grossly dysfunctional.

Consistent with past blog posts, for most people it is easier to control expenses than to go find an ever higher paying job meaning expenses are a function of our own discipline and that most of us won't find a job that pays us $50,000 a month.

One vague suggestion in the article was about giving more in the way of tax incentives for retirement savings. This might help but to the extent that people don't have enough saved I wonder if there is a way to stop taxing IRA distributions for retirees. I don't recall mentioning this here before and I am not sure if anyone else has talked about this but if someone has $300,000 saved and they take out $15,000 a year they might be paying $2250 in taxes on that money which sounds like a big number in relation to $15,000. Having access to the total distribution would be a difference maker for a lot of people (I realize some folks would pay more in taxes and some would pay less).

Most of my ideas on this subject focus more on things that people can do for themselves because, again, we have more control over the outcome than we do from positing what a dysfunctional bureaucracy should do but if we are in store for some combo of higher retirement age, lower payouts and means testing then not taxing IRA distributions could help smooth over the ill will that will come from social security austerity.

Japan has a Trade Deficit

2012-01-25T06:33:00.001-07:00

Yesterday was a busy day for me so I am not sure how much attention this got but Japan recorded its first trade deficit since 1980. Japan has always exported a ton of stuff and imported all of its oil. The earthquake on March 11, 2011 shut down the nuclear industry and so now the country needs to import more for all its energy needs, so much so that it caused the trade deficit.

This article from the Telegraph makes the case for the trade deficit to persist which can't be huge shock given the state of the nuclear industry there. The back drop for Japan has been poor for many years and I have thought this would continue to be the case long into the future even before the earthquake.

Japan has always been an interesting destination. It seems like every year, maybe not 2012 though, there is a contest for market pundits to come out and say that this is the year that Japan finally turns it around. There have been years here and there where Japan has done well but it never turned it around.

The problems with Japan appear to include an aging population, an enormous debt load and they seem to be getting undercut on manufacturing. The generally poor results, I believe, reveal a long term weighing of the fundamental backdrop with the conclusion being there is no visibility for a sustainable recovery. The Nikkei is down 76% from its high 22 years ago. That is a mind boggling nugget and the market is still not cheap. I remember from 1990 Japan's PE ratio being in the 50s and according to the iShares website the iShares Japan ETF (EWJ) has a PE ratio of 18.

PE ratios aren't necessarily a great predictor of future prices the combination of being relatively expensive (again, relying on iShares for this) and lousy economic fundamentals leaves little to be optimistic about. Simple avoidance of this type of trouble spot remains the path of least resistance.

A Foundation to an Investment Philosophy

2012-01-24T06:18:00.000-07:00

Josh Brown had a fun post up yesterday about his Twenty Common Sense Investing Rules. While I would probably frame some of the points differently and don't necessarily agree with all of them there is plenty of utility in the post.

Josh's number 4;

The moment a stock disappoints you or makes you wish you hadn't bought it, sell it. Immediately and regardless of price. Life is too short to hope a bad decision reverses itself.

This is tricky because there have been many exceptions over the years. Actually too many for me to take this rule at face value. When a stock misses earnings by a few pennies and takes a 10% drop selling might be the right thing but it may not. What I mean is that some sort of disappointment might merit revisiting the investment thesis to see if it is still valid and then making a decision.

For example in late 2002 and into 2003 Altria (MO) was facing some serious problems as this was the height of the law suit frenzy around tobacco litigation. The market was generally doing poorly but MO almost cut in half during this time. This was a bad stretch for the stock but for the last ten years it is up 151% (per Morningstar which I believe includes the dividends) compared to 16% for the S&P 500 (SPX including dividends might be about 36%).

The other side of the coin might be Yahoo. At some point it went from owning the world to something akin to a no growth utility. The reason to mention these two specifically is because I have owned both for clients. We sold Yahoo a few Mays ago when MSFT wanted to buy it but Jerry Yang famously said no and we kept Philip Morris International as an across the board holding but some clients still have some MO.

While no one can be right 100% of the time, this part of the management process requires understanding not just the stocks that you own but also the respective industries that your holdings are in.

Josh also has several bullet points about not being emotional; don't get too excited and don't get too angry. This is of course correct. No matter what type of investor you are or what you own there will be times that you are wrong. This is guaranteed to happen. If you know this ahead of time then it should lessen the emotional toll when it happens. Similarly there will be times when the market goes down a lot. We know this rationally but we seem to forget our well reasoned understanding of large declines when they actually happen.

It probably takes some training but the extent you remove the emotional highs and lows, the better your long term result will be.

The other point to share from Josh is don't blow up. Any market segment, I'll repeat that; any market segment can blow up. Blowups are improbable but they are not impossible. You might be heavy in some area that has a very low probability of blowing up but if it does then you will be in a world of hurt. Trust me when I tell you things that could never blow up have indeed blown up in the past and this sort of blow up will happen in the future. Your weighting will determine the magnitude of the consequence.

Barron's on Dividends

2012-01-23T06:21:00.002-07:00

The Barron's cover story was about seeking a 4% yield from stocks. It was a broad look across many sectors in the S&P 500 at stocks that have the room to increase their dividends substantially or in some cases initiate a substantial dividend.

My take on dividends has been consistent; they are crucial to long term portfolio success but I do not believe in owning high yielders or dividend growers exclusively. There was one point made early in the article that I think needs to be dissected because I think it distorts how markets tend to work.

During 2011, high-dividend payers were the top-performing group in the S&P 500, with the top 50 yielders at the start of 2011—all with 4%-plus yields—returning more than 8% (not including dividends), compared with a flat showing for the entire index, according to Birinyi Associates.

Further down in the article is a table that notes the performance of each of the sectors in 2011. Utilities did the best at 14.8% followed by staples at 10.5% and healthcare at 10.2%. While there can be no absolutes it is a good bet that in a year where the S&P 500 is flat, and some might say it was lucky to have been flat, it is going to be the defensive sectors that do better.

Things like utilities, healthcare and staples do better in years like 2011 for two reasons; the dividends of course and more fundamentally the steadiness of the demand for the products.

So far in 2012 the S&P 500 is up 4.58% which is pretty good for three weeks. In that same three weeks utilities are down 3.8%, healthcare is up 3.3% and staples are down 0.2%. Again, there are no absolutes but if 2012 is somehow a repeat of 2009 then these three sectors will very likely lag and the dividends won't mean much as was the case in 2009. Of course 2008 was a terrible year for stocks and all three of the dividend sectors mentioned above outperformed.

For the long term there is no question in my mind that dividends are crucial but the assertion that dividend stocks will have a good year in 2012 because...is simply the wrong way to frame this. The other day I mentioned about the importance of thinking in long term increments like complete stock market cycles or even decade long chunks. The importance of the yield of the portfolio can be better understood in those time frames. In one year time frames the more correct framing is that in a great year for stocks dividend payers will usually lag.

Sunday Morning Coffee

2012-01-22T06:14:00.000-07:00

Bernie Schaeffer had a write up in Barron's in which he referred to an article from the New Yorker. There was one line in there that intrigued Bernie that was particularly interesting;

In effect, [investors have] decided that, in a market as volatile as this one, the only way to win the game is simply not to play.

The cash that is built up on the sidelines has been talked about for a while with some believing that it will provide a big lift to equities. I tend to discount the argument because the cash we hear about includes money that was never and will never be put into the stock market.

The more interesting nugget is the psychology or impatience that leads to people giving up. Many believe that capitalism is broken and that capital markets no longer work. I hope I have been clear that I disagree with that idea. Clearly some things have changed with economies and debt levels such that it has weighed heavily on equity market returns for many of the largest markets but long dry spells have occurred in the past--this is not unprecedented in terms of how the market has reacted.

That we are 12 years into this for the US and almost 23 years in for Japan certainly makes the slog long in the tooth but as pointed out in many previous blog posts there have been plenty of other markets that have had normal returns or better than normal over the last 12 years.

The extent to which the above New Yorker quote has any merit it expresses people's inability to see the long term and to understand why they are actually invested. I contend that for most people the real objective is to have enough money when you need it which is usually upon retirement. Then of course the money needs to last during retirement.

In that context the time horizon becomes decades and for many of those decades there are two elements of portfolio growth; price appreciation and savings. Periods where the growth is not so hot needs to be met with more savings. Some will say that this is unknowable but I don't think that is exactly right.

It is not terribly difficult to look at some basic macro economic indicators and see whether things look relatively healthy or relatively unhealthy. Looking at the big picture and concluding things aren't going well and that an increase in savings, if possible, is warranted is not a form of wild speculation. Similarly concluding that things look ok and maybe the normal 10% 401k contribution might suffice is also not reckless. Neither scenario guarantees success but this is not black box type work.

Taking one step further I think that people can also look at macro economic indicators for several countries and see where things might look promising and perhaps favor those and see where things look bad (unfavorable demographics, lousy debt situation and so on) and either avoid underweight those markets.

Again there is no guarantee of success but I do believe in the long run the market weighs these attributes accordingly with the last decade as supporting evidence and for most people it makes more sense to think in terms of decades not years.

The picture is from yesterday's fire training.

The Big Picture for the Week of January 22, 2012

2012-01-21T06:23:00.004-07:00

One of the first ETFs for Latin America is the iShares is the iShares S&P Latin America 40 Index Fund (ILF). I am pretty sure that iShares Brazil (EWZ) and iShares Mexico (EWW) predate ILF going back to the WEBS days (WEBS=world equity baskets).

A few days ago iShares came out with a surprisingly similar Latam fund with its new MSCI Emerging Markets Latin America Index Fund (EEML). Obviously the index provider is different but the I can't imagine there is any real differentiation.

Brazil is by far the largest country in both at 57% in ILF and 66% in EEML. Mexico weighs in at 24% and 20% respectively and Chile, Colombia and Peru round out the rest of the funds. Peculiarly, Peru accounts for 3.9% of ILF but lest than 1% in EEML. The sector weightings for the largest sectors are virtually identical with financials and materials being the largest.

ILF having only 40 stocks means the holdings are larger; America Movil (AMX), Petrobras (PBR) and client holding VALE are the largest in ILF at about 10% each and those three are also the largest in EEML.

iShares has done something similar in other segments. For China it has the FTSE Xinhua 25 (FXI), FTSE China (HK Listed) Index Fund (FCHI) and the MSCI China Index (MCHI). There is a lot of overlap under the hood and the performance has been identical.

On the other side of the coin iShares has all sorts of unique funds or at least funds that are not identical to there own funds; with examples including iShares New Zealand (ENZL) and iShares Small Cap Hong Kong (EWSS). At the same time as iShares launched EEML it launched iShares Emerging Market EMEA Index Fund (EEME) where EMEA stands for Europe, Middle East and Africa. I think the fund is unique to broad based emerging funds (but maybe someone else has a similar fund?) in that it weighs heavily to South Africa and Russia (those two add up to 73%) and energy is the largest sector at 28%.

iShares is due to come this week with iShares Norway and iShares Finland. Global X already has a Norway ETF (NORW) but Finland would be a first and I think that Finland would be a huge beneficiary (after the initial puke down) if the euro were to breakup.

Obviously iShares has the scale to create more funds even if there is little chance that they will gain traction or offer much that is new (the essentially perfect correlation of the three China funds can't be a surprise to anyone at iShares). It is more difficult for smaller ETF providers to mass produce funds.

I think part of the equation here is that iShares can create a lot of funds such that it might simply be trying to crowd out the smaller companies. This is of course what competition is often about but as users of ETFs we should hope that smaller competitors survive.

Market Favoring Risk Assets Right Now

2012-01-19T06:15:00.004-07:00

A few weeks ago I shared an opinion (or hunch if you prefer) that I thought the US market was going to be in for a range busting rally that I think will then retrace. It is too early at this point to know whether this is yet correct or incorrect but I have made an observation that I hope is useful even if not original.

If you've been reading this site for a while you may be familiar with my preference for owning stocks with all different types of attributes, I think it makes for better diversification. The stocks at the riskier or more volatile end of the spectrum are up a lot of late. This is not a comment about what we own but about the recent performance of things like emerging markets, some tech, some financials (we do not own US banks but they are on a good run), some materials, some energy and some industrials.

Again, although not an original thought, when these types of areas outperform for a while like now it is often a sign of some sort of confidence being expressed and this can last for a while, like several months and many percentage points. As a bit of a contrarian nugget, it seems like many pundits were looking for a lift in the second half of the year and one outcome of that consensus being wrong is that the lift comes in the first half. Another contrarian outcome of course would be no lift, that the market in fact drops instead.

For all I know this run could of course end today but I think there is merit in assessing the current mentality of the market because occasionally you will make a change in the portfolio on this.

Short post, busy week.

Filtering Content

2012-01-18T06:17:00.004-07:00

A very long time reader left a comment on Monday's post telling me that he had read a bunch of content from William Bernstein and concluded that Bernstein's approach seems more rational than my sort of approach. The reader said he didn't really get top down and that things like country selection takes way too much time. The reader said he was going to move on from reading this blog and wished me luck.

This was a very positive comment (I'm not being sarcastic). There are quite a few facets here that deserve attention. As an end-user of stock market content, so here we are presuming that you are interested enough in the subject to seek out stock market content, you take in some range of opinion and method for the purpose of trying to learn, trying to improve some aspect of how you invest or some similar objective.

Along the way you take in information that is useful to you and information that is not useful, you filter that information and move on. Personally I find no utility in the articles that are along the lines of five stocks that famous money manager is buying. I know that plenty of people love those articles and find them useful. Like the reader mentioned above not getting top down, I don't get those types of articles.

To beat my yoga metaphor to death; there is plenty of room in the yoga studio for the reader's mat of indexed investing, along with my mat of active, top down along with everything else. Active, top down has flaws but seems easiest and most logical for me. Likewise with indexing for the reader. Both have positives and both have flaws. All investment approaches have positives and drawbacks. Not understanding the drawbacks to your approach is bad and I think prevalent unfortunately.

As far as not getting top down, for as long as he read this sight I think he does understand what it is about but maybe doesn't see the utility. It is simple, look at the big picture first. There are several competing studies that conclude the same thing which is that the majority of your return is determined by whether or not you are in the market and then making the correct sector and country decisions. Stock selection, the studies conclude, only accounts for 10% of the eventual return. Top down would say it is more important to figure out to avoid France, own China and be correct about oil prices (just a random and abbreviated example).

As far as taking too much time, investing is a pursuit where you can put in as much or as little time as you want. Obviously there is an entire industry of people that make it a full time vocation and there are also many 401k participants who simple select a portfolio from the administrator and spend no time on it. In between those extremes are all manner of investors with wide ranging interest spending varying time. To say one approach takes too much time would probably be more accurately captured by saying "too much time for me."

I wish the reader luck and thank him for his contribution in the comments over the years.

Reuters Says Invest In Yourself

2012-01-16T06:14:00.003-07:00

For many years I've been writing about the extent to which retirement will not be the same for people as it was for their parents (obvious observation) and that this has created a problem/challenge for each of us to solve for ourselves--meaning everyone needs to weave together their own personal solution. The other day Yahoo Finance ran an article from Reuters saying pretty much the same thing with some ideas very similar to what I've been talking about all this time.

I make no claim of originality as I think just about everything I have ever said on this subject is common sense that most people would ultimately come to on their own at some point. One item from the article that I had not thought of was bartering. The article had an anecdote of a woman who traded work for free access to a vacation home.

One of the ways the article suggested to "invest in yourself" is to try to beef up your investment knowledge. This doesn't typically come up in an article like this that is not really about investing. It makes sense to do this for a couple of reasons. One is that most people are likely to go it alone, at least I think most do it on their own, and given the importance the more you know the better off you'll be. And although not mentioned in the article there is no end to what can be learned about investing which seems like a pretty good way to stay engaged. There are of course lots of interests where you can always learn something new.

One suggestion I really liked from the article, and that I have written about, was having a "money making skill." The article talked about eBay sales, handyman work, cooking, babysitting and driving as ways to make money which of course can work but the ideas here are limitless. In past posts I've talked about how to monetize a hobby which could take years of pre-planning but would be worth it. I've mentioned my wife's uncle getting offered office work that tied into his career with a major league baseball team (not high paying but something and he could go to games for free), seasonal work for all sorts of things including state and national parks and of course backhoe work. There are many others.

There was even a don't drink soda shout, sort of, but comments about staying fit. The book assigned for my EMT class had a chapter on geriatrics which went into detail about the things that start to happen as we get older--but that start when we aren't that old. We start to lose muscle mass at 28. The loss of muscle mass when we are much older can start to cause various problems. That is just one little thing, there is a lot here but things like serious and regular exercise can make a big difference. Even just staying active doing stuff can help here--my neighbor with the backhoe as exhibit A. To repeat from past posts, he reported to a smoke call when he was 79. At 77 he worked the fireline on a serious fire up a steep hill.

The thing behind the thing with this article is the extent to which these types of suggestions can, to use my term, relieve a portion of the burden that would otherwise be placed on the portfolio. In my opinion these types of issues need to be sorted out before getting to how manage an investment portfolio as life choices and life circumstance factor heavily into asset allocation.

My brother took this picture the other night when Oregon State played at Arizona State, I thought it was pretty cool.

Sunday Morning Coffee

2012-01-15T06:09:00.002-07:00

Big news on the personal front; yesterday I was appointed Fire Chief of our volunteer fire department here in Walker. I've never had many goals but this has been one of them and while I am beyond thrilled it will be a lot of work. Long time readers will know that this is something I love being involved with and is all kinds of fun.

This will not meaningfully change my schedule or routine as I've been assistant chief more often than not since 2005 but now I will be making a few more decisions and hopefully getting help from my colleagues within the department.

Tying into monetizing a hobby in retirement I hope to never need to monetize this hobby as I hope to manage money until I am very old, but you never know what the future holds and you never know what you will need in the future. Hopefully you all have something that you enjoy as much as I enjoy firefighting (the calls, helping people, interaction with the rest of the group, continuing to learn new things and problem solving).

Yesterday was an amazing day for NFL games. As for the picture; sports fans, is Rob Gronkowski going to turn out to be the greatest tight end ever? Serious question.

I should have a regular post tomorrow.

The Big Picture for the Week of January 15, 2012

2012-01-14T06:15:00.004-07:00

In the middle of the day on Friday we executed a trade for most of our "large" clients. We bought the Global X Fertilizer & Potash ETF (SOIL). Long time blog readers may recall my long term belief that the growth rate of the world population combined with an ascending middle class in countries where there previously was no middle class creates a long term catalyst for increasing demand. This is a theme we have owned in the past. The stocks in this group are volatile but I believe the demand has been and will continue to increase at a steady rate.

SOIL is an upstream, to borrow a term from the energy patch, sort of exposure. I considered buying a farm/plantation company which would be a little further down stream but felt fertilizer and the global footprint of SOIL would be a better way to capture the space but obviously that is the type of thing we will continue to monitor.

As for the fund I've always thought it is very well constructed index. It covers 15 countries in 25 holdings and owns many companies I've mentioned on the blog in the past. Comparing SOIL to the last couple of purchases for the portfolio, the last two have generous dividend yields and will probably not add a lot of volatility to the portfolio. SOIL on the other hand will be a relatively volatile holding and will not be a meaningful source of yield (it paid out less than 1%).

The fund, as with most stocks in the area is down a lot, 15.8% since inception last May. Obviously it could go lower but for now we have bought low. This contrasts with our recent purchase of KLAC where we bought strength. I am a fan of owning various attributes in a portfolio is and this is one example; the willingness to buy weakness and to buy strength.

There is obviously a potentially depressing Malthusian aspect to this investment but it strikes me as an area then benefits from a steady demand and while I do expect volatility with the position I believe that the demand underlying the theme will prove out to be significant in driving returns.

What Type of Buyer Are You?

2012-01-13T06:11:00.005-07:00

Yesterday a reader left a question about where I was on investing in the banks. My answer was probably not a surprise in that I said I still believe the fundamentals stink, assuming he was talking about the US banks, because of a lousy real estate market, a slow moving economy, muted loan demand, the job market is still struggling and I do not believe that the book values being reported will stand up.

Right or wrong that is my take and I acknowledge there will be short bursts where they trade well as appears to be going on now.

Something occurred to me though as I was answering the question. Does it ever make sense to buy a stock if you believe the fundamentals stink? And if so when? Everyone has their own way of doing things and my way is to not buy things that have no fundamental justification or I should say not buy things where I perceive there is no fundamental justification.

What about people who buy distressed companies? There have always been investors who have bought into companies when things look very bleak and had success in doing so. The ideas here appear to include that something that was once great can be great again with the right management or that there is something there to be salvaged, again by the right management and so one way to think of this is a bet that somehow someway the business can be restored even if it is not clear how or when.

I'm not knocking that, some people have great success with this (repeated for emphasis) but it is not something I'm comfortable doing and to be clear, what I have in mind here is not a stock that is merely down in price but where something fundamental has changed or appears to have changed truly distressing the asset. Sears (SHLD) might be a current example of this. Sears appeared to be on the way down, then Eddie Lampert breathed some life into it (or at least he appeared to deserve credit for this) and now it appears to be waning again.

We have a Sears where I live. We went in one time when we needed a refrigerator a while ago and they were not competitive on price (as a personal belief I think price matching is a sham; we'll charge you this but if you can find it cheaper will give it to you for that price?). Our Sears is very close to our house and so I go by it on occasion (our Fire Department does driving training in their parking lot) and any time I go by it is always easy to get a parking spot very close to the door. We also have a K-Mart here which I've never been in.

Given the history of the brand and where some of the locations are I could easily see where someone could make a convincing turn around argument of some sort, even if the stores in Prescott have to be closed, and either that argument would be right or not. This is a valid way to invest but not my way. Is this your way to invest?

This post is really about knowing yourself. Investors have always had success with every form of investing imaginable. Buy high-buy low, buy and hold-actively trade, indexing-stock picking, dividend strategies-momentum strategies; the choices are endless and they all can succeed. They also can all fail.

I believe the utility of investing blogs is about taking bits of process from many sources to create or improve your own process. I think too many people don't know what type of investor they should be which often leads to poor results and sometimes catastrophe. This is an important thing for people to figure out for themselves.

Finally a couple of more pictures from the CHL All Star Game in Prescott Valley on Wednesday night. These were with the "good" camera, yesterday's pictures were with my phone. The first one I think I caught a kick save by the Sun Dogs goalie and if anyone could get an artistic picture at a hockey game, Joellyn could--the second one is hers.

Re-Equitization

2012-01-12T06:20:00.003-07:00

Over the last couple of weeks I've disclosed a couple of trades we've placed for our large accounts that started the process of moving toward being fully invested. Yesterday we executed trades for most of our small and mid sized accounts with the same goal in mind.

Large account are ones where we believe using mostly individual stocks is suitable. This is usually a function of account size. If there were no trading costs then we could put 40 positions into any sized account. In mid sized accounts we still build the portfolio at the sector level using mostly ETFs but include a small number of individual stocks and with small accounts we use mostly broad based funds in an effort to capture weightings to foreign versus domestic, large cap versus small cap and defensive versus fully invested.

Part of our defensive approach for the mid sized accounts was to meaningfully reduce our exposure to the industrial sector. In the face of a bear market or recession industrial stocks are often one of the hardest hit sectors and reducing exposure to this sector is something we did in the large accounts also. Defensive action in this sector is a way to get more bang for your defensive buck by taking a lot of beta out of the portfolio.

To put the exposure back on we bought the Industrial Sector SPDR (XLI). If my thesis about a range busting rally (followed by a retracement) actually happens then it is likely that industrial stocks will be one of the leading sectors and so we are slightly overweight the benchmark S&P 500.

In many instances XLI will not be the only industrial holding. Sorry if this is confusing but larger accounts within the mid sized tier may own the PowerShares Water ETF (PHO) and/or the iShares Emerging Market Infrastructure ETF (EMIF). The specific holdings in any account are dependent on the planning/screening process for new clients.

For small accounts our defensive strategy was to cut small cap exposure in half as similar to the industrial sector, small cap tends to feel bear markets more than large cap. We got defensive when we were still using Schwab as our custodian and so we used Schwab ETFs where applicable because they were commission free. At Ameritrade there are other commission free ETFs, a lot more than Schwab, and so we bought an iShares ETF that is commission free so clients have a split position for the same asset class.

For small and mid sized accounts I waited a little longer to re-equitize in hopes of minimizing the chance of getting whipsawed, and of course that could still happen and we'll deal with it then if that happens. But with the flirting back and forth between the SPX and its 200 DMA and then slow move above the 200 DMA I felt as though I could move a little slower.

The CHL All Star Game was here in Prescott Valley last night including a visit from the Stanley Cup and Pete the Stanley Cup guy from the Peggy credit card commercial--Pete's real job is to be the keeper of the Cup. We sat right behind the Sun Dogs bench right on the glass (the format was the Arizona Sun Dogs versus all stars from the rest of the league.

Could Happen To Anyone

2012-01-10T06:14:00.002-07:00

Over the last couple of weeks or so I've disclosed buying two new individual stocks for most of our large client accounts (in this context large means accounts where we believe using mostly individual stocks is suitable). A hopefully amusing thought occurred to me that actually relates to a potentially serious issue, certainly a frustrating issue.

Using individual stocks in a portfolio offers the chance for outperforming a relevant benchmark index with the trade off being that the single stock risk goes bad for turning out to be a bad choice. I've talked about this many times before of course in the context of a particular stock not working out over some reasonable period of time.

Occasionally something will go wrong immediately after purchasing a stock (fortunately not yet with the last two I purchased). You may need to click on the image to see what is going on there but yesterday WD 40 (WDFC) had a pretty good day during the regular trading session.

It chugged higher most of the day, there was relatively a lot of volume in the last hour of the day as the stock kept going up. Then after hours the company missed by what seems like a lot on earnings and by what seems like a little on revenue which lead to an 8% decline after hours.

I follow the stock only to the point of merely staying in touch. Over very long periods of time the stock generally has gone up but occasionally it gets clobbered. It seems like a fine company, we all have a can of the flagship product somewhere in our house and many of us have at least one other product as well. I can't quite get my head around why it gets hit so hard, again only occasionally, and so we've never owned it but it does have volume and a real market cap; $650 million.

Buying the stock may or may not work out but it is not absurdly reckless. It just so happens that people who bought in yesterday had it go badly immediately. Clearly this caught the market by surprise and while the report might alter the prospects for the next few months it probably does not change the prospects for the next five years.

Sometimes of course news can come out of nowhere and meaningfully change the prospects for years. Obviously people bought Union Carbide on December 2, 1984. Later that night a gas leak at the company's facility in Bhopal, India killed, by one count, 3787 people and lead to other related deaths. The stock immediately fell 30% in the face of the news, was never the same and was bought in what might be called a take-under by Dow Chemical (DOW) in 2001.

That is not something that can be factored into a forward looking analysis of a stock other than anything can happen so I'll only buy 4%. More realistically someone who bought Union Carbide on December 2, 1984 or WDFC yesterday was just unlucky and that can happen to anyone. If you have a 40 or 50 year investing career using individual stocks it will probably happen two or three times. To the extent this sort of blowup cannot be reasonably predicted it speaks for avoiding big bets which is of course something I have been preaching here for years.

Apples to Apples

2012-01-09T06:14:00.001-07:00

A reader at Seeking Alpha left a comment on my "Revisiting Yield Products" post from the other day noting that ETFs have recovered much better than CEFs, aka closed end funds. Generically speaking this is probably true but not the best way to look at it.

I mentioned in the post the amounts a few products were down but noted that I had not factored in the yields but that I thought it was still an apples to apples because I did not include the dividends for any of them. In that context, within the same group it gives some idea of relative return but does not give an idea of relative return compared to other segments as implied by the comment comparing ETFs and CEFs.

One of the call writing/put selling CEFs I looked at was NFJ Dividend and Premium Fund (NFJ). For the last five years the price is down 33%. Compare that to another call writing fund and you might be able to make a comparison but comparing it to something like the SPDR S&P 500 ETF (SPY) probably does not deliver an accurate comparison.

Five years ago NFJ was at $24.79 and it closed Friday at $16.61. But in the interim it made 20 "dividend" payments totaling $7.12 per Google Finance. I put the word dividend in quotes in that last sentence because I do not know what portion, if any were capital gains or returns of capital. Adding the payouts back in leaves the fund down 4.2% for five years which although lags the S&P 500, once dividends are added back in, does paint a different long term picture.

For me this does not change the short term picture. For calendar year 2008 NFJ was down 45% and although the payout had not yet been cut I would not say the fund offered much shelter which is not to pick on the fund because most of them did not offer any shelter, actually I don't know of any call writing CEFs that did.

ETFs on the other hand are the market, the broad ETFs anyway. If the SPX were back at 1565 then SPY would be back at its high (or thereabouts). The managers of the CEFs may have done a good job or a bad job in the face of the crisis but they are actively managed funds and even if they made good decisions during the crisis they could have made bad decisions in subsequent years. There are a lot of variables to this including portfolio decisions and factoring in the payouts.

CEFs can be complicated products as outlined and we've made no mention yet of premiums or discounts to NAV which is yet another layer of complication.

I've always limited our exposure to these as there is value in tweaking up the yield (this can apply to equity or fixed income) but they can and occasionally do blow up in spectacular fashion. Things may go smoothly for them collectively for years with people getting more and more comfortable with holding increasingly more of them and then whammy (Ron Burgundy reference) they come unglued. This was the case in 2008. This will happen again at some point and the impact it might have on a portfolio will depend on the amount of exposure in that portfolio.

Sunday Morning Coffee

2012-01-08T06:03:00.001-07:00

No post today just a (hopefully) cool picture of the Grand Tetons through the window of the Cunningham Cabin.

The Big Picture for the Week of January 8, 2012

2012-01-07T05:43:00.005-07:00

Yesterday we executed a trade for most "large" accounts buying KLA-Tencor (KLAC). The pick is more of a top down decision (more on that in a moment). The company makes equipment used in manufacturing many types of semiconductor; data storage, LED, solar, nano and several more. The company has been around for quite a while, its history has generally been to outperform on the way up and lag on the way down. In the last few years it has evolved into a dividend payer, currently yielding a little under 3% which is very good for a technology company. Similar to our other recent purchase, there is far more cash than debt, its PE ratio is around 10 which is low and earnings and revenue estimates point to meaningful growth over the next couple of years which paves the way for dividend increases as the company has done a couple of times before. The company's fundamentals in terms of ratios and balance sheet stacks up favorably with its competitors.

I think the more important aspect of the trade are the big picture effects on the portfolio. You may be aware that for quite a while my thesis has been for below "normal" GDP growth and below "normal" US equity returns over the course of the decade and that has been playing out. This makes increasing the dividend yield of the overall portfolio increasingly important. Additionally it looks as though GDP growth will be a little better in 2012 than it was in 2011 although still below "normal." If that plays out then it makes sense for technology to do relatively well with slightly stronger GDP so we have chosen to increase our weighting slightly to technology.

The above is from an email I sent to my colleagues in case any clients had questions about the purchase except as I sent the email yesterday the first word was today-referring to Friday. To add a little more color this is part of a series of trades to generally increase the yield of the portfolio which I've been telegraphing for a while. I spelled out the logic for this above but I think this speaks to the long term focus I try to place on the portfolio and long term themes I try to embed.

A few days ago I made a comment about the longer term slog I expect from the market in terms of looking back on this decade at maybe something like 4% annualized growth and that for the last couple of years that is what it averages out to. Then I remembered that 2007 was up only slightly; something like 3.5% plus another 2% or so for dividends.

If this continues then as I mentioned increasing the yield will make sense as will owning countries that appear to not be facing systemic threats (Latam, Antipodes, Scandies, parts of Asia as some examples).

During the week a reader asked why so much attention lately on dividends, why not focus more on total return. My answer was that I do focus on total return but that I've been interested in writing about yield lately. The reason for the interest is that we have been increasing the yield of late but there are still quite a few holdings that don't have much of a dividend.

Consistent with what I think I have been saying for years here; there are times where yield doesn't mean much like 2008 and 2009 but that most of the time yield does matter. In this instance where I have an opinion about the next few years it makes sense to tilt in that direction. I am not making a lopsided bet as I could be wrong. The threat to the dividend thesis is if interest rates go up a lot, I mean really a lot. Yes, that is unlikely for a while but that is one of the threats.

Also part of the total return question is that if it turns out there is less price appreciation then more of the total return needs to come from dividends.

Revisiting Yield Products

2012-01-06T06:32:00.004-07:00

This blog started in 2004 and back then markets were functioning normally (mostly). Equities were mostly moving higher even if returns were lumpy and there was no speculation about which would be the next country to need a bailout. It was not a riskless environment but the risks confronted were rather pedestrian compared to what they have been since 2007.

Back then I used to write a fair bit about what I'll refer to as yield products. My take on these was that owning one or two types of products in moderation was a good way to kick up the yield of the portfolio and if something horrible happened then a modest allocation would not devastate the portfolio. We owned two of these in a very modest weight, like 2% each; a call writing fund and an infrastructure trust.

Both of them worked for a very long time, as did most of these types of products in the various yield product segments. Then the crisis started to unfold and the market started to rollover and many yield products blew up in dramatic fashion. These types of products have blown up before but before 2008 a blow up was 20-30% which was then usually recovered over some length of time. In the financial crisis many of these products dropped by 50-60% and have not come anywhere close to recovering their pre-crisis levels. Many of them have been "working" as one might expect or hope for since bottoming out in that they have been making their payouts and trading with pre-crisis volatility but still down a lot from 2007.

If they are making their payments and the volatility is back to "normal" then it is reasonable to take another look at these and decide whether any exposure is warranted. Just like 2004-2007 anyone wanting to dabble in these should keep allocations modest because at some point they will blow up again. A 2008-style blowup is probably (hopefully) unlikely but every few years it is likely that they will take a 20% or so hit. When you have a 5% exposure to things that blow up, and again, in the past they usually came back, it is merely a source of frustration not a back to the drawing board situation.

So what the hell am I talking about? Here is a overview of a few segments in the yield product world but there are more than the following.

First is the call-writing, put-selling closed end funds. For a while these things were insanely popular with CEF IPOs coming just about every week there for a while. I looked at a chart of four of them (these are easy for you to find on your own and they are mostly interchangeable), I chose the symbols randomly from memory and in the last five years three of them are down 50-60% and one was down 33% so they all fell a lot had some comeback in 2009 and then have meandered sideways for a while but then rolled over in 2011. For the last year they are down 20-30%.

I also looked at a few airplane leasing companies. This business seems simple enough in that many airlines lease planes but the companies are very transaction oriented, similar to infrastructure trusts, and markets need to be functioning in order for the companies to do what they do. Markets ceased up for a while there in 2008 and these stocks got crushed. The three I looked at bottomed out with 80-90% declines but for the last two years are up an average of 20%. Only two of them pay dividends and they have been paying them.

Next I took a peak at three large closed end high yield bond funds. They have all traded fairly closely together; down 60-80% at the worst of the crisis, down 20% for the last five years and for the last two years they range from flat to up 10%. The yields all range from 7-11% and the funds have been paying consistently.

Lastly I looked at a few of the tanker stocks. Again these seem simple enough but collectively they are overly cyclical in terms of reacting to economic activity. They seem to have been punished every which way but loose, some are paying dividends now, some are not--they've really been on a wild ride including over the last year where the declines for the few I looked at ranged from 35-50%.

If you are interested in any specifics they are easy to find. The idea with this post is merely to revisit the space. These types of products worked just fine then they blew up, the blow up is over and they might work again (you can decide for yourself). One point that I've tried to make before is that occasionally you need to go away from some market segment for a while (I've felt that way about treasuries for several years and we don't own any now) for whatever reason but that does not mean you should completely lose touch.

In terms of owning just one yield product, the above seem to have different fundamentals driving them, have some vulnerabilities in common and some unique vulnerabilities and they also have different volatility characteristics; the shipping stocks are shockingly volatile for my tastes, I'm surprised that the airplane leasing stocks have done well and impressed by the resiliency of high yield funds.

Obviously the various ups and downs of the products mentioned above did not include dividend. If you actually investigate any yield products you would factor in the yield in order to get a more precise understanding of the total return but for purposes of this post the numbers are apples to apples.

This was about process, about revisiting things that I used to pay a lot more attention to in order to start figuring out whether any of these have a place in the portfolio and should be investigated further.

Chasing Heat

2012-01-05T06:31:00.005-07:00

Yesterday I was in Phoenix for a client meeting. In the meeting I was asked about whether I would ever try to seek greener pastures and while the answer is I can't envision a better scenario than what I have now it got me to thinking about the extent to which investors (including professionals) seek (chase) greener pastures in their portfolios.

This is really about patience and the potential consequence of losing patience. A big part of what I do with my typical day is to try to learn about other people's process, companies that are new to me, developments in companies we own, countries and themes. Like many people I am interested in getting a little better at what I do and so the overall portfolio approach evolves over time. If you read this site then you probably have some similar interest in learning in the manner I describe.

This might be difficult to articulate but the above describes the honing of a process. You probably have some sort of investment process that you have a basis for believing will give you a decent shot of having enough money when you need it. Over time you learn a lot of things about markets and investing and maybe incorporate some of what you learn into your portfolio and so it evolves.

The flip side potentially comes in a year where some particular process doesn't work so well (no approach to investing can be best for all market conditions) and patience is lost. This is what leads to panic selling and panic buying. An example might be last April with silver. At one point last spring iShares Silver (SLV) was up 60% for the year (at that point) while the S&P 500 was up 7%. Seven percent is pretty good but it's no 60%.

There was quite a mania around silver at the time, hopefully you remember, and while it seems obvious now plenty of people bought above $50. This repeats in dramatic fashion like blowoffs in things like silver or Netflix (NFLX) or far less dramatic like canroys or REITs. People get caught up in the excitement, feel like they are missing out but instead of learning about something and then incorporating a modest allocation they end up going too heavy.

Gold is another example of this. Many believe in a 20% allocation to gold which I think is way too high. Like all of these things the good times can last for a while and then the rug gets pulled out. Jim Rogers has made some comments about gold having been up for 11 years in a row, being due for a correction and that he would buy more at $1100-$1200. I have no idea if it will go that low but it is a pretty good bet that if it does there will be all sorts of people with regret over having too much.

Some exposure to the manias is reasonable but it is important to realize when it is a mania. It is also important to stick with the strategy that gave a reasonable basis for having enough money when needed. Whatever strategy chosen probably needs to evolve but it was chosen at a time not clouded by the lure of the latest mania. Manias and the behaviors that accompany them will repeat over and over and there is a difference between adapting to new things and chasing heat.

Vote For Pips!

2012-01-04T06:14:00.005-07:00

An update on Pips, the dog that Joellyn and I took to the University of Washington last March to join the Conservation Canines program.

United Animal Friends, the animal rescue that my wife volunteers for, entered Pips' story into a contest being run by PetFoodDirect where the winning rescue gets a $5000 grant for food and related supplies.

Pips' story made the top ten which is the finals for this contest. If you have a Facebook account please go to the page for PetFoodDirect, "like" the page and then please vote for Pips--the page to vote will load onto the screen.

That Pips' story made the top ten is probably a big deal because PetFoodDirect has over 50,000 followers on Facebook.

The picture is from Clear Lake with a view of Mount Rainier as we drove Pip to the Conservation Canines facility which is actually in Eatonville. Thank you for your consideration on this.

If you would like to read something market related please visit my page on the 2012 Bespoke Investment Group Roundtable.

The 5% Solution?

2012-01-03T06:28:00.003-07:00

A few years ago I wrote an article for theStreet.com where I tried to construct a diversified portfolio that yielded 4%. While the overall yield came in just below 4% it covered a lot of bases toward being diversified. The objective was not that anyone should have bought that portfolio but I wanted to try to illustrate my point from the other day (I have been making this point for years) about managing the yield of the overall portfolio, at least that was the intention.

The other day I also mentioned that there are now a lot more stocks that yield 3% than there was four years ago, at least this appears to be the case. With yields generally higher I thought it would be interesting to update the 4% portfolio from a few years ago in search of 5%. The names are stocks that I generally keep tabs on (a couple of exceptions) but don't own which should tell you something.

Financials-

Westpack Bank (WBK) 7.8% yield; This is one of the big four Aussie banks. If I am wrong about the risks in the housing market then this would be a good hold. The big difference between WBK and ANZ (ANZBY) that I sold in May is that ANZ has a lot more business throughout Asia than WBK.

Annaly Capital Mortgage (NLY) 14.2% yield; I am quite certain I am never going to own a mortgage REIT but the name has been a good hold more often than not and many people do recommend the name. I could easily be wrong but whatever happens it will happen without me. The thing with mortgage REITs is that they chug along just fine and then something catastrophic happens. My introduction to this came with Northstar Financial which had symbol NFI before it blew up, fortunately I never owned that one. NLY has cut in half twice in the last ten years. Anyone who thinks they can be out in front of the next time that happens might be willing to take the risk in exchange for the yield.

Energy-

Enterprise Products Partners (EPD) 5.2% yield; EPD is one of the big gorillas in the MLP space it is relatively low in volatility. There are plenty of MLPs with much higher yields, generically speaking going in higher in yield should mean taking on more volatility. This would not be my first choice but I don't believe there is any realistic threat of the name hurting anyone in some unique fashion (if all MLPs cut in half for some unforeseen reason EPD would not be immune).

Total (TOT) 6.32% yield; Total is big French oil. I am not a fan of Europe from the top down but it held up much better than iShares France (EWQ). TOT was down 4% in 2011 versus a 19% drop for EWQ. If I am wrong about Europe or if Europe goes up a lot in the face of a lousy fundamental backdrop then TOT should participate. TOT is also cheap, Google Finance has it at 7.4 times earnings.

Healthcare-

AstraZeneca (AZN) 5.8% yield; AZN has a PE of 6.3. Like all of the big drug companies it has a bunch of products that you have heard of and has a few interesting things in the pipeline. There are always patent issues with these companies and to the extent the company is pretty generic, its five year chart looks a lot like many of the other large drug companies although most of these stocks lag the broad ETFs like Healthcare SPDR (XLV).

Sanofi (SNY) 4.8% yield; Pretty much everything about AZN applies to SFY but SFY's PE is 15.9.

Technology-

Taiwan Semiconductor (TSM) 4% yield; within semiconductors there are many 3% yielders to be found. TSM has always had a high yield. The stock has done relatively well over the years compared to the iShares Taiwan ETF (EWT). There are a couple of other easily accessible Taiwanese semiconductor names but TSM appears to be on the surest footing.

DDi Corp (DDIC) 5.1% yield; This name got mentioned once in passing on CNBC, it makes printed circuit boards which can be thought of as a commodity which embeds some risk into the name and this is reflected in the price over the last few years but for a microcap it did not go down as much as you might think in 2008. Also the PE is just below 10 and it has very little debt (far more cash than debt). Obviously this would a pretty aggressive hold but the stock has been around for a while and after blowing up in 2004 seems to have matured.

Industrials-

Douglas Dynamics (PLOW) 5.6% yield; PLOW makes equipment and material for snow removal. Similar to DDIC this is a very small company but has a much shorter track record than DDIC. It has done very well since coming out a year and half ago, outperforming iShares Russell 2000 (IWM) by about 25%. Its end market appears to be small business owners that are contracted by municipalities, HOAs and the like. In Yavapai county (where I live) the country owns the vehicles which would seem to be more prevalent. Given the state of the states perhaps there will be more outsourcing of the work and the repair headaches which might be a slow moving catalyst for PLOW?

Lockheed Martin (LMT) 4.9% yield; From the top down LMT is not much different than the other large cap defense contractors but LMT has the highest yield. I prefer Northrup (NOC) and know that name much better but these stocks, add General Dynamics (GD) to the list, seem to take turns being the best performer from year to year. While I continue to prefer NOC long term LMT should hold its own without hurting anyone.

Staples-

Reynolds American (RAI) 5.4% yield; Obviously Altria (MO) and Philip Morris (PM) are the big names in this space. I prefer PM, we own it for clients, because there are less obstacles to smoking in other countries than in the US but RAI has held its own price wise. In addition to tobacco stocks offering high yield in this space there are plenty of booze stocks with high yields also.

Discretionary-

Leggett & Platt (LEG) 4.8% yield; It is difficult to find yield in this sector. LEG makes a lot of stuff, components for products such that it is unlikely you would see their name on anything, at least I cannot recall seeing the name on anything. This sort of company reminds be of a company from a long time ago called Applied Magnetics which made the arm that went on disk drives back then but with LEG the products are much simpler. The stock is a small cap, went down every bit with the market during the crisis but has come back a little faster. The stock is not cheap but the dividend is well covered and earnings are forecast to grow meaningfully in 2012 setting the stage for an increase in the dividend.

Telecom-

Telstra (TLSYY) 8.1% yield; This is the Ma Bell of Australia. It is not riskless. There have been issues with the future of broadband not going favorably for the company. It went down much less than the ASX 200 during the worst of the crisis, then lagged the index in 2010 but lately has outperformed. I would also note that its chart has never looked much like the US telecom sector as measured by Vanguard Telecom ETF (VOX) which we own for clients.

Utilities-

National Grid (NGG) 6.1% yield; NGG is a UK utility but has a presence in the northeast US as well. For a utility it went down a lot in 2008, almost as much as the iShares UK (EWU). It then hugged the index for a while but in mid 2011 when EWU turned lower NGG actually drifted higher and had a much better 2011. The dividend is easily covered by earnings, the current PE is 10 but not surprisingly it has a lot of debt. This is not riskless but as with many of the others, unlikely to turn out to be a house of cards.

Materials-

Terra Nitrogen (TNH) 8.2% yield; This is probably a common name but I don't know if people realize that it is a partnership. It has no debt, pays out almost all of its earnings (by definition) and is a volatile stock. Southern Copper (SCCO) is also a high yielder for anyone not wanting too much exposure to partnership stocks. To be clear, one is not a substitute for the others, the two charts look to be almost negatively correlated but SCCO also yields about 8%.

Again, we don't own these stocks for clients. If a portfolio is built with nothing but these types of stocks then the risk becomes finding out they are leveraged to the same types of unpredictable risk after they have all gone down a lot. I generally would be more concerned about risks I can't see coming. This type of threat is reduced when you make sure you take in holdings with all typed of attributes. With NLY, again a name I can't imagine using, I could be overly concerned versus the reality which is fine but complex dealings in mortgages is not an area I want to own.

A practical application could be summarized in the following example. It would be reasonable for someone to own Fedex as a proxy for industrials. In 2009 it trounced the Industrial SPDR (XLI) and has since tapered off versus XLI. Fedex only yields 0.6%. After a great 2009 for the SPX it made sense to think that the market would not do as well in 2010 making yield more important. A swap from something like Fedex to something like LMT obviously increases the yield of the portfolio. A few trades like this would be enough to meaningfully increase the yield of the entire portfolio. The difference between a 2% yield and a 3.5% yield won't mean much in a year like 2009 but did mean a lot in years like 2010 and 2011 and I think will mean a lot in 2012.

As a bit of a disclaimer on the stocks mentioned, I keep tabs on these stocks I do not know them cold and don't own them. My opinion is that none of them will prove out as frauds or truly hurt anyone relative to other stocks in their respective groups (if all mortgage REITs go down by 75% NLY will too but it don't think it would go down 75% if the group goes up by 5%).

One more point is that generically speaking there comes a point higher yields lead to more risk. A 5% yield is pretty modest these days for an MLP but there are plenty that yield 9%. Not that you shouldn't own a 9% yielder but a portfolio full of them has a high likelihood of ending in tears.

Dakar Rally 2012

2012-01-02T09:16:00.002-07:00

For anyone who forgot, the 2012 Dakar Rally has started, there is daily coverage on ~~Versus~~ NBCSports Channel. If you care about this you might want to record the coverage as it is on at odd times.

The big news is that Volkswagen is out of this year's rally which I am guessing is a business decision and not a competitive decision because they have dominated the race for years.

Among others displaced by the Volkswagen decision is last year's winner Nasser Al-Attiyah. He has joined up with Robbie Gordon's Hummer team for 2012. Last year I mentioned the extent to which the H3 appears to be the wrong vehicle for the Dakar's terrain of dunes and mountain roads. Obviously this is based on the performance turned in by Gordon year after year. It would be very funny if Al-Attiyah somehow won the race in the H3.

The coverage on NBCSports is starting out much better than last year. Last year they gave the studio host a lot of face time and had what amounted to a sideline reporter who did a segment every day on the town that the race was near or something like that and of course any time devoted to the studio host or the cultural segment was time not spent covering the racing and actually the racing not covered was my favorite class which is the big trucks (pictured above).

Speaking of the big trucks they've updated some of the vehicles and this Vladimir Chagin is not in the race. I think he won that last 30 Dakar's in a row (slight hyperbole) so someone new will have a shot.

The reason to post this is that the scenery is spectacular, similar to the Tour de France and the action is usually exciting, the race stages take hours but the show is 30 minutes and you have to figure they are not going to stuff the show with the boring parts. If you've never seen this before, I encourage you to try it.

Right Place Right Time

2012-01-02T05:52:00.003-07:00

A little anecdote from my weekend that I think can be applied to investing;

The dog in the picture is a pitbull named Blue. While watching bowl games and reading Barron's on Saturday afternoon our dogs starting barking up a storm as they occasionally do. I went outside and there was Blue on the other side of our fence.

I went outside the fence and Blue came right up to me. I brought him in to where the dogs could sniff through the little gate you see in the picture and because the barking was more "hey I want to meet you" as opposed to "hey I want to kill you" I let Blue in to meet everyone and it went just fine, actually he fit in better than Wiley (dog number six who after a year and half still doesn't quite fit).

Blue had a tag with his name and a number in Phoenix so I left a message hoping the people would check their phone once the realized Blue was gone. I then called Joellyn who was where she is almost every Saturday, a UAF adoption event at Petco, to tell her what was up and see if maybe she knew the dog (not impossible) but she did not.

I took Blue out for about half an hour walking around the mountain to see if anyone was looking for him, I ran into people here and there but no one knew Blue. I brought Blue back and we all hung out for a while, he was so well adjusted he was even able to eat with everyone for our normal 3pm feeding time .

Our neighbor, also a dog person, coincidentally had an errand at Petco. Joellyn told our neighbor about Blue because maybe the neighbor knew the dog (not impossible) but no dice. As our neighbor was just about to drive up the road we live on as she was coming home she ran into people looking for the dog. One thing lead to another and she was taking Blue back down the hill for me to the dog's owner (the owner did not have a four wheel drive vehicle and you need one in the winter to get up our road) for a happy outcome.

There were several things in this little story that had to go just so for Blue to be returned so quickly (this all transpired over the course of two hours). Take from this whatever you think can be applied.

Enjoy the football.

New Years Day Morning Coffee

2012-01-01T06:01:00.004-07:00

Just a couple of random thoughts this morning.

My base case for 2012 is some sort of range busting rally that then mostly retraces. If this scenario plays out then I think we would be lucky to finish out 2012 100 SPX points higher but I think a smaller gain is more like it.

That being said one idea that I believe many subscribe to is that US equities have benefited because of what is a lousy backdrop in Europe. The idea is that money that might have otherwise gone into European equities instead went into US equities because as shaky as the US fundamentals are, in my opinion, the fundamentals in Europe are far worse.

If the above is true then it stands to reason that some sort of recovery in Europe, real or perceived, could come at the expense of US equities meaning that US equities get sold to buy European equities perhaps leading to a reversal of the 2011 result where the US was in the green by a whisker and much of Europe was down in the low teens, or worse, percent wise.

We lagged by a small amount in 2011 (talking specific numbers makes a blog post a marketing piece subject to a lot of compliance stuff) as foreign mostly lagged domestic. I talk a lot about foreign because we own a lot of foreign because I believe in the long term fundamental outlook for foreign but in any given year where domestic outperforms then we obviously will lag the benchmark but over the course of an entire stock market cycle (which is our objective) I have unyielding faith that foreign will continue to be the better hold. We still have domestic exposure in case I turn out to be wrong.

2011 was a good year personally, we finally went to Yellowstone National Park, I became an EMT and our trip to take Pips the dog to University of Washington would have been awesome even without going to the town where Northern Exposure was filmed . Hopefully 2012 will be an even better year for everyone, I hope one personal highlight will be my project with AdvisorShares coming to fruition.

The Big Picture for the Week of January 1, 2012

2011-12-31T06:04:00.003-07:00

After listening to the umpteenth segment on CNBC where both guests extolled the virtues of some version of dividend stocks, dividend growers or high yielders or the like, it has become clear that we have a very popular theme here. Over the last couple of years I've had some posts where I have tried to isolate the importance of dividends to a portfolio but tried to warn of the risk of a cultish devotion to them hence the term dividend zealot.

Also during the week I read a post at Seeking Alpha with a cautious tone on a dividend stock bubble and all the usual suspects chimed in about why dividend stocks can't be a bubble.

For people not cultishly devoted (read all the comments on dividend articles at SA and tell me there isn't a cultish tone) but still very interested in the topic I thought of a different way to articulate my thoughts on this subject which hopefully is useful. In listening to the aforementioned CNBC segments and the articles that have popped up people seem to think of dividend stocks as an asset class which I don't think is the right way to look at it. People also think of dividends in terms of various strategies like dividend growth and so on and the strategy idea is a correct way to look at it but I don't think it is the only way.

I think of dividends, more precisely yield, as an attribute to be managed in the portfolio. In the trade we executed during the week we added a name that has a pretty easy time paying 6%. I also mentioned that I expect to add a couple of other stocks with similar attributes (higher yield and low volatility) with an idea toward increasing the yield of the portfolio.

Part of my thesis for the decade is equity returns for the US market that are below "normal." The last two years averaged out don't refute the idea. Dividends over extremely long periods of time account for about half of equities' total return and if I am right about the new decade then dividends might account for more than half. While I believe this to be a very plausible scenario it also appears that from the bottom up yields on many stocks are now quite a bit higher than they were in the 1990s or 2000s. It is much easier to find stocks yielding 3% than it was ten years ago.

In years past I wrote many times about targeting a 3% equity yield against the SPX's 2% yield but now it might be possible to get a 4% yield against the SPX's 2% for the next few years or longer. Please note that the context here is a portfolio diversified to include all SPX sectors along with foreign exposure and taking in a full range of attributes into the portfolio.

The reason SPX still yields only 2% is because the financial sector is still a large component and many of the biggest banks pay little or no dividend as ongoing fallout from the crisis--at least this is my opinion as to why SPX only yields 2%.

If my idea of a diversified portfolio (not that you should care about my idea of a diversified portfolio, but this is the process I am working through) can yield 4% (I've not yet come to that conclusion) and if it turns out that domestic equities only average 3-4% per year then that yield does a tremendous amount of heavy lifting for the portfolio. From there a couple of correct country decisions and figuring out one thing to avoid (hint:US and European banks) and there is a good chance of having a "normal" return in a below normal world.

And for anyone doubting their ability to correctly select a couple of countries and correctly avoid something; they can still have that yield to fall back on.

The picture is from the Arizona Sun Dogs hockey game last night. The Sun Dogs are Prescott's minor league hockey team.

Happy New Year!

Trade Executed

2011-12-30T06:19:00.001-07:00

We executed a (mostly) across the board trade for large accounts on Thursday buying ASX Limited (ASXFF) which is the stock exchange in Australia. The trade obviously increases our exposure to financial stocks and takes us back to Australia after having been out for about seven months.

First from the top down I have been concerned that Australia is at risk for some sort of housing problem although with a far less severe magnitude as occurred in the US and so I sold our holding in ANZ Bank (ANZBY) for large accounts and at the same time sold our Aussie ETFs for their large exposure to the banks. ANZBY is down 13% since that sale and the ETFs are down a little more which is nice but I would not call the sale a major transaction.

Going forward I think housing can still be a drag and so I think the banks will underperform but my take overall is that things in Australia look good--drawing this conclusion means you have to believe that China will not stop buying resources and I think Yanzhou's intended purchase of Gloucester Coal supports that belief.

I would also note that the SPX is right at its 200 DMA (give or take) but we have more cash raised than I think is ideal by virtue of selling American Tower. I wanted to buy something with relatively low volatility and higher yield (more on that in a moment) and actually if we have more purchases to make I think most of them, but not all, would be lower vol and higher yield like ASX.

In terms of picking an exchange stock, I think I've been telegraphing this for a while in how much a talk about this group and obviously this adds exposure in the financial sector while still keeping away from US or European banks and Aussie banks for that matter although I would reiterate that I do not think the Aussie banks face anywhere near the magnitude of risk that US and European banks do.

The stock itself is cheap in terms of where it has traded in the last couple of years and while it is a little cheaper valuation wise than where it was a couple of years ago it is not a deep value stock. It has essentially no debt, almost 2/3s of the share price is in cash and yields abut 6% with a pretty reasonable payout ratio.

A little while back ASX was going to merge (be taken over) by the Singapore Exchange (SPXCF) but the deal was nixed. While I think odds of a takeover are low it would not be a black swan event either.

After lagging the US for a couple of years I think Australia can come around again and if that turns out to be correct then I would ASX to do a little better than the broader Aussie market.

As a small logistic item, we bought the stock directly in Australia so it was entered overnight on Wednesday US time which is Thursday in Australia. We bought in this way because it doesn't trade enough volume here for our entire client base but the name is very liquid on the home market. If we buy the name for any new clients for whom it is appropriate I am quite certain the we could get individual trades complete on the US pinks.

Getting to Know the Future You

2011-12-29T06:08:00.001-07:00

A writer named Doug Carey had a post at Seeking Alpha called 3 Pitfalls To Avoid When Retirement Planning. He says don't wait to start saving, don't count on Social Security and make sure you beat inflation. Obviously all three important but as I read through I stumbled across what I think could a huge dilemma.

In talking about starting early he starts out with something like let's say a 25 year old wants to retire at 65 and then he crunches some numbers showing the importance of starting early and he is right but there is a problem here that I have thought of often but could never figure out how to articulate (and maybe I still can't).

Think back to when you were 25. Could you have possibly had any understanding or what it meant to be 65? When I was 25, even 40 seemed to be so far into the future that it would never come (not that I wouldn't make it to 40, but more like it would never come for being so far off in the future). As I got close to 40 I realized that when I was in my 20s I had no concept of what 40 would feel like. At 45 now, from a self-awareness point of view I am quite certain that I don't really know what it will feel like to be 65, it is possible I don't understand 50.

If I am even articulating this in a way that makes any sense it creates a lot of unknowns in trying to plan for retirement. I think it is easy to understand at any age that you need to save money for the future and the more you save the better off you are likely to be. Someone who is 25 can understand this I think because as framed in this sentence there is no need to envision or guess what your life will be like in 40 years. "I know I will need money" is easier than "I will need $3400 month starting out and my health insurance will go up 10-15% per year."

I believe in crunching the numbers. At 40 or 50 you have some piece of money and you have whatever knowledge about yourself that you have accumulated and you need some sort of blueprint. So I guess the point is to have enough self-awareness to know that the 65 year old you might view things much differently than the 50 year old version of you.

To the extent this line of thinking resonates, the solution needs to be keeping as many options open as possible. How each person does this is where personal solutions come into play. I tend to think of options as including not needing every last nickel you make to pay for your lifestyle (as in live below your means) and having some sort of plan B in case the unexpected happens with your primary source of income. In trying to think about post-retirement; what about having a job that you love enough that you don't want to retire or putting in the time to create some sort of ideal job for yourself (monetized hobby) for when you do retire such that it covers a decent chunk of what are hopefully modest expenses?

I believe I walk the walk in this regard in that while I can't envision a scenario where I want to do something besides manage money in the stock market, I realize that anything can happen and between the writing and a small income I could take from the Fire Department (we can be paid for certain patrolling and certain fires) it would cover our fixed expenses by a slim margin. As I have said before I am very motivated to avoid financial stress and having a small monthly nut is probably easier for most people than finding a job that pays a lot of money.

Everyone needs to figure these things out for themselves but everyone can benefit from keeping as many options available as possible.

Yesterday came surprising news that the Red Sox traded Josh Reddick to the A's. Oh, boy. ~~In Theo we trust~~ in Ben we hope.

It's The End of the World and Paul Farrell Knows It

2011-12-28T06:23:00.002-07:00

Paul Farrell had a column up yesterday that detailed ten reasons why 2012 will be a doomsday. Included in the list are failings of US democracy, class warfare and some disturbing prognostications about global warfare.

If you read the paragraphs that Farrell wrote on those points, it is hard to disagree with the nature of the problems he cites. However these are not new issues and Farrell offers no reason as to why 2012 must be a tipping point for any of them. While I apologize for not taking the time to look I would venture to say that these points or similar ones were predicted by him to be tipping points in previous years.

Expectations of torn social fabric, or the breaking down of society were made at the beginning of the crisis and have not panned out and are unlikely to. Some things have gotten worse and will continue to get worse but we collectively can adapt better than most, probably not all, countries. To repeat an idea I have mentioned frequently, the US is the world's most important customer and so other countries have a vested stake in our remaining functional. Remaining functional is not a Jim-Paulsenian argument to be bullish but does argue for the US' ongoing ability to slog through as we have been.

Some of the other reasons cited by Farrell seem totally disconnected from the thesis of doomsday. His number 7 was about market technology whose consequence is that "average investors are no match for Wall Street’s 'high-frequency traders.' " He's probably right here for average investors who actually try to hit bids and lift offers faster than the machines but more practically average investors buy a few shares of broad based ETFs or blue chip stocks with the intention of holding long term not to scalp pennies before lunchtime.

Further, individuals have always been disadvantaged when compared to professionals and they always will be. No argument from me if anyone thinks that is wrong but it is hardly new. It is not plausible that a decades old issue can cause a breakdown in the magnitude he seems to suggest.

Farrell's last reason for doomsday was actually a suggestion of sorts about what to do in the face of doomsday not a cause of it. He cites advice given by Barton Biggs about being able to grow your own food, real everyone into the bunker stuff, except that advice from Biggs came from a book published in 2008. Based on what I have seen of Biggs' TV appearances he appears to have distanced himself from those opinions (please comment if I have that wrong).

We have real and seemingly (almost) unprecedented problems but end of the world arguments like "the next crisis, according to Weiss, 'will destroy the incomes, savings, investments and retirements of millions of Americans.' Yes, destroy. 'It will plunge vast numbers of families into the nightmare of poverty … hunger … and homelessness. Only a minority of investors will survive intact' " have been made for thousands of years, there has always been a big market for selling fear.

It is important to understand the threats but not overreact to them. It is also important to understand the hopium sold by Wall Street and understand how markets and compounding can work. Understanding both sides gives a better chance for successful critical thinking that is required for successful cycle navigation.

Away from investing we need to do our best to be healthy (fit might be a better word) and remain individually adaptive. We can't know how our individual circumstances might evolve. While I hope that my financial situation never relies on my generating an income from being an EMT if it ever does, then I will be grateful that I went through the process.

The need for innovative personal solutions, a long running theme here, will become increasingly more important as time goes on. My neighbor with the backhoe is the best example of this that I know.

What Do You Think?

2011-12-26T05:44:00.003-07:00

From Larry Swedroe's 2012 outlook piece for Seeking Alpha (similar to what I did with them a week or so ago. The following is offered without comment from me (this time), only a question. What do you think of the approach outlined in his answer?

Seeking Alpha: So under specific circumstances such as the current situation in the Eurozone, you don’t lighten up on particular problem areas at all in client portfolios?

Larry Swedroe: That would not make sense. The reason is simple. If we know there are problems, the market surely also knows and that means the problems are already incorporated into prices. And why would you buy when things look safe, and thus valuations are high and thus expected returns are low, only to sell when risks show up, and thus valuations are low and expected returns are now high? That doesn’t seem like a rational strategy, yet it is exactly what most investors do, and it explains why they do so poorly, underperforming the very funds in which they invest.

Christmas Morning Coffee

2011-12-25T06:05:00.003-07:00

Barron's cover story was about the rough ride of Gap Stores (GPS} over the last decade. I was surprised to see that for ten years GPS is up 41% versus 10% for the S&P 500 and for five years GPS is down 6% versus a 10% drop for the index. That all actually sounds pretty good for a supposedly down and out stock which on top of everything else yields 2.4% which is a little more than I would have thought.

I haven't thought about Gap as stock since I don't know when and when I saw the headline of the article I thought I would put up a post about how any must-own or hold-forever stock can have its fortunes change for some reason, either a sensational reason like with Worldcom which was a wildly popular stock that obviously went bust in scandalous fashion or in the case of Gap which seems like a well run company (casual observation only) that has simply become less relevant which of course has happened with fashion companies many times in the past (LA Gear was an amazingly hot stock 20+ years ago).

While the above is an important lesson it doesn't seem to actually apply to GPS. Given the five and ten year results for the name this is probably more of a story about patience. Returning 41% over the course of ten years is still below "normal" but not a catastrophe in an up 10% world.

To be clear I have no interest in Gap Stores but the example is constructive nonetheless.

The Big Picture for the Week of December 25, 2011

2011-12-24T06:09:00.002-07:00

In my 2012 outlook piece for Seeking Alpha and in the upcoming 2012 Roundtable for Bespoke Investments I have some positive things to say about investing in China. As the chart below shows, investing in China has been rough for the last few years. Since the 2007 high for the S&P 500 the Shanghai Composite is down about 60% and the Hang Seng is down about 30%.

One thing that is true in general terms is that markets can correct in time not just price. After four years of going down in fits and spurts it is possible that the China markets are now ready to go up. We can explore this a little further in this post and you can draw your own conclusion but correcting in time is not an outlier phenomenon.

In mid 2007 we sold out of Sinopec (SNP) and a little over a year later went into China Mobile (CHL). SNP was a great hold, I became wary and moved into a less volatile name with CHL but that was a mediocre hold at best and we sold it. After having no China exposure for a while we added an underweight by virtue of China's weight in Market Vectors Coal (KOL) and iShares Emerging Market Infrastructure (EMIF)--our China weighting is about 1% by way of these funds.

The negative argument for investing in China surrounds anything to do with real estate, over capacity, empty cities, debt loads of the banks and debt loads of the municipalities which contributes to questions about whether China will be in for some sort of hard landing. There are also concerns about demographics. GDP growth has been 9-10% for a long time and I have seen several different definitions of what would constitute a hard landing but many believe that if there is a hard landing in China there would be serious social unrest.

The positive argument centers around urban migration, ascending middle class (an "American-ish" lifestyle), China playing an ever increasing role in the world economic order and the country continually becoming wealthier.

I don't think there has been much change to either side of the ledger in quite a while. I think the same threats will continue to threaten for a while longer and the same positives will continue to be the positives for a while longer. I think the decision about what to do with China boils down to a combination of how long the China market has been slogging on and which of the two sides will win out from here.

As you know there has been a lot of commentary about how bad things might get in China because of the various things mentioned above along with other reasons. The reasons are valid but it is also true that the market has fallen by 60% in four years and while it is of course true that it could fall another 60% from here I believe the decline thus far discounts a lot of problems.

China is not facing the systemic threats that the US and Europe are facing yet it is down more than these markets, I looked at Germany, France, Spain, Belgium and Italy (Italy is down about the same as Shanghai) in this context in the last four years. I think this is saying that China is over done, Europe has a lot farther to fall or both.

If you can buy into the idea that China is not facing systemic threats then it is a cyclical event and a cyclical events tend not to last this long. A 60% decline more than prices in a cyclical recession in my opinion. And if a recession of some sort is what is coming then it is plausible that since equities turned down so long ago that they could turn up before a recovery starts and in this instance maybe even before the hard landing. Again, you can agree or disagree.

About that hard landing, although merely anecdotal China is still doing a lot of buying of resources around the world with the latest news being this week that Yanzhou Coal (YZC) is buying Australia's Gloucester Coal (GCRLF).

For many years I have been saying I want no part of the banks or real estate companies, and for that matter I don't want to own companies that rely on discretionary purchases of Chinese trade partners. I'm not changing my opinion on that so this rules out many of the ETFs that exist for investing in China.

For me the story has not changed, it has simply evolved. I don't like the banks and RE companies and haven't for a long time, that has not changed but the story in terms of what appears to be going on with lending and overcapacity continues to play out. Likewise demand for energy, resources (although resources are in part tied to the overcapacity) and something close to the American lifestyle continues to increase. This demand creates a tailwind as I often say, that has not necessarily mattered lately but it is the starting point for an investment thesis.

I think energy can be owned, but not solar, also industrials and utilities. For consumer I would avoid exporters and focus consumer items made in China for Chinese people but to be clear I favor the other sectors mentioned. I will be looking to add a little more Chinese exposure probably with one stock at 2-3% which obviously would take the total exposure to 3-4%.

One point of clarification is I am not talking about reverse mergers or companies that otherwise domicile in China but list primarily in the US.

Obviously you may weigh out the positives and negatives and conclude it is still something to be avoided but if you have ever had some interest in China and think that you might in the future then you do need keep tabs on current events and reassess these various factors every so often because if I am wrong about China in the near term, then it will be a buy at some other point.

Merry Christmas.

Concessions A Comin'

2011-12-23T06:12:00.002-07:00

The other day I found this article about beneficiaries of a public pension (retired police and firefighters) agreeing, by necessity, to a reduction in their payments. While I don't know whether the cuts will be big enough I do know that the idea of of benefits being reduced in a public pension used to be unthinkable.

Over the years I've talked about the importance of not taking anything for granted with things like pensions or social security (probably a good idea in non-financial matters too).

In the news this week was whether or not Congress would extend the payroll tax holiday for two months (so they can then extend it for the full year later) or extend it for the full year all at once. If it is not clear, anything we don't personally pay in FICA during this period is being made up by the treasury which contributes to the ever increasing debt load. This may obviously lead to some bad outcome for social security in the future that ten years ago was equally unthinkable as pension cuts.

For a long time I've been saying that something will have to give with Social Security in terms of benefit cuts one way or another. There have been comments taking the other side noting various data points to the contrary. Things are evolving such that I do not believe it is wise to rely on various assumptions and projections as things have developed over the last ten years in a way that I would submit has been unfathomable and more realistically unanalyzable.

If the last ten years has been reasonably unanalyzable then so too could the next ten years. I am still not in the financial apocalypse camp, I'm not that pessimistic of a person, but do remain in the noticeably uncomfortable camp consistent with my ongoing assertion that the US will still be the world's most important customer but that we will slog through.

A little longer term, as I've said once or twice before, something will have to give with entitlement payments. I think it will be some sort of means testing but either way I think the math being assumed is shaky at best based on assumptions being used, but again I think it is a bad idea to rely on the current assumptions and projections.

As grim as it may sound, prepare for the worst and hope for the best. Preparing for the worst has to mean, in my opinion, expecting nothing from social security especially if you have a high income and did the "right thing" in terms of saving money. Yes, the odds of this being unfair is very high, again, in my opinion.

Obvious statement; it would be better to not be financially done in by a surprise in your social security payment.

The picture; I tried to make a joke on Facebook out of taking it cross country next summer but no one knew I was joking so I'll just say neat motorcycle.

ETFs in the News

2011-12-22T06:16:00.003-07:00

IndexUniverse reported that Global X will be closing several ETFs for lack of AUM. Included in the list are the Fishing ETF (FISN) and the Farming ETF (BARN). Both fisheries (although subtle, I think this would have been a better name than fishing) and farming are themes that I have written about many times and I continue to believe are valid.

However stocks in both, as I mentioned recently in another post, are far more volatile than the underlying demand for protein. Look at the charts for the companies in the funds and you will see they are difficult to own. The combination of being difficult and unlucky timing is what hurt these funds, in my opinion. At some point the stocks within will again catch fire but obviously at that time investors will only have individual stocks to choose from.

The funds got made fun of a lot which I never fully understood. They targeted narrow niches, turned out not to catch on and so they are being closed. Investors were not hurt in any sort of unique or flawed product manner, the funds simply did poorly like any individual stock or narrow fund might.

The other bit of ETF news, also reported by IndexUniverse, is that ProShares has filed for a suite of low volatility ETFs. Broad based, low vol ETFs are being issued left and right and attracting a lot of AUM. The PowerShares S&P 500 Low Vol ETF (SPLV) has attracted $700 million in about ten minutes of trading (hyperbolic comment).

The funds in the filing are targeted to track the Nasdaq 100, Dow 30, Russell 2000, Russell 1000, MSCI EAFE, MSCI Emerging Market and the S&P Mid Cap 400. You can read the IU link for more specifics but basically the strategy will be to increase or decrease equity exposure to the respective index based on realized volatility of that index going above or below 15%.

Obviously I have no idea how well these particular funds will work but SPLV and the EG Shares Low Volatility Emerging Market Dividend ETF (HILO) have both traded as advertised in the short histories.

I think these funds, the ones that end up working as advertised, offer a chance for the core and explore concept to evolve. One aspect of portfolio construction and management for do-it-yourselfers is limited time available to spend on the task. The drawback for using regular cap weighted, broad funds is the lack of portfolio precision and absorbing every bump on the way down.

The low vol funds are obviously designed so that holders do not absorb every bump on the way down (you need to decide for yourself whether they achieve that objective). A broad based fund portfolio capturing various segments (small cap, emerging and so on) could be assembled using low vol fund with some disproportionately large chunk of the portfolio and put the smaller portion into various themes, niches or countries.

This could end up as some combo for the equity portion of four or five low vol funds for the broad portion combined with maybe five individual stocks or narrow ETFs as described above. Keeping track of ten holdings would address the time constraint issue that some folks have. Defensive action could be achieved, at least partly, by selling or reducing exposure in the narrow holdings. The remaining broad, low vol holdings would (or should) be less volatile than straight beta holdings and maybe even have a higher yield.

I am not about to switch to this approach but it can be valid way to go; broad access, some specialty exposure, the chance for more yield and no 40 hour time requirement. For some this would be a very good way to go.

Small Trade

2011-12-21T06:18:00.005-07:00

Yesterday we executed a trade for large accounts selling American Tower (AMT). We bought the stock in October 2009 at about $38.60 and sold it yesterday near $59.35. It was generally a great hold for over the two years and the gain obviously was a nice boost for the portfolio.

The reason for the sell has to do with the story appearing to change. There are several reasons for an outright sale including being wrong about the stock, something wrong at the company, top down reasons and in this case a possible change in the story.

If you know the stock then you know it will be changing to a REIT soon. This doesn't have to be good or bad but it does represent a change. While the company is in process of managing this transition it is also dealing with an SEC inquiry from a few months ago about its accounting. This by itself is not unheard of but the combination of the two simultaneously is unique. I also stumbled across data that insiders had increased their selling of late. As this has been going on the stock price doesn't really seem to be any worse for wear, it made a new yesterday a couple of hours after we sold it.

From the a man has got to know his limitations Harry Callahan school of thought I know I am not the guy to sniff out an accounting scandal. Someone (the SEC) has some questions and the insiders are selling a little more stock. There probably is no meat on this bone but I do not want to take that chance. Where things like this are concerned I would rather have to defend selling too early to a client than selling too late.

I can't recall another sale made where insider activity had much of a seat at the decision table which raises a useful point for narrow based portfolios. I've tried over the years to convey my preference for avoiding slavish devotion to any single indicator or narrow combination of indicators because not everything can work all the time. Sometimes cheap stocks get cheaper, sometimes insiders are wrong, sometimes support fails and so on. I guess I would say to stay flexible my friends.

Speaking of "my friends," a funny Tweet from the most interesting man in the world; He once defended a small village in the amazon basin from ferocious fire ants by using only a pitchfork and a glass of water.

The picture was taken yesterday on a quick hike on the mountain.

Market to BAC and T; Drop Dead

2011-12-20T06:21:00.004-07:00

Or should it be the other way around?

Bank of America (BAC) closed below $5 yesterday during the regular session although traded above the figure after hours. The whole sector was down a lot yesterday; I saw articles blaming Europe and others blaming the new capital requirements. I usually get pushback on this but I will say again that this is not over. The financials will continue to have more shoes drop.

The book value arguments made by Barron's and others over the last few years have not mattered and will not matter for a while longer. I don't know how long this will last I just know we are not done yet. By financials I mean the big banks in the US that dominate the Financial Sector SPDR (XLF) and the big European banks although I would note that that our only US financial exposure is an index provider. Not related but I would also continue to avoid Chinese banks which means avoiding most China ETFs.

The other news of the day was AT&T dropping its bid for DT and so presumably having to fork over the $4 billion break up fee. The worst reaction I can recall to an M&A going bad was when the LBO for UAL unraveled in 1989. It caused a 6.1% drop in the S&P 500 on October 13 of that year.

I don't know whether this news could be that significant (probably not) but it is worth knowing a little market history about this and that deals collapsing can adversely affect the entire market.

The idea that the market volatility would decrease to close out the year as function of towels being thrown in seemed very plausible to me but based on the last couple of hours yesterday's trading seems to be off the table. Volatility; engage.

As I've disclosed in the last few weeks, I've been a little more tactical in the portfolio and mentioned doing a little buying if we dip far enough. No trade yet but I do have one penciled out and ready to implement if this current slide continues, I will keep the blog posted.

A little bit of personal news to share; I am now an EMT. I went to classes twice a week starting in August took the state final two weeks ago, the skills final a little over a week ago and the national final this past Saturday. I was lucky enough to pass all three on the first try; they give multiple chances because, as my instructor said frequently, they really want you to be an EMT.

The process was not fun but the fire department needs more EMTs and since I have responded to almost every medical call since 2003 it only made sense. I've written a lot of posts about volunteerism and finding something along these lines to do but my involvement with the Fire Department sort of found me; I was recruited in by my neighbor with the backhoe. Anyway, I am pretty excited.

Foreign Markets in 2011? Not So Good

2011-12-19T06:24:00.004-07:00

Bespoke Investment Group had a post the other day with the YTD returns of all the stock markets in the world. Of the 78 that they track only ten were positive. Of the ten that were positive, only six were up more than 2%. There are still two weeks left in the year so the numbers could of course change.

There were 13 markets that are down less than 10% which to my way of thinking constitutes down a little. There were 30 markets down between 10-20% and 17 markets down 20-30%. By any reasonable account that is a bad year but that goes with the territory.

Relative to the numbers on Bespoke's table the US had a pretty good year down just a hair. I tend to think the fundamentals are such that the US should not have outperformed quite a few of the countries that it did. Either that assessment is correct in which case 2011 is a good reminder that for a short period of time anything goes regardless of fundamentals.

If I am wrong about the US' fundamentals in relation to other markets then it raises the need for have some sort of counter strategy in a narrow based portfolio for the times you are wrong.

During the last decade there were stretches where the US was a relative solid performer like in 2011 but that did not change the rather long term result for the decade. Along the lines of the market being a short term voting machine versus a long term weighing machine I think it is important to understand what you're investing for and so what is consistent with your real objective.

Long time readers will know I tend to think that for most people the real objective is simply to have enough money when you need it. It would be great if everyone could beat the market every year or maybe go up the same 12% every single year but neither is realistic which, to my way of thinking, shifts the orientation to the longer term--again for most people. There are people who have the emotional makeup and skill for short term trading and there is no reason those folks should not pursue trading in that capacity. But if that isn't you then you need learn that and figure out what type of participant you really are.

The picture is of University of Louisiana Lafayette strength coach Rusty Whitt on the sideline of ULL's bowl game against San Diego State. The coach is very committed, in fact I think he was, once (Rodney Dangerfield line from the movie Old School in reference to the Sam Kinison character). I'm guessing some sort of seemed like a good idea at the time headbutting incident but I'm not sure.

Sunday Morning Coffee

2011-12-18T06:06:00.003-07:00

We all know that the concept of retirement will, by necessity, look much different for many now-working age Americans than what it did for the parents and grandparents of now-working age Americans. Over the years I've tried to explore this inevitability in what I hope is a positive way in that I believe this is a problem/challenge for each of us to solve for ourselves in a way that is right for us.

As long time readers will know, my wife works (volunteers actually) in dog rescue. By virtue of how hard she works and the type of person she is (while I am of course biased she is very innovative one many fronts in her role) she talks to all sorts of people from every conceivable part of the animal rescue world.

She was telling me about a situation that she thinks is coming up at a rescue whereby a rescue will give a free place (one of several houses on the property) to live, utilities included, in exchange for being the onsite manager (not the most accurate word). I believe the circumstance will pay $8/hour for 40 hours but realistically the typical work week would be longer. There are other employees that come and go during the week so the onsite person might better thought of as a coordinator but there is physical work involved.

For the right person, this could be a dream situation. The person would need to be moderately fit first of all but free housing, a $1200/month income, maybe the person doing this has a spouse with a part time job, maybe rental income if this couple owns a house somewhere and maybe a little bit saved to fill in the occasional spending need.

For the right people, how much would be needed per month if there is no mortgage/rent or utilities? A married couple with a modest lifestyle; how much do they need to be comfortable if all they are paying is various insurances (including health), groceries, a car payment and maybe they take one trip per year? While this would be a lot of work, for the right animal person with the right motivation this seems very plausible to me. Again, for some small segment of the population.

It is unlikely that the above would be your ideal solution which is of course not the point. The above is offered as a reminder that whatever it is that you really enjoy doing or otherwise put a lot of time into (or would like to put a lot of time into) can probably be woven into your own personal retirement solution.

The Big Picture for the Week of December 18, 2011

2011-12-17T06:16:00.002-07:00

A reader asks;

Will you comment a little further on deflation, disinflation and inflation? With gold on a slide, the euro approaching parity, world deleveraging, and the US consumer only shopping the "blue light specials" - seems that the economic climate is vastly more complicated than ever before and deflation may be taking hold.

My conclusions here are not very dramatic, no need to load up on whiskey, gun powder, jerky, ivory soap, cans of tuna or, to add a new one to this joke, bacon (see the picture).

The back drop seems to be increasing extremes of long standing patterns. For example we have deflation in asset prices which is the bad kind of deflation. In certain countries and certain sectors here we have what looks to me like a debt deflation which would be very bad depending on how far it ends up going. We have creative destruction in certain consumer goods (we just bought a DVD player at Walmart for $39) which is a good deflation.

As far as inflation, for many years we enjoyed a little inflation (for the most part) which it turns out is a good thing. People have been grappling with serious inflation with education and healthcare costs for quite a while and while I am not sure that it is getting worse it is not improving. I have a post every November griping about how much our health insurance is going up for the next year.

The price of propane to heat our house has gone up a lot but it has been lumpy; one year was a massive increase and it has been the same for the last couple of years (maybe this is because of how they positioned in the market?). Gas at the pump is up a lot over the last few years but it moves up and down such that sometimes we benefit and sometimes we get hit. I know people talk about the cost of groceries and produce having gone up but candidly I am not sensitive to this other than I know blackberries at Costco have gone way up.

The push pull here leads to the search for the right term for the situation. Someone will make a fortune for coining the right term ala stagflation back in the 1970s. Seriously, the push pull is part of the complicated times we live in idea in the reader's question.

One reader noted that now may not be so complicated, he noted what was going on in the 1970s versus now. A point of differentiation between now and the 1970s is the threats that sovereigns are facing. Perhaps that does make things more complicated, perhaps not, that seems like a subjective thing and this part of the conversation opens us up to a discussion of recency bias.

To the question of gold, I don't think is broken in terms of how it should behave but during short stretches I think anything goes. If we have meaningful price inflation for some period of time and/or dollar devaluation then I think gold would do what people would expect but it may not do so with the magnitude that people would hope for; I have to wonder whether the move up in gold over the last ten years was some sort of pricing in of what might be coming.

As for the euro story, it strikes me as a story of relativity in terms of looking at the EURUSD obviously if the euro stays the euro and it goes down then it will provide some consumer benefit for various goods but not for healthcare, education or most items from the grocery store and so I don't think will have a huge an obvious benefit to most Americans.

Lastly as far as deleveraging; it needs to happen. I don't know how painful it will be but I tend to believe that tearing off the band aid is the better way to go. I believe that had we done the hard thing a few years ago we would at this point understand what the end will look like along the lines of Iceland's improvements. At this point, we have not done the difficult things and we have absolutely no idea what the resolution will look like (mostly we just have guesses and opinions about what should be done, not what will be done).

My conclusions have been the same for quite a while which is that GDP growth will be sub-standard but positive. Equity market growth will be sub-standard but positive. Price inflation will be higher than what we have been accustomed to (as measured by CPI) but not ruinous. I still believe yields should go up and be a little higher than what is comfortable but not be ruinous either.

The idea behind the not ruinous meme is that the US is still the richest country (not per capita of course), is still just about everyone's largest customer, is still at the epicenter of the vast majority of global comings and goings all of which adds up to the world having a vested interest in our getting by. Getting by is not the same thing as being wildly prosperous as a country but more like still being a viable customer who is generally able to function. Hence my comments in past posts about slogging through while other countries do prosper wildly.

About the picture, Joellyn saw that at the store, went back to buy it but they were out so she special ordered it. It is Rogue Brewery and Voodoo Doughnuts which of course are both from Oregon. As an amusing note, Rogue was one of my nicknames in college. Even more amusing, a couple of weeks ago I watched the last half an hour of a show on the Travel Channel about doughnut shops. I saw enough of the show to see four shops profiled and we've been to two of them; Voodoo in Portland and Top Pot Doughnuts in Seattle.

What Happens if Correlations Change?

2011-12-16T06:12:00.003-07:00

You probably are aware that gold has gotten taken to the woodshed recently. YTD it is still up 9.8% (as measured by client holding GLD) but it is down over 15% since peaking in August.

The chart is a very near term comparison of the SPDR Gold Trust (GLD) and Bank of America (BAC). For the last couple of weeks the correlation between the two is pretty tight. If you zoom out for just about any other period the correlation is very low and often is negative including for most of 2011.

Obviously there is not much information in a two week chart but it does serve as an example of the extent to which correlations can change. In 2008 there was a stretch from March to October where GLD and the S&P 500 took different paths to the same 25% decline. What has started recently may or may not continue (obvious statement) which makes the point that the various relationships between asset classes can and do change periodically.

The bigger threat looming out there in this regard is the relationship between iShares Barclays 20+ Year Bond ETF (TLT), and other similar products, and domestic equities. TLT did very well in 2008 rising 23% (most of that coming in the last two months of the year) making for another year where the Permanent Portfolio performed quite well on a relative basis.

I think a lot of people are relying on the relationship between long bonds and equities to continue as it has. Predicting that the relationship might change is obviously difficult to do and not really my intention so much as to point out that if interest rates were to go up a lot and stocks were to go down a lot at the same time that it would cause market pandemonium the likes of which not too many of us have seen.

I've made the case numerous times that prices for bonds are very high and I would have thought rates would have started going up by now. While this has obviously been incorrect, the prices are still high and so the risk is still there.

Zooming out a little it is a good idea to understand what assumptions your portfolio is relying on and what the consequence would be if the things you are relying on do not go your way by some magnitude. For a dramatic example all those mutual funds that were grossly overweight financials in 2008 got crushed not just in absolute terms but also relative terms. This year we were right about being underweight financials and having cash raised but were wrong for the year for having a lot of foreign exposure netting out to an incredibly unremarkable result versus the benchmark.

An ongoing part of my process is trying to understand what would happen if the assumptions embedded into the portfolio don't work out for some finite period of time. I believe long term portfolio success comes from not getting blown up on the occasions where you are wrong--staying disciplined to a defensive strategy and avoiding a large chuck of a big decline helps too.

Process

2011-12-14T06:09:00.003-07:00

In the last few days I've made a couple of references to the 2012 Outlook article I've been working on for Seeking Alpha. In the follow up questions that came back on the original submission there was a question that in the context of the article did not call for a blog-length answer but I thought it would still make for a good blog post without front running the article too much (I've only published the answer to one out of 20 questions).

The question had to do with how I decide whether to use an individual stock or an ETF for a particular exposure in the portfolio. The short answer is that in an actively managed portfolio, regardless of what analysis is done a decision needs to be made based on the information taken in and the decision is really a judgement call that hopefully turns out to be correct.

Once the top down decision of what country or theme has been made the next step is sifting through alternatives which requires looking for and then finding alternatives. In reality this is a very long term process of first maybe reading a couple of articles about something like farmland/plantation stocks. Then I might look at a few names and see what other names that might lead to. In June 2008 I did a write up about farmland stocks that would constitute an early step in the process of trying to learn about a theme.

Part of the learning process involves seeing how the various stocks trade and react to various types of news. For example I would think farms would generally not be that volatile because of the nature of the demand for the product but it turns out they are very volatile. I've written many times about this space, and quite a few others, I've spent time on the group but have not bought in for clients (yet?). I've explored and written about far more niches than I've bought for clients and I continue to follow them in case it does make sense at some point to buy an airport, for example.

The chart compares Caterpillar (in green) with a stock I have been following for many years in red. The stock plays into a country exposure and a theme I have been following. The blue line is the benchmark index for the red line stock's country which I am interested in adding to the portfolio.

The volatility of the stock is very low compared to Caterpillar which is a very volatile name. I chose CAT for this because we have owned it more often than not over the last seven years. The chart goes back far enough to give a sense of how a stock will react to all sorts of things. The stock is red, despite being a foreign small cap has a volatility profile that most people could live with, IMO, compared to CAT's volatility which, because of the name, is also a holding many people can be comfortable with.

Knowing how a stock processes news is very important to me as I place emphasis on managing the volatility of the portfolio. I know that if I buy the red-line stock it is unlikely to get crushed on "ordinary" bad news. However the stock must be monitored in case there is bad news that comes that is somehow out of the "ordinary." Obviously a stock, once bought, needs to be monitored for all sorts of typical things like changes in the business, changes in the industry, changes in earnings trends, changes in revenue trends, changes in the balance sheet and any of the other typical things that you might think of.

In terms of selecting a stock, I don't think there is too much that I do bottoms up-wise that is unique. I try to learn about the business, learn about the financials, relative valuations (relative to its own history, relative to the industry and relative to the market) try to understand if any big changes are looming for the company and so on. From the top down I want to understand how it might react to the economic cycle, understand what the stock will be a proxy for, how it plays into various themes, what attributes it will deliver to the portfolio and so on. I choose to believe that more value is added here than with the bottom up work.

For these things I will also look at an ETF if there is one. We have owned the iShares Emerging Market Infrastructure ETF (EMIF) for a while. I've looked at and written about many stocks in this space but the ETF is also appealing because of what it owns and what it doesn't. It has some yield and is easy trade, the stocks are difficult trade, or at least they used to be before we changed custodians. Choosing the ETF was a judgement call as would a switch to an individual stock be a judgement call as would keeping the ETF and increasing the exposure by adding a stock.

If you are going to use an ETF in the above context there is still work to do. EMIF has large weightings to China and Brazil so it makes sense to keep tabs on those countries. If instead of China and Brazil EMIF had 30% in Hungary and 30% in Latvia then the fund would be a sell based on what is going on in those two countries now, as an example. As another example from quite a few years ago I disclosed not wanting to use iShares Sweden (EWD) for exposure to that country because of the then very large weighting in Ericsson (ERIC).

One final point about process. This is my process for doing things and is right for me (and should be right for people who hire us). You probably have your own process for doing things. If you read blog content then you must have some interest in taking in information to refine your own process. As I say often, take little bits of process from various sources to create (or refine) your own process.

Portfolio Expectations

2011-12-13T06:17:00.004-07:00

Over the weekend I spelled out a scenario where I think at some point in 2012 there will be a large, fundamentally unjustified lift in the S&P 500. I also said that I would sell the rally if it happened. I think it is plausible as opposed to the implausible like saying Greece will get its house in order in 2012.

Occasionally over the years I have made these sorts of projections and my track record with them does not suck but the same caveat always needs to go along with such a look forward which is that having opinions about what may happen can be useful but it is far more important to live in the moment with your portfolio.

Right now the SPX appears to be backing off from a one week 7% rally which was itself preceded by a very swift decline. The SPX is below its 200 DMA and the 200 DMA is sloping downward. Long before a big, even if short lived, lift comes in 2012 it will have to break above its 200 DMA so there is no need to abandon the discipline.

We are currently defensively positioned with a large cash position but no SDS. We have been less defensive than we were in 2008 and into 2009 because while I believe another scare has been plausible I have never thought a revisit of the March 2009 low was likely. If this current down move (if you even think it is a down move) takes another 50 or 60 points out of the SPX then I would buy one name to add to the portfolio and may buy the one name sooner than that but we still would have a lot of cash built up in case the timing of this next purchase turns out to be poor.

Tying in to thinking a big lift might be coming in 2012 the influence there might be buying two stocks (or ETFs) when SPX takes back its 200 DMA where I might normally just buy one on a retaking of the 200 DMA. I would describe that as giving the market the benefit of the doubt when the time comes.

In terms of cash levels we probably have room to buy a half dozens names, slowly, into a market that hopefully shows signs of healthy demand soon.

One last point about this type of prediction is that with what my job is, managing portfolios for people who simply hope to have enough when they need it, one part of this is trying to communicate with clients as to the possibility of an outcome that might be difficult to see from here and to convey the extent to which there might be a difficult purchase or two coming soon. If I turn out to be wrong then I think we are well positioned if we have more of the same.

Finally, an update on Pips (whose name was changed from Pep) the dog that Joellyn and I took up to University of Washington in March to go into a program that tracks animals by their scat which requires ball obsessive dogs.

Pips is now working after months of training. Here is one link about Pips from the USGS and another one from the San Diego Union Tribune--Pips was down in San Diego county looking for badgers. This was a very cool thing to be apart of.

Thinking Long Term

2011-12-12T06:25:00.003-07:00

I spent most of the Patriots Redskins game yesterday working on a 2012 outlook article for Seeking Alpha. I had answered one question for Saturday's post and then the other 19 yesterday. This was interesting in terms of comparing how I answered the questions this year to how I answered similar questions last year.

There are two factors here. One is that not much has changed. We are slogging through, there has been some evolution in terms smaller issues but the bigger issues both here and in Europe are not yet resolved even if we know a couple of things now that we did not know before.

As a result, the fundamentals for the things I have been saying stink still stink, the housing market is not started any sort of significant recovery, jobs are still not where they need to be to belie health, treasury yields are still getting what I'd call a panic bid, our political situation has somehow become more dysfunctional and Europe is even worse.

The other factor is the extent to which I try to take a long term view with the portfolio and themes and exposures embedded within. Not everything in a portfolio will work as hoped for of course but assuming something doesn't turn out to be immediately incorrect, then most long term exposures can be given time to do well. That does not mean that each exposure will work for all times but one year means a lot less than five years, at least for us it does.

A perfect example of this might be Vale (VALE). We've owned the stock for almost seven years with a tweak or two along the way. Since we bought in it is up a little less than 200% versus about a 15% lift for the Materials Sector SPDR (XLB). Over the longer term VALE has turned out to be the better hold (the comparison is to the sector exposure of our benchmark, XLB is comprised of the materials stocks in the S&P 500) but it has not been better for every single period. In the second half of 2008 it fell far more than XLB. In the future there will be occasional six or 12 month runs where XLB will be better to hold but I believe over a five year period VALE will have made much more sense.

Again there will be some of these exposures that don't work out as I hope for. There will be a couple of holdings (maybe more) where after a great run the story will change necessitating a sale. The best example there is probably our hold forever position in Bank of America (BAC). The takeover of Merrill Lynch was immediately and obviously unforgivable and an immediate sale despite my previously having thought we would keep it forever. If VALE, another hold forever does something that stupid I would not hesitate to sell that out immediately as well.

There will also be holdings that, to paraphrase Dennis Green, won't be what I think they are and will need to be sold. Fortunately I have not had many of these but this will come every so often (hopefully not too often, knock on wood) and part of managing a portfolio is being on the lookout for something that just proves out as just being flat out wrong.

Something that just meanders either up a little or down a little or moving with the market becomes a risk for losing patience as some themes or countries may take longer to work out than you think.

Obviously I prefer to think longer term as I think it is more consistent with clients objectives which I think of as being having enough when they need it not beating the market this quarter or this year.

A couple of unrelated snippets from the weekend; I got a kick out of the serious argument between Patriots' QB Tom Brady and the Pat's offensive coordinator. I may have this wrong but Brady wins any argument with a non-Belichick coach. University of Cincinnati basketball coach Mick Cronin was very impressive in the aftermath of that hideous fight with Xavier in saying he has to decide who is still on the team and that he made every player take off their game jersey, hopefully he backs up the tough talk. Lastly I watched the movie Step Brothers starring Will Ferrell and John C. Reilly on Saturday afternoon (Saturday was a day of some procrastination). Like all of these movies they are very stupid and very funny. There was a line in the movie that I thought was hysterical and brilliant for how subtle it was, "wait, Dale got Hulk Hands?" It's funny for anyone who saw the movie.

Sunday Morning Coffee

2011-12-11T06:15:00.001-07:00

I am starting to concoct a wacky theory about US equities for 2012. A part of how I think markets work is that price performance can deviate from fundamentals and obviously when this occurs there is not necessarily any reason it just happens. Sometimes there is a reason though and usually the reason is more top down.

A good example is 2009 where domestic stocks skyrocketed despite what I think were lousy fundamentals at the time. After such a vicious decline in 2008, and into Q1 2009, a big rally was very likely (I said as much in a 2009 outlook piece for Seeking Alpha).

As you know when the big firms are surveyed about what the stock market will do in the new year there is almost always a consensus of up 9-10% no matter what year we are talking about, I am very confident that will be the consensus for 2012 and this consensus is almost always wrong. There have been very few years that the market is up 9%, 2010 was actually pretty close at about 12%. This means that the market then is usually up more than consensus or lags consensus (obvious statement).

My wacky idea for 2012 is that there will be a huge, range busting rally sometime during 2012. I will try to explain this but to be clear this is not a bullish call. I still believe the US market, the economic fundamentals and the current political dynamic make for a very unhealthy cocktail but the market can still go up against that backdrop or as I have said in years past; the market can go up a lot for no reason at all.

I have no expectation that if this turns out to be correct that it will fit neatly into a calendar year. If we get a 25% lift from February to September, take it as I could easily see a huge lift then being mostly given back depending on how quickly it were to happen; the more panicked, the lift the more likely it retraces.

There are several ingredients to why I think I am leaning in this direction (I will clarify my opinion in subsequent posts). In no order of importance I believe the main street distrust of the market is immense and has been now for years. More than four years after the peak and the SPX is still about 20% below where it was in late 2007.

Over the last two years the average return is only 5% which is low. The nature of returns often is that most of the positive return for a multi year period comes from just one year which is important because if I am wrong about a big lift coming sometime in 2012, then there will be some other year that has a very big lift. Support this idea is the possibility that 2009 was more about mean reversion than anything else.

While sentiment is always mixed I think there is more pessimism right now, with good reason, so there is an element contrarianism to this thought as well. I don't think too many people are expecting a meaningful lift if you can believe that opinions from people like Binky Chadha are generally ignored then this might be a good ways from consensus and part of this is built on consensus frequently being wrong.

I will spend some time developing this but I will repeat this is not about being bullish or trying to make a correct prediction. Markets make big moves exactly when they shouldn't. I have no fundamental argument to make for why the market could go up a lot right here but it is important for market participants to always be cognizant of the fact that, like in 2009 and in other past years, the market can go up a lot for no reason. Further, if you can buy into the idea of lumpy returns with a disproportionate amount of a cycle's return come from just a narrow slice of the cycle then missing a 2003 or a 2009 becomes very damaging to long term results.

Maybe one way to think of this is that there is so much going against the market that something has to give in a big, range busting way and in such a manner as to be very shocking even if it only lasts for a short while.

I would hope that if this theory plays out that foreign markets with healthier fundamentals would do a little better than the US but of course better fundamentals does not have to result in better returns for such a short period of time.

The picture is of the Buckey O'Neill statue in front of the Prescott courthouse Friday as we went to Acker Night.

The Big Picture for the Week of December 11, 2011

2011-12-10T06:32:00.002-07:00

Every December I am fortunate enough to be asked to participate in various roundtable (ish) panels. The way they work is that a word document goes out and we are asked weigh in on a multitude of topics. One of them is due in a couple of days so I thought I would answer one of the questions for today's blog post.

12) Where are the real growth stories overseas right now?

I would turn this one around a little bit based on the current reality of the investment world. Before figuring out the "growth stories overseas" it is crucial to understand which countries are facing systemic threats that far exceed the threats posed by normal economic and stock market cycles.

For example the Bovespa is down 15% YTD as of this writing up from what was a 25% decline. In looking at the totality of the story it is clear that the country is not wading through different forms of desperate and unprecedented action to try to restore something (growth, jobs, housing market etc). Brazil has had ups and downs and of course that will continue but the nature of the threats are nowhere near what they are in the US, Europe and Japan, not even remotely similar.

We look out longer than one year in building an investment thesis. Part of the country selection process we prefer is, among other things, owning countries where there is a middle class ascendance. The idea here is that the demand for access to (relative) middle class lifestyles is very consistent. This means electricity, potable water, cable TV, telephones (probably wireless), better roads, cars, higher quality personal goods and so on--in short, their perception of an American lifestyle.

The demand is a one way trade but of course the stocks will not be but the demand does create a long term tailwind that is a valid investment thesis. Although not the only form of country selection we use this is one and countries we like and own in this context are Brazil, Chile, Colombia and China (by virtue of that China's weight in two thematic ETFs).

The process for possibly adding more countries in this context is ongoing. I've written many times on my blog about learning about countries and following them for quite a while before buying in, this was the case with Colombia and will be the case with other countries we add in to the portfolio in the future.

Friday Look In

2011-12-09T05:30:00.001-07:00

Quick post to start what will be a very busy day for me.

Yesterday the S&P 500 was down 2.1% and this morning the futures indicate a 14 point upside open about two hours before the open. If this lift sticks throughout the day then we will hear a lot of positive comments about progress with this or progress with that but to repeat a long standing theme here, this sort of thing must be viewed as noise.

The building block should be understanding normal market behavior and the things that drive normal market behavior. This type of volatility is not normal market behavior. The time being spend by various authorities trying to figure out the most effective ways to bail out ailing (ailing is not a strong enough word) countries for the problems of excess and bad policy are not normal market drivers.

The market can churn in either direction in this environment, this is what it has been doing, but it is not normal or healthy and we should expect this will still take a long time to work out. It took more than ten years for the great depression to resolve, it is only logical that the "worst financial crisis in 80 years" will need more than two or three years to resolve.

What Is Diversification?

2011-12-08T06:16:00.002-07:00

Yesterday I found this post by NYU professor Aswath Damodaron that tried to reconcile the divergence between Mark Cuban saying diversification is for idiots and John Bogle's (essentially) saying that diversification is all that matters, advocating owning the entire market. Like with all aspects of investing there is no single correct answer, simply a topic for each investor to explore and sort out for themselves.

Here I offer my approach for you to agree with or disagree with as you sort this out for yourself.

In terms of equities and using individual stocks or narrow ETFs I am a big believer in not letting one position that goes wrong seriously damaging the entire portfolio. As an exaggerated example a 20% position in a stock that then cuts in half could be a serious problem depending on what the rest of the market is doing.

I've disclosed many times that our portfolio typically has 30-35 holdings with most of the positions being targeted at 2-3% of the portfolio. There are several layers to this preference.

From a single holding-risk standpoint if a three-percenter cuts half unexpectedly then the drag obviously is only 150 basis points which can be overcome elsewhere in the portfolio (not necessarily with a 1000 basis point hit from one stock). In a portfolio of 30-35 stocks it is plausible that in a given year one of the stocks held will go up 50-100%. This can be "by accident" but either way it's plausible but realize the one you might think would be up that much won't be the one that ultimately goes up that much. A two-percenter going up 50% adds 100 basis points the portfolio, if you pair that with a 3% yield for the portfolio then you already have a meaningful chunk of your return for an "average" year in the market.

From a smoothing out the ride standpoint I want enough holdings that I can take various types of attributes which potentially creates a zigzag effect in the portfolio. The importance here is that if your base case assumptions turn out to be incorrect then some exposure to things that don't tie into your base case will minimize the consequence for being wrong.

Another element to this is that, as long time readers will know, I think it is very important to build in various themes and countries into the portfolio. The objective in picking themes and countries is to build in what are hopefully some obvious tailwinds into the portfolio. As a totally made up example, if we know trillions must be spent on greasy wool from Laos, then you might want some exposure to greasy wool from Laos.

Going too many holdings makes it difficult for a "winner" to matter and going with too few holdings means a "loser" (and there will be losers) could damage the entire portfolio as mentioned above.

Europe Is Still Burning

2011-12-06T06:12:00.002-07:00

By now you know that S&P put 15 Eurozone countries on credit watch with negative implications. This was of course not a black swan but simply the latest in a long unfolding saga. The point of today's brief post (I have an incredibly hectic week) is to isolate the ongoing thesis that the worst financial crisis in 80 years for both the US and Europe is going to take a long time to fully unwind (unravel?).

While it may no longer correct to say it is early days in this, using the baseball analogy I would say it is the middle innings at most and to take the analogy a little further it is the middle innings of a Red Sox-Yankees game which tend to last 4.5 hours as opposed to the normal three hours.

I have had and continue to have serious doubts about valuation arguments for the most affected market segments. As I have been saying all along there will be trades to be had for those who are nimble--XLF is up 11.7% in the last five days--but a nice lift does not mean things are fixed fundamentally. At some point the valuation argument will turn out to be correct but for now the news continues to be bad without even a vague notion of what a resolution might be.

Yes buying when there is fear and uncertainty is more than valid, there has been fear and uncertainty surrounding this for several years and "opportunistic" purchases has amounted to catching falling knives and it has worked out badly. Whatever positive argument anyone is making today, the same argument was made a year ago and two years ago and three years ago and four years ago and has been consistently wrong fundamentally.

The Slog Continues

2011-12-05T06:12:00.002-07:00

By now you've read a dozen articles ripping into the Friday's jobs data. The big bone of contention of course was the extent to which the decline in the headline rate dropped to 8.6% due to a large contraction in the labor force.

Whether you call it new normal or something else this is the middling, sluggish US economy continuing to unfold. A few years ago there was a mix of complacency that the then credit crunch wouldn't be that big of a deal which then gave way to serious fear, maybe even terror, that this was the end times in terms of the social fabric of the society.

Sluggish and/or middling has been my base case the whole time for several reasons and I expect that will continue. Obviously I am biased to seeing my thesis as playing out over the last few years and continuing to play out. If this turns out to be the case that does not mean some equities won't still do well.

If there is an economic condition where GDP growth is sluggish or perpetually teetering into a recession we know that certain defensive stocks tend to do well; usually staples, healthcare, utilities and ma bell telecom (with those last two be careful when interest rates are going up).

Year to date the S&P 500 is down a little over 1% while long time client holding Philip Morris International (PM) is up about 30%. Going a little broader the Staples Sector SPDR (XLP) is up a little over 8% which combined with XLP's yield is close to an 11% return--pretty good for soda and diapers. The Utility Sector SPDR (XLU) is up almost 11% on a price basis plus then it's 3.8% yield. The Healthcare Sector SPDR (XLV) is only up 6% but 7% ahead of the benchmark is noteworthy and XLV kicks in a little yield too.

Obviously the albatross around the market's neck has been and I believe will continue to be the financial sector. At this point the Financial Sector SPDR (XLF) is down 19% for the year and while I don't think it can drop 20-30% every year forever, I think it will be a long time before there is sustained price appreciation which contributes to the top down idea that the SPX will have a hard time making meaningful progress without the financial sector.

One of the reason's I prefer top down is that I think it makes the job much easier to do. If the above scenario is right then that means finding a domestic financial stock that skyrockets becomes much harder to do than in a year where XLF goes up by 25%.

Sectors like staples and the others mentioned above can be populated in the portfolio with domestic stocks in this scenario. The other sectors, like financials, would be a good place to look for foreign exposure either with individual stocks or ETFs. For example I am favorably disposed to quite a few countries for the long term like Australia (out temporarily as I have been disclosing for months), Chile and Norway.

There are individual stocks from these countries in the sectors that I think should be avoided in the US, like financials, and the ETFs for these countries have decent weighting in financials as a way in.

Going the individual stock route requires bottoms up research and monitoring of course and going the ETF route requires looking under the hood to understand what is in the fund and taking time to monitor the countries themselves and that is a lot of work. However if the US turns in another sub par decade (new decade to date the SPX is up 10.46% so you be the judge) and some of these other markets can again muster close to normal returns then the effort put in will not only have been worth it but could be (financial) life changing or better yet; (financial) life sustaining.

Sunday Morning Coffee

2011-12-04T06:17:00.000-07:00

In the comments of yesterday's post a little discussion broke out about my definition of large accounts and mid sized accounts or more correctly the differences, as I see them, in portfolio construction based on account size.

The relevance could be that many do it yourselfers might be inclined to have fewer holdings not as a function of account size (for our "mid sized" accounts we tend to only have about 20 holdings, most of which are ETFs so that commission expense is not excessive) but as a function of time available to spend on the task. If someone has a full time job then they may not be able to make another full time job out of managing their money which is very reasonable.

I do this going sector by sector same as with large accounts. Decisions need to be made for each sector about overweighting and underweighting and the best proxies (per the person building the portfolio) need to be chosen to fill out the portfolio.

One way to come at this, as we've discussed before, would be one stock and one ETF for each sector which works out to 20 holdings (for someone benchmarking to the SPX). This would not work for everyone of course but it is one way to do it. The idea with one stock one ETF is avoiding over exposure to single stock risk, building in some yield and some precise themes.

I do it a little differently. For the smaller sectors I use just one ETF, again the context is mid sized accounts not large accounts. The three smaller sectors are each only about 3% of the index so even an overweight in those three would still be a small exposure for the portfolio and where commission drag is a concern I think one pick can work.

The financial sector is a tough place for me to find an ETF to use for the way they are constructed. I don't want to own the common of the big US banks, the big European banks, the big UK banks, the big Japanese banks or the big Chinese banks. So for financials I tend use individual stocks that we use for large accounts.

For other sectors we use a mix of an ETF or two and/or a stock or two.

One thing I mentioned yesterday was trying to change the volatility profile of the portfolio with the trade executed. This obviously doable in the context of the type of portfolio we're talking about today. There are a few good compare and contrasts to illustrate the point. In the materials sector you could compare the Global X Fertilizer ETF (SOIL) and the Materials Sector SPDR (XLB); XLB being benchmark beta. The Malthusian argument underpinning SOIL is easy to understand, you may or may not agree with it but it is easy to understand.

Not surprisingly SOIL is quite a bit more volatile than XLB. Someone believing in the argument to own SOIL could keep the fund and switch to XLB at a time where they want to reduce volatility of the portfolio but still maintain exposure to the sector.

There could be a similar dynamic in tech with the eTracs Next Generation Internet ETN (EIPO) Tech Sector SPDR (XLK) although given tech's huge weighting in the SPX, putting that much into EIPO seems very aggressive but you get the idea. With energy maybe this could be illustrated with the Jefferies Wildcatter ETF (WCAT) and the Energy Sector SPDR (XLE).

Before the 1+1=11 brigade comes out, the above symbols are just examples to illustrate a point, we don't own any of them.

The same type of work can be done for yield, cap size, foreign/domestic or anything else you might be interested in trying to capture in your portfolio. More likely there would be several variables being managed at once but again you get the idea.

The picture is from yesterday of Roscoe surveying our second storm of the season.

The Big Picture for the Week of December 4, 2011

2011-12-03T06:26:00.003-07:00

A week ago Thursday I disclosed selling our position in Pro Shares Ultra Short S&P 500 due in part to believing that after a very fast decline in the market, an equally fast snapback was possible. By the time yesterday morning rolled around the SPX was trading near 1250 up a lot for the day, again, perhaps due to the jobs numbers.

So in the face of a 7.7% lift in the SPX in about a week (based on the Friday open which is when we placed our trade) we sold our position in WisdomTree Global Natural Resources (GNAT) for large accounts. GNAT used to be the WisdomTree International Energy Sector ETF (DKA). GNAT is more volatile than DKA used to be. GNAT is still a good proxy for the sector and so we still own shares for mid size accounts that generally own an ETF or two for each sector.

I had this trade in mind for a while if we needed to sell something in this context. Our energy sector exposure in large accounts is pretty volatile and so after selling GNAT at the open I plan on replacing it with something less volatile and with more yield but I will hold off as I think some sort of swing down like from a couple of weeks ago is plausible.

As I said with the SDS sale, the GNAT sale looks good relative to Friday's trading but if the market rockets higher from here (obviously not my expectation) then selling GNAT will have been poorly timed and if the market stalls out or reverses then it will look like a good sale. This is true with every trade but the strategy here is to reduce volatility a little while people are feeling pretty good about the market.

On the post disclosing the SDS sale someone commented that it was pure speculation on my part and maybe they will be back again. Depending on how you define speculation then yes it was or maybe, no it was not, again depending on how you define it. Obviously the portfolios I manage are actively managed. The site is in part a look over my shoulder as I try to navigate cycles. As I have said many times an actively managed portfolio is a series of decisions, some of which will be right and some of which will be wrong.

Not everyone, obviously, who tries to manage an active portfolio will be correct often enough to be successful with it but there are enough examples to show it is very possible to have success with active management. One objective here is sharing process so that you can take little bits of my process (if you're so inclined) and also collect little bits from other people's process to build your own process. My way is right for me and should be right for anyone who hires our firm. You need your own process as that will be right for you or if you choose to hire someone then you need to be sure their process is right for you.

Our Current Reality

2011-12-01T06:00:00.001-07:00

Wednesday's market action had all the music, lighting, choreography and party-like atmosphere of an Earth Wind and Fire concert (I tried to find a picture of the Ohio Players in this context but couldn't find one I liked).

We are in a period where we have very fast moves in both directions that seem to last for a couple of weeks or so. This has been going on for a while and seems like it will continue but who can say for sure. If it does continue then this fast move up will end (maybe near the 200 DMA like the last one?) and then the market will move back down just as quickly. Of course it could be over now, this post was written Wednesday night.

I am not trying to make a prediction with the above possibility merely pointing out (mainly to clients) that another whoosh down is very plausible. We've had all these whooshes with out dramatic changes in the fundamentals in the US. I would say the fundamentals in Europe are changing a little quicker but I think it is correct to say that Europe is the same story and we are living through the deterioration at this point.

Last we I said something very similar while also noting that I think the upper and lower ends of the range are moving up slightly. Where the last one peaked at SPX 1275 maybe this one will peak 10 or 15 points higher as an example and where the intermediate bottom last week was 1158 maybe the next bottom will be something like 1170 as an example. Maybe we churn in that manner up near the May high of 1363 which then becomes the real test for the market to which I would lean bearish. If this plays out I think it would take months and to repeat, sentiment would swing from glee to despair every couple of weeks or so.

One reader has commented a few times about hating this market but going along for the ride, I suspect he would really hate the above scenario.

To be clear this not a description of a healthy market. The market can get healthy again in any number of ways but it appears to be a long way from there now. If this has changed somehow we are decently long such that we should continue to participate which is philosophically where we want to be; smoothing out the ride if possible not being completely out.

Using The Media

2011-11-30T06:27:00.004-07:00

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.

Financial Bulls Will Be Right Eventually

2011-11-29T06:16:00.001-07:00

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.

It's Not an Apocalypse, But In Case It Is...

2011-11-28T06:15:00.007-07:00

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.

Sunday Morning Coffee

2011-11-27T06:17:00.003-07:00

Gone hiking (the picture is from the Grand Hotel in Jerome, AZ).

The Big Picture for the Week of November 27, 2011

2011-11-26T06:17:00.003-07:00

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.

Thanksgiving Morning Coffee

2011-11-24T06:33:00.004-07:00

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!

Newt Likes Privatized Social Security

2011-11-23T06:23:00.001-07:00

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.

The World According To Rosie

2011-11-22T06:27:00.003-07:00

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.

Is The Market Frustrated?

2011-11-21T06:08:00.004-07:00

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.

Sunday Morning Coffee

2011-11-20T06:09:00.002-07:00

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.

The Big Picture for the Week of November 20, 2011

2011-11-19T06:37:00.001-07:00

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%.

All ETF Portfolio? Part Two

2011-11-18T06:23:00.001-07:00

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).

All ETF Portfolio?

2011-11-17T06:08:00.004-07:00

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.

Finally, Inverse JGB ETPs!

2011-11-16T06:17:00.001-07:00

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.

Is It Really That Bad?

2011-11-15T06:14:00.001-07:00

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.

Not Much In The Way Of Innovative Thinking

2011-11-14T06:09:00.003-07:00

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.

Sunday Morning Coffee

2011-11-13T06:14:00.003-07:00

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.

A Hoax?

2011-11-10T06:09:00.003-07:00

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.

An Explanation?

2011-11-09T13:59:00.002-07:00

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.

Something Is Going To Give

2011-11-09T06:17:00.004-07:00

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.

Odd & Ends

2011-11-08T06:18:00.001-07:00

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.

The One Missing ETF

2011-11-07T06:17:00.003-07:00

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.

Sunday Morning Coffee

2011-11-06T06:11:00.000-07:00

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).

The Big Picture for the Week of November 6, 2011

2011-11-05T05:23:00.001-07:00

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.

Wait, Was This My Idea?

2011-11-04T05:13:00.003-07:00

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.

Replacement Rate; Hokum and Hooey

2011-11-03T05:15:00.003-07:00

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.

Bonds Over Stocks

2011-11-02T05:13:00.002-07:00

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.

What The MF?

2011-11-01T05:06:00.002-07:00

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.

New Insurance Premium, Ouch

2011-10-31T05:19:00.004-07:00

Every year in late October we get our annual notice from our health insurance provider telling us how much our monthly premium is going to go up. Last year it went up by 20%. This year's notice came with news of an almost 12% bump.

Maybe I have this wrong but while there may be uncertainty on what will happen with Obamacare not much has actually happened yet (in relation to what was promised, or threatened depending on your perspective) but the newness of the Obamacare concept is no longer with us and so I don't think they can legitimately blame a policy that is no longer new for the gouging.

It seems pretty obvious that this expense is going to continue to increase at a rate well above the reported rate of inflation.

One aspect in my role on the Fire Department is that I participate in just about all of the medical calls. One normal part of the process is to ask what medications the patient is taking which can be important in treating the patient in the field and for whatever treatment the patient might receive at the hospital.

The reason to bring this up is that based on my casual observation people have a lot of prescriptions that must be refilled on some regular interval. The costs of these prescriptions of course goes up as well and depending on the insurance coverage this could result in more expense for the patient.

As this relates in large part to retired people living on a fixed income it underscores what most people know on some level even if they haven't tried to map it out which is healthcare expenses will be a nasty variable expense.

A couple with $2000 in social security income and taking 4% from a $200,000-$300,000 portfolio probably can't easily absorb a 50% increase in medical costs every five years (simple math) or in our case a 30% increase in two years. Sadly portfolios of even $200,000-$300,000 is probably unrealistically high.

There is no answer that will make people happy. I don't think it is realistic to expect the government to create an effective regulatory framework that creates a competitive industry, doesn't create resentment by customers or otherwise have hideous unintended consequences.

While I don't think there is a happy answer there is a simple answer. Save more and spend less.

On a different note the Madoff interviews on 60 Minutes were fascinating although I'm not sure I can pinpoint exactly why. Whether they were guilty or otherwise complicit they have clearly been crushed as a result. Ruth seemed very medicated and I can believe she blocked out as much as she apparently did even if it was along the lines of "it's not a lie if you believe it."

I have to admit I don't watch 60 Minutes very often but it seemed like every commercial was either for pharmaceuticals or financial services which was interesting too.

Sunday Morning Coffee

2011-10-30T05:34:00.003-07:00

The Barron's cover story was their "Big Money Poll" and I stumbled across something in there that leads to a broader question worth exploring. In there was mention that Lockheed Martin (LMT) is yielding 5.30%. That is pretty substantial for a defense contractor.

Many decades ago it was typical that stocks yielded more in dividends than bonds yielded in interest payments with the logic being that the dividends were meant to be a compensation for taking on the risk of owning the common. Along the way this changed, for most stocks anyway, and we came to expect to get more yield from holding bonds, and more price stability too.

The last decade has been odd for stocks. Although decade long round trips to nowhere are not unprecedented they can create a catalyst for some sort of meaningful change. After the last decade long round trip to nowhere the change was an 18 year run of spectacular returns. Perhaps the change that comes from the current decade long round trip to nowhere is a reversion to stocks yielding more than bonds--if so then really it started a couple of years ago.

We are not there yet at the index level as the S&P 500 is still close to 2% which if we looked we might find is attributable to the relatively large financial sector not paying much in the way of dividends. I made a reference the other day to how many semiconductor stocks yield close to 4% and if you look around you will find many more stocks (excluding REITs and MLPs) with pretty serious yields.

At the March 2009 the SPX yielded more than the ten year as a function of the yields for both stocks and bonds being distorted. Bond yields are still distorted but as of right now stocks are clearly not at a panic low and so probably not distorted, at least I don't think they are.

If this is a reversion to a bygone era where many stocks will yield more than many bonds then this would not be a valuation call to buy equities as the idea here is that this could persist for a couple of decades. This is not to say that stocks aren't cheaper just that I don't think it is a catalyst to immediately rocket higher.

One positive from this could be that yield from a portion of the equity part of the portfolio could offset the reduced yield that most people are having to endure from the fixed income side of the portfolio. The downside, and this is more behavioral, is that too many people will get caught at some point with too much equity exposure for not remembering that dividend stocks are not high quality bonds.

Friday Tidbits

2011-10-28T05:23:00.001-07:00

First up is a comment or two on the current goings on in the market. The action of the past few days, and really for the month of October, has been a buying panic. This buying panic came after a selling panic in September. One of the two months (you can decide which one) is closer to what is appropriate given the total backdrop we are working in now.

The bear case ties into the feeble housing and employment numbers combined with desperate action being taken by central banks in many corners of the world. The bull case ties into quite a few data points showing signs of improvements, some aspects of the earnings for the quarter looking good and a very impressive rally over the last four weeks.

Take whatever side you prefer but I would point out that most of the time these types of monster moves do occur during bear markets. There is nothing that says this can't be a bull market because it is possible that the worst is behind us, that we will never go below SPX 1200 again and that the market has turned up in advance of an economic turnaround. This is not my base case but it could be correct. We did not get as defensive as we did in 2008 but as I've been saying all along, on the way down you always wish you owned less and on the way up you always wish you owned more.

Today would normally be the day that we begin to redeploy some cash but we recently switched custodians to a firm with a more robust foreign offering and it is not logistically plausible to trade in these markets late in the day Friday. As I am more interested in adding foreign, if we add anything now I will plan on next week.

One weird element of the SPX' dance with the 200 DMA is that it went below at about 1283 in the middle of the summer and when it took it back almost three months later it did so at 1274. The 200 DMA stayed remarkably flat and obviously it is still tilted slightly downward and the 50 DMA is still well below the 200 DMA.

A reader left a comment asking whether it makes sense to avoid putting foreign holdings into 401ks or IRA for tax reasons having to do with what is withheld from foreign dividends. Not everyone has both types of accounts first of all. Secondly taxes are one of those things where people have their own thoughts about what to do and from the standpoint of being a portfolio manager the normal course of action as I know it is to simply honor any requested mandates along these lines when possible and after any potential downside has been explained to the client.

Finally there was an interesting thread the broke out on several blogs including Felix Salmon and Abnormal Returns that stemmed from a Twitter fight between Keith McCullough and Steve Liesman about going on TV too much.

Felix's argument (and Abnormal Return's too but not quite as loud) is to question how can someone who manages money be on TV constantly. They have a job to do and being on TV so often is time not spent doing what people pay you to do; manage their money.

Being on CNBC's "G" list (a reference to Kathy Griffin Life on the D list) I go on two or three times a year and I will say it is fun to do. I got to do a segment from the NYSE floor a couple of years ago and that was a blast.

Without accusing anyone else of being a self-promoter in the manner Felix does I will say I don't understand how people do their work done while appearing so much but they must figure out how. My idea of the work is that most of the time is spent reading. I read a lot of news and I read about companies. Other managers may have other ideas about how to do the job which is just fine.

Certainly there must be team situations where being the face of a group or firm on a very regular basis is the job. For however many times I have been on I've had to say no just about the same number of times usually for not being able to take the time and there were a couple of instances where I would not have been able to add value to their viewers (insert joke here about never adding value to their viewers).

The implication from the linked posts is that the work product suffers for the time spend being a pitch man. For someone who is inclined to hire someone the client must be on board with what is going on with any and all aspects that matter to them.

I would say the most important thing is to be on the same page philosophically as the manager. If you hire a DFA guy then you will ride the market up and down fully invested. That is not bad or good but simply a philosophy that someone hiring a DFA guy must be on board with. Asking about process, or how the day is spent or whatever else is fair game but no one will change their routine for you.

Someone who hires us knows I work from home and that once, maybe twice, a month I will have a fire or medical call, usually medical, that I have to go on (obviously this is something I choose to be a part of my life). Anyone is entitled to think this is unacceptable but then that person should not hire me. Someone who goes on CNBC a couple of times a week should not be expected to alter that behavior so if you can't live with that then you should not hire that person.

I will say it was fun reading the Twitter fight.

Very Important Technical Formation

2011-10-27T11:09:00.004-07:00

I like to move it, move it.

Now That Would Be A Disclaimer

2011-10-27T05:17:00.003-07:00

A reader left the following comment on the Seeking Alpha version of my post about the Fairholme Fund from the other day.

I'd be more impressed if these Monday morning quarterbacks had been around warning investors during Berkowitz's good times.

But that would be the hard part, wouldn't it?

I left sort of a smart alecky comment in reply;

Warning about what exactly? "Hey the manager might do a couple of really dumb things two years from now so you might want to avoid the fund."

I went on to mention that the type of blow up that has occurred this year at Fairholme can happen to any concentrated fund even if the backstory might be a little less sensational.

This brings up an important investing dilemma that I believe exists and contributes to why so many people complain about 401k plans. Berkowitz was a master of the universe for a decent amount of time (some believe he will regain that status again).

Unfortunately there is no way to know what an active manager will do in the future. You can know what the strategy is and hopefully likely to be but the exact trades are of course unknowable which makes the funds essentially impossible to analyze. With an actively managed portfolio you are expressing your belief in the strategy and that the past success can be repeated. You might draw the correct conclusion about a fund in that context but this is not really an analysis.

Most 401k plans are a mix of index funds which are simply asset class exposure and actively managed funds which might correctly fit into some Morningstar box or might not. I have seen some plans where the offerings are shockingly thin. I looked at one plan recently with only 12 choices of which there was only one international fund (there was also a global fund).

We have another client who has dozens of choices in his 401k. While too many choices can make the task daunting there are many plans that simply have a dreadful selection with not only funds but even asset classes. The one above has no choices for emerging markets or foreign fixed income.

Many times I have used the typical 401k results that get published every so often as the reason for why we should not have privatized Social Security accounts. Based on published studies, the 401k results are dreadful. Some of this is clearly attributable to the choices available.

More and more employers are moving to running their plans through brokerage firms such that employees have what amounts to a brokerage account with access to stocks, ETFs and traditional mutual funds. This is a boon for people interested enough to do some work but I do believe there is some burden on employers to provide access to at least some education on the subject.

The number of 401k-like plans that exist as brokerage accounts is pretty small at this point which leaves most plan participants having to make choices that amount to nothing more than guesses that some active manager won't make some sort of catastrophic move in the portfolio.

The good news is that most fund managers don't blow up the funds they manage, I say most but we know not all. If most of them underperform their benchmark that is unfortunate but it is not catastrophic. If you were in a plan with only one equity fund and it went up 7% per year versus 10% for the market then clearly that will compound into a big lag which I repeat is a bad thing but that type of scenario can be overcome with increased savings whereas recovering from a serious blowup might not be possible.

I doubt there are any one choice 401k plans but the numbers are understandable. A lag can be mitigated. Perhaps the education needs to be your employer is giving you crappy funds to choose from that you should expect will lag the market so you need to save more money than you are saving now.

Netflix!

2011-10-26T05:12:00.002-07:00

The blowup in Netflix has been epic on multiple levels and provides a great reminder for what I would call a very old lesson about investing in certain stocks. Netflix is, was and always will be a fad stock in my opinion. This can be even in the face of a very useful or convenient product but not all fad stocks have something as convenient as Netflix as their main product.

There have been a lot of these over the years of course some of which you may not even remember and at the very least you have not thought about how hot these stocks were both in price action and media attention. Do you remember how hot Snapple was once upon a time? Bottled ice tea trading like it would change our lives.

What about Andrea Electronics? Do you even remember that one? I don't recall what the product was but it went wildly parabolic in its 15 minutes. Comparator was another one from way back when. Of course there are many others as well.

The first AOL.

The nature of these tends to be the same in that there are always a lot of people who make a lot of money in these on the way up. The story is always compelling in one way or another as potentially life altering (in a good way). As I've said many times the actual internet has far exceeded the hype from the mid 1990s but it did not have the expected result on the stock market as many related stocks are trading at a fraction of their share price from 12 years ago and many others of course disappeared.

At some point for no reason (or any reason) the music just stops. Netflix is down 72% in three months which probably means the music for this one has stopped. Assuming the party is over for the stock the service is still very convenient which will always have a decent appeal (I realize subs went down a little over 800k) but maybe the future is that at some point it gets absorbed into another company or competitors come into the market offer something that, as far as the end user is concerned, is the same service.

When the music does stop people get crushed. The people getting crushed is always some combo of people who held on too long with too much and people who got in very late.

There will be stocks like this of course that come along in the future. The strategy here is quite simple which is sell some as it whizzes higher. You don't have to sell all of it but selling a 1/4 or 1/3 or 1/2 of the position every 50% or 100% or any other strategy is a good way to make sure the eventual implosion that you probably won't see coming (and good for you if you do) doesn't do you in. Had you tripled your original investment in NFLX and then reduced your position by selling 2/3 of your stock by virtue of making a couple of sales on the way up, then the current implosion is far less of a traumatic event.

The above example may seem ludicrous but it is far from impossible that that some stock you own goes parabolic for whatever reason making some sort of risk management prudent. If you start with the assumption that this one is not different and that rules of risk still apply then you can still do very well and not give it all back.

Diversification Rules Be Damned

2011-10-25T05:19:00.003-07:00

RBS launched a new pharma ETN with ticker DRGS. It appears to be a large cap, global tracker similar in a lot of ways to many of the other health care sector ETPs, there are probably a dozen ETFs with large weightings in Bristol Myers (BMY), (Merck) and the other usual suspects.

What is interesting about this fund, from a where is the industry going standpoint, is that the underlying index only has 16 components. The names held also include Glaxo, client holding Novartis (NVS), Abbott Labs (ABT) and you've probably heard of all of the others.

The ETN wrapper apparently allows for fewer holdings than ETFs. I wrote an article about the Disk Drive ETNs recently which track an index with only eleven constituents. ETFs need to have at least 20 holdings and it appears that ETNs don't have this burden. There have been jokes before about single stock ETFs which are meant to take the specialization to an extreme.

I have no idea who needs another choice in global health care sector products but this does raise the possibility of the ETN wrapper offering access to themes or niches where there are not enough stocks for an ETF. Off the top, an ETN for Scandinavian banks or Chinese toll roads would offer non single stock access to relative health in the case of the former and relative non cyclicality in the case of the latter.

The big obstacle here is the ETN wrapper. ETNs are unsecured debt of the issuer. The banks that did not fail a few years ago are unlikely to be allowed to fail now but I don't know why anyone would take that on in the face of an alternative that does not take on this added element and with healthcare there are of course many funds.

An ETN for some segment where there is no ETF for whatever reason becomes more plausible than what appears to be a me too product. The RBS' Trend Pilot funds offer a unique enough solution that some will be willing to take on the risk.

The other drawback is the dividend. Most ETNs do not pay a dividend. The 16 component index yields 3.3%. The ETN will not pay out a dividend however. The index will still capture the yield (probably 2.7% after accounting for the 0.60% expense ratio) but it will be reflected in the share price as if it was being reinvested. Not getting an actual payout is more of a psychological obstacle to overcome but it does need to be overcome to consider the product and obviously anyone taking income from their portfolio would need another wrapper that had an actual payout.

Berkowhathappened?

2011-10-24T05:25:00.003-07:00

Barron's had a feature on the recent goings on at the Fairholme Fund (FAIRX) which is primarily managed by Bruce Berkowitz but the fund has always been pitched as a team effort. Assuming Barron's has it right I can only conclude that this is and has been a truly bizarre situation.

Read the article but there were odd implications surrounding giving giving a seat at the table to his cousin's husband which seemed to have contributed to the departure of Larry Pitkowsky and Keith Trauner who went on to start the Good Haven Fund (GOODX) and it seems like the magic may have left with them.

There were lawsuits from ex-employees and really it just creates a very odd picture. The article also lays out a theory about how difficult it would be for the fund to unwind it's positions, if it had to, based on average volume of the stocks and a sort of unwritten rule of not wanting to exceed 20% of the day's volume, apparently the fund is more concentrated than most concentrated funds.

I've picked on this fund quite a few times along the lines of how I have picked on the Bill Miller funds, everyone gets things wrong and no one beats the market forever or under all market conditions but the risk in making not just huge bets but more like career makers (or breakers) time and again creates a consequence that probably can't be recovered from when the bets become breakers.

I suppose there is an argument to be made for an investment pool to take these kinds of outsized risks but probably not one that is available to unaccredited individual investors who bought a mutual fund because it was on the cover of some magazine as a hold forever fund because of a great ten year track record.

The article leans more eccentric than egoist but perhaps ego has been a component here? Certainly that would not be a surprise anyway. Learning from someone else's downfall is no doubt opportunistic but it is also helpful.

Congratulations to the All Blacks from New Zealand on winning the Rugby World Cup. They made easy work of most of the tournament but France, whom the beat in the final, has always been difficult for them as was the case in the final but when I saw the French's first reaction to the Haka was to hold hands (not lock elbows but hold hands) I felt good about the kiwi's chances. While I know how the scoring in rugby works, I don't get the rest of it.

The Big Picture for the Week of October 23, 2011

2011-10-22T05:33:00.001-07:00

The other day I read yet another article about how to capture yield in this environment of zero percent rates. We've not made any radical changes to what we've been doing fixed income wise in the last few years as US rates have been low and generally gotten lower and the visibility for them to remain low for quite a while is pretty clear. I have not changed my belief that the US' fundamentals argue for higher rates but market prices diverge from fundamentals all the time.

A common case being made these days is that investors should buy dividend stocks instead of bonds. If you want do that just realize that dividend stocks are stocks not bonds and have volatility characteristic of stocks not bonds because they are stocks. There is a reason why most people have some sort of mix of stocks and bonds; they tend to react and behave differently. The manner in which a dividend stock may react to various factors might be relatively muted compared to the broad market but they are merely different shades of the same color.

To the extent people need income from their portfolios (so not talking about the accumulation phase people) one suggestion is to add some yield to the equity portion of their portfolio. This is not a call to change the asset mix but to increase the yield of one portion. This can be done several ways but I will say I think it is easier by using individual stocks instead of funds.

So with the energy sector an equalweight allocation is low double digits. That is enough to take in something like Statoil (STO) which we have owned for years and usually pays 4-5% in dividends or some other big cap foreign stock with a similar yield. There is also room to take in an MLP or two and those yields range from 5-9%. Something yielding 5% will probably be less volatile than a 9% yielder so maybe one of each MLP (that being one 5%er and one 9%er). There would still be room for something that was more growth oriented which might come from some theme with good prospects. This mix obviously tilts to yield but is not exclusively yield oriented.

With the tech allocation, someone needing more yield might have luck with a semiconductor stock. There are a lot of them that yield above 3% with quite a few near 4%. Financial stocks typically have decent yields but I would suggest looking at banks outside the US, Big Western Europe, Japan and China. There are some relatively healthy smaller US banks with good yields but this is difficult work.

There are also higher yielding products that should be treated like equities to consider. We owned one a few years ago, MIC, and it got crushed in the crisis. That it got crushed was not a big deal because our exposure was so limited. Something like Brookfield Infrastructure (BIP) could work but I would expect it and anything like it to get crushed should there be some sort of 2008 repeat. Own one of these in moderation then it is just an inconvenience like MIC in 2008, own a bunch and it becomes a problem in a 2008 repeat.

As for actual fixed income, yields are low. If the yield of an entire fixed income portfolio is not low right now then there is risk being taken. That is only bad if the end user doesn't know that risk is being taken. A large portion of what we own are short dated, high quality domestic corporate debt and the yields are very low but better than treasuries. We are not taking meaningful interest rate risk with short maturities because of how soon they come due, mostly 2013.

I've made a big deal over the past few years about owning individual issues of sovereign debt from other countries. Some yields are quite good and some are very low and we have a mix of both. Again these are short dated. Just about everyone has Australia and some have New Zealand (a little riskier than Oz) which is where we get decent yield. For Norway we rolled to 2015 when our 2011's matured in May and that yield is pretty good but not in the fours like Australia.

We have one closed end fund that we use as an across the board holding (we have a couple of other ones in our ownership universe). Relative to closed end funds this one is quite stable pricewise. The yield is pretty good as you can imagine and it does feel big market moves but it usually has a muted reaction when CEFs in general are puking down. It is a very old fund, and the reason not to mention it by name is there are plenty like this to find, research for yourself and then buy if you are so inclined. But again some of these get crushed, I specifically want one that is very likely to not get badly hurt. If you take more risk here than me then you will get a higher yield.

We have two preferred stocks that we use heavily; one from a big US bank and one from Public Storage. That might seem like a surprise given how lousy I think the banks are but thinking they won't go out of business is not really an argument for going long the common. The yields here are pretty good or like some of the other segments I've mentioned we could even say the yields are about "normal."

One other segment to mention is that we own the PowerShares Emerging Market Bond ETF (PCY). The bonds are dollar denominated but currency moves can move the price of the bonds. The yield is around 5% but as this is an ETF there can be no certainty about what future dividends will be. it is not terribly volatile but occasionally there is some noticeable movement.

We have a couple of other things but the point here is that the collective yield is not zero, I believe we have spread out normal market risks so that we are not over exposed to any one part of the market.

Bigger picture, I believe it is very possible to get some yield out of a portfolio but remain diversified--not selling out for yield at any cost.

Investor Awareness?

2011-10-21T05:27:00.003-07:00

A thought occurred to me as I read this article from IndexUniverse about four new low volatility ETFs from iShares. The overall education level of the typical investor (talking someone with a brokerage account as opposed to someone whose only involvement is through a 401k) has improved versus where it was in the 1990s.

If you ask most ETF providers why they create the products they do they will most likely tell you that these are the funds that their clients/customers want from them. While there is probably more to it than that there is the belief that a demand is being met.

We are seeing a lot of funds coming out that offer a low volatility spin on some broad index including the four new ETFs in the above article. We've covered the extent to which lower volatility concepts, when executed correctly, can offer a better long term result by going down less and going up less over the course of a full stock market cycle, or as I have described it; smoothing out the ride. You should be able to find research on this as there are many different ways to capture the same general effect.

If there is new demand, compared to years past, for products that target better risk adjusted returns then I take that as a sign of more investors understanding the concept of risk adjusted returns on some level. I don't think this existed 15 years ago.

I believe we also know far more about foreign markets, how certain aspects of macro economics impact countries and markets at a far deeper level than we used to--this as a function of the macro economic failings of so many countries.

If we do know more about these things, it is because the seemingly dreadful stock market results of the last eleven years and the financial crisis of the last four years (or longer) have caused more people to ask more questions, rely on fewer assumptions and seek out better answers.

This will not prevent the same old behaviors from every other past big bad event from manifesting themselves as some people will always panic, be done in by misusing leverage one way or another, be too confident and so on. I will repeat this probably only applies to people engaged enough to have a brokerage account but I do believe this is meaningful progress.

Round Up All The ETFs

2011-10-20T05:12:00.001-07:00

I've really gotten a kick out of all attention ETFs have gotten in the last few days but I wasn't sure exactly why and then it clicked; scapegoatism. We are having severe financial problems on an almost global scale (I say almost because there are plenty of countries that have just been dealing with cyclical downturns) and "we" need someone or something to blame it on.

The crisis came about from some combo (define it however you want) of a flawed regulatory backdrop and greed on the part of people (banksters if you like, and people who lied on mortgage applications). We are now at a point where the newness of it is long over but in the most affected countries there does not appear to be an end in sight.

This is slogging on with various market abnormalities (real and perceived) with no signs of returning to the way it used to be and so we need something blame. Actually we need more than one thing to blame as blame for one thing exhausts we need something new to blame.

Right now the blame directed toward ETFs is relatively intense. They are distorting the markets in several different ways, the non-plain vanillas pose serious risks to the unsuspecting, investing public and they cause obesity in children--yeah, it's been scientifically proven.

This is a manifestation of herd mentality that I think is similar to the need to explain things along the lines of the market was down today because... We need to understand why even if that means blaming the wrong thing for the wrong reason or somehow just not being correct. As I've said a couple of times the blame-ETF meme misses the mark in terms of understanding how much of the current malfunction is attributable to ETFs--far less is attributable than people think. Although I concede that they might contribute to distortions, they are a small and possibly insignificant part of the equation. It is even possible that it is something else that is distorting ETFs in such a way as to make it look like it is ETFs' fault.

We did not understand what the financial crisis really was in real time (we probably don't fully understand it yet, several years after it started) and so I believe we are very unlikely to understand what it really distorting the market in real time.

Some traders will be able to trade this environment and some won't. But how is that different than any other time in market history? Some investors will keep their heads and navigate through fairly successfully and some others will not. Again, that is the same as any other period in market history. Invariably that will draw comments telling me why this time is uniquely unfair or whatever, but it is not as different as many think.

The Stock Market Dropped Yesterday Because It Did

2011-10-18T05:11:00.000-07:00

This appears to be the market we have right now, it was up on Friday just because and that was the same reason why it was down yesterday. I say this not to point out something new as it has been going on for a while but simply pointing out that this is what the market is giving us.

As a matter of investment philosophy this is an environment where I would rather try to shave off the peaks and troughs as the market seems intent on grinding around in the same range. The intent would be to go down less if the SPX goes back down to 1100 as we went up less as the market went from 1100 to 1200 the last time.

One relevant point I may not have conveyed adequately is that while I took defensive action consistent with how we always do it, I disclosed the various trades made along the way, and I do believe a recession is in the cards I do not believe the stock market action will be anywhere near as bad as late 2008/early 2009. We have been in the slogging through phase for a while and I think that will continue. A low from here of 900-1000 might sound terrible but it is obviously nowhere near SPX 666. The 900-1000 range is not meant to be a prediction so much as trying to have some expectation of worst case magnitude. Obviously I could be wrong and if we get to 900 or 700 then, as I have said before; however much defense we'll have taken by then we will wish we had more--human nature.

#OWS Evolves

2011-10-17T05:13:00.005-07:00

The Occupy Wall Street movement (and the other locations being occupied) seems to have escalated in terms of protesters v law enforcement clashes. As I said a few days ago, I do not take this lightly even if I do not fully understand where they are coming. You don't need these protests to know that some aspects of our financial and economic system appear to have changed and may not be "working."

The reason I hedge in that last sentence is that we are still in the middle of the event. I believe this event will turn out to be very historically significant but if we are still in the midst then we probably do not fully understand the context of the event. As bad as the OWS movement thinks it is, maybe when we look back on this in 2020 or 2025 we will conclude it was worse than we thought or hopefully we'll think it was not as bad as it seemed.

As I also said in my other post on this, the OWS movement is trying to ask some difficult or uncomfortable questions. Actually I think they are still trying to figure out what they really want to ask--still trying to find their voice.

One of the ideas emanating from OWS seems to be that they (here we're talking about the younger protesters) did what they were "supposed to," they went to college but incurred a lot of debt and now cannot find work that gives them a chance to pay off that debt.

One of the retorts to this aspect of the protest is to criticize them for majoring in medieval folklore (a little humor is ok) and expecting that major to have any value in the job market. Early on in my college career someone wisely told me that there are only three undergrad majors; accounting, engineering and everything else which I took to mean that companies don't hire your major (except for those two), they hire you. Someone else told me that unless you go to Harvard, Yale or Stanford it doesn't matter where you go.

With that in mind I went to San Diego State, got a BA in econ and graduated with $3000 in student loans that had a minimum payment of $100 per quarter. When I was college age I was interested in having as little student debt as possible as I knew I would have to pay it off. Hence I chose a school that cost me $300 for my first semester. Has the thing about majors and schools changed? Were they never actually true? There are relatively cheaper ways to get through school like going to a community college for the first two years.

The logical reply to my comment about companies hiring you not your major is that there are fewer jobs available coming out of school. While that might be true in the traditional sense I believe the internet is a great tool for people looking to make their own way. I don't mean on a Zuckerbergian scale but more modestly. As an example, go look at some of the younger contributors on Seeking Alpha. There are quite a few guys right out of college producing content and making some money. I doubt there are too many 24 year olds making $10,000 a month with their blogging but someone who writes prolifically might make $1500 and if they can't find a "real" job then maybe they have a not so good job for now while they are young and putting their time in to try to become successful.

This sort of combo of starting out on your own with what you want to do/shit job has a low barrier to entry. There is nothing wrong with this sort of sacrifice in pursuit of what you want to do. I've disclosed previously that before this part of my (internet based) career took off I took side work around here like putting on a roof, doing logging, and building a rock wall. We needed the money and I was (and still am) too cheap to raid our savings.

I realize there is a lot to be down on right now in our country but I believe that there is ample opportunity for those who can really apply themselves. Maybe many of the OWS protesters are doing this but not talking about it much as it might be bad for business, I mean protesting.

Some things do need to change and I am glad these people are asking some questions but their "list of demands" will probably need to evolve some to make the movement more practical and relevant.

This post was longer than I thought it would be but this could be important and might help the country light a fire under its ass if the right questions get asked in a productive manner.