Checking In

I had to come to our office in Phoenix today and am just now able to check in on the blog; thank you for all the comments!

Last week I mentioned the Latvian lat (the currency there) as being vulnerable to some sort of Iceland-like episode. This morning I found this article in the International Herald Tribune about the same thing and also mentions a couple of other countries in the region that are less at risk but at some risk nonetheless.

I believe generally knowing about these things is useful. Knowing that China has been frothy for the last couple of months (or longer?) and that government officials were concerned (Tuesday was not the first time the officials expressed at least a little concern) may have helped make yesterday a little easier for some folks.

Herb Morgan has an article up at Seeking Alpha revisiting why he doesn't own emerging markets and using yesterday as a validation of some sort. While I think he has it wrong he did not deserve to get filleted in the manner he did in the comments.

He obviously missed out on more than he benefited yesterday but chances are his clients are generally comfortable without emerging markets or they own it elsewhere.

In case you missed this; here is an interview with Mark Mobius.

Marc Faber would not be a buyer in emerging markets here.

I view the yen as a canary for the market for the time being as yesterday sorts itself out.
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"Two Days Before The Day After Tomorrow"

The above title (think about that one) refers to a South Park episode about global warming.

There is obviously a fair bit of heat on global markets right now.

The video I posted yesterday morning was obviously made Monday afternoon before things started to happen and so all was still right with the world.

The reason to bring it up again is to reiterate my belief (and by extension how I act on my belief) that this sort of thing happens, there is nothing unusual about it and so there is no need to assign emotion to this if you are properly diversified and are in touch with how your portfolio is likely to react to extreme moves in either direction.

I noted that Asia was likely to get smacked hard (although China was up 3.94%) which is what happened and Europe continued to decline too.

Obviously the US market is indicated higher but I don't have any feel or hunch for whether this reverses today or not.

I will say that it did not feel like a lot of people (based on what I read, watched or the many comments left on this blog) were feeling real pain or angst. If this assessment turns out to be correct then the decline may not end up being very constructive or cathartic.

Any outcome is of course possible but the 8% correction last spring turned out to be fuel for a very nice lift and the anguish then was palpable. If the market turns around and goes higher starting today then I don't think the correction will have turned out to be meaningful.

This notion is not so much an attempt to predict what will happen but to try to set up visibility for the next few weeks. If the bottom came yesterday or comes today and we go back to 1450 or maybe 1475 I might look to take action to reduce exposure a tad.

If the panic continues as a panic and we approach last springs' 8% or the elusive 10% decline I would probably look add some exposure.

Historically, panics are better to buy and gradual declines are better to sell. For now there is no outcome yet.
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Oh By The Way

Europe and the Americas did much worse than the rest of Asia. It makes sense to expect Asia to get smacked overnight although I am not sure what this portends for the US on Wednesday.
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Make A List!

Put me down as someone who hates that term.

Throw "shopping list" in there too.

This line of thought makes so many assumptions about people and their portfolios that are almost never true.
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Stay Classy

"?Como Estan....?"

If you saw the movie you know what Ben Stiller's line was and sorry no upside down question mark on my keyboard.

A little Ron Burgundy will always be good for a laugh even on a big down day.

Some folks have come on TV or have said in print that this is healthy. I think a better word is normal. Declines and corrections are normal.

As I see the SPX now it is down on the year which is probably not a call to panic but will probably rattle a cage or two.

It is strange, to me anyway, that gold is down today and it is interesting that the yen is up a lot. I have been pointing to the yen as a possible catalyst for a correction for a few weeks now and while China is clearly the catalyst the yen would seem to be playing a big supporting role.

When the market opened I was lagging on the day but somehow the lag has evaporated and things are going a little better for me today. While that is fine, any clients who have not been reading my stuff for the last umpteen months will probably not take solace although no phone calls yet (insert nervous smile).

For people that were looking ahead to when the next bit of ugliness (what I have been preaching) would come and realize that it has no direct impact in their long term goals are probably in a better emotional place today than some other folks.
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High Anxiety

That's what the market seems to be feeling today. China was down 8.8%, something happened with Dick Cheney and just about everything is falling.

True to this morning's video I expect to lag the market today and if you do too it does not really matter, it is one day. It doesn't really matter if you lag for a year for that matter (lag does not mean miss).

Disruptions like the one that happened (or perhaps still happening) in China are not new and will happen over and over.

I have written several times about looking at your portfolio and knowing what you are vulnerable to, I had an article run yesterday on RealMoney on this exact topic. Once you know your vulnerabilities you can decide whether you should cut back. This is especially relevant for things like emerging markets.

As best as I can tell my lag on the day is around 35 basis points so far. The things that should get hit especially hard are doing just that; getting hit hard. Regardless of which direction the next 10% is there is very little that is fundamentally different, nothing really.

I have obvisouly been expecting a correction for ages and despite that some of the TV folks are saying that this is it, for now the market is only down 1.09%. Regardless of what this does or does not become there will be nothing with this that the market has not seen many, many times before.
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Mental Check

I'll write about China later but it looks as though Europe is feeling it worse than the rest of Asia which is interesting.
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Use Narrowly Themed ETFs? Never!!

An article on Bloomberg by John Wasik is the latest to pick on some of the newer and narrower ETFs.

There are some points made that seem to recur on financial websites over and over that I believe miss the mark and this article is no exception.

Right out of the blocks Mr. Wasik draws a parallel with increased ETF issuance today and dot com IPO mania from the Internet days.

The Internet bubble produced countless $50 billion, $100 billion and larger companies. The article picks on the HealthShares ETFs (don't most articles pick on these funds?) as being emblematic of this effect but at this point I would be shocked if the entire HealthShares line even had $100 million in assets (I have a call into HealthShares to find out).

In picking on HealthShares the article asks if you really want to invest in endocrine disorders, climate changes or US livestock futures among others. This line of questioning misses the point. Most investors will not need these funds which has nothing to do with whether they should exist or not. The market will decide whether these funds make it not someone's arbitrary concept of what we need.

The regard for do-it-yourselfers is noble but people who view the market as a casino will always find something to bet on, if not ETFs then something else; this is a fairly obvious point. And for investors that really don't know any better a the narrower you get with an investment the more risk you take.

Personally I don't have an interest in most of the new products that come but I owe it to my clients to at least give them a quick once over because some of them are better mousetraps.

On a personal note I have wanted to use a picture of Skeletor for ages; we may see more of him on future posts.
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What Did He Say?

I usually watch the Consuelo Mack show; it is on Sunday at 1pm where I live. The topic this week was the importance of dividends with Ben Stein, Robert Kessler and David Winters.

Kessler and Stein got into a tiff over something said by Kessler that I too question or perhaps the result is a data anomaly.

Kessler said that over the last "20 odd" years the return of treasuries, specifically zero coupon bonds, has equaled stocks. I think Ben would still be telling Kessler he's wrong if Consuelo hadn't jumped in.

Kessler said one thing that was confusing for people new to zeros he said "over the last 20 years they have outperformed almost every asset class for only one reason; that they are consistently paying interest." Well zeros pay no interest they accrete higher in price yes but pay interest no.

At one point he says it works because over the last 20 or 25 years zeros have compounded at 5% or 6%. Well at no point in the 1980's (according to Yahoo Finance) did 30 year treasury yields go below 7%. He may be using yields as high as 14% for his work.

I am not positive what long term zeros were "yielding" 20 years ago but Yahoo has the yield of a regular 30 year treasury bond at 7.5% (about the low of the decade) in March 1987.

I did a calculation of a 20 year period ending 12/31/2006 and zeros bought 20 years prior compounding at 10% would have had a roughly 610% increase. The S&P 500 opened at 242.17 on January 1, 1987 and closed out 2006 at 1418 so the gain from that period in stocks works out to about 590% so he's right! Oh wait, no, dividends, dang!

According to BigCharts.com the yield for most of the time studied has been around 2% (you probably already know that) and while I did not take the time to calculate it through, 20 years of even 1.5% would put stocks over the top, so it seems, but I have not seen Kessler's data.

The thing that stands out about Kessler's comments is that he uses the 1980's as a starting point which had some of the highest yields (if not the highest) in the history of our country, certainly the last 100 years.

Later he said that stocks would, over the next 20 years, have to go up 300% to outperform zeros. Well over the last 20, which takes in a crash, cutting in half and many crises, the market went up 590%. Twenty years before that (so opening day 1967) the SPX opened at 80.38 and went up 305%-ish to the 242.17 and this period included a big stretch of "going nowhere" and yes we still need to add the dividend in. Twenty years before that (so opening day 1947) the SPX was at 15.30 so the the following 20 years the market was up better than 500%, uh plus the dividend. The numbers here are from the Stock Trader's Almanac.

The lowest closing price I can find for the S&P 500 after the tech wreck was on March 11, 2003 at 800.73. Twenty years earlier the S&P closed at 151.24 which is about a 520% gain, plus dividends.

So betting against 300% in 20 years seems like a bet I would not want to make.

Clearly Kessler has data to back this up but looking forward I don't see how it can help unless you really want to take the under on the US stock market and think 5% compounded will beat stocks. I have written before that I think we may be in for a period of below average returns which I think might be in the 7-8% range. If this turns out to be correct I think adding a couple of hundred basis points is possible with foreign investing.

If Kessler's model is built around double digit rates, well how useful is that today? It will be useful if rates go back that high to be sure.
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Dow Chemical Getting A Bid?

So says this article on Marketwatch.

I own Dow Chemical for somewhere around 2/3s of the accounts I manage. The above link posits a $60 bid coming but questions the validity of the source.

This is not necessarily good news. If you are investing with a 20 year time horizon do you care more about 33% now or possibly several hundred percent over 20 years?
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Sunday Morning Coffee

Last night we had a fire call; someone was burning on their property which is OK for this time of year but the fire department needs to be notified.

Three of us responded and we tried to tell the homeowner he needs to call in before he starts. This guy could not focus on the simple matter at hand he would just start talking on and on without focusing on the important thing; just saying that he would call in as asked.

As is often the case I see a parallel to portfolio management. Many investors get distracted by all sorts of things like hot stocks, trying to game a commodities market, making lopsided bets and other similar behavior.

When you flip on the TV, pick up a magazine or visit a web site a lot of the focus will be on something that probably does not really jibe with your long term needs.

Most of us just need to worry about having enough money when the time comes. If we can get from here to there without going on a white knuckle ride; all the better.

I concede it is easy to get distracted by a stock touted on Bulls & Bears with a compelling story that hits the right emotional spot for you. I know I am a sucker for a good story. I don't buy stories but they always sound great.

That being said most people will take an occasional flier. The other day T left a comment about devoting 25% to speculative plays. That is a little too high for the way I view the world but it is human nature to want to make a killing. Well OK but I would urge anyone before placing this type of trade to question if it really fits in with their financial plan and goals.

This idea will not be popular but this is how I see it.

Well the picture above has no coffee in it but I think it is pretty cool. We took it last summer in Reykjavik looking down an alley of sorts.
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The Big Picture For The Week Of February 25, 2007

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Old Time Hockey

If you like "B" movies and sports you know the above quote from the movie Slap Shot and know about the donnybrook last night in Buffalo.
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Will This Matter?

Jyske Bank has commentary today that there could be a little dust up in Latvia and Bulgaria as both countries need to stay close, economically, to the euro as both countries are on the path to EMU inclusion.

However, they appear to be struggling and a devaluation could be in the cards. S&P downgraded its outlook for Latvia from stable to negative, hence the big move on the LVL chart.

Both countries have current account deficits but
Bulgaria's is covered by FDI (per Jyske) but Latvia only covers 1/3 of its deficit with FDI (again per Jyske).

These places may seem like they are off the investment map but Iceland's problems, along with yen strength contributed big time to the correction last spring and how many people were following Iceland back then?

To be clear I don't know what will happen here or how important this will or won't be but it is worth staying in touch with.
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Coasting Into The Weekend

ProShares listed 12 more double long and double short ETFs covering a lot of growth and value (style) versions of some of the bigger benchmarks like Russell 1000 and Russell 2000. These products provide the potential to some very sophisticated strategies that I am not smart enough to come with but that we will be reading about soon enough.

I found this little nugget about the Australian Banks on a site called The Stock Advisors written by Jon Markman. He is bullish on the two of them in particular; National Australia Bank (NAB) and ANZ (ANZ). I first disclosed owning ANZ for clients a little over two years ago in a post referring to my first appearance of Forbes on Fox (the gang at Fox has since decided I have a face for radio). ANZ has been in client accounts for four years (the couple that have been with me that long).

Over the long run ANZ has done very well relative to the NYSE listed bunch but over short periods of time they all have their turn as the top performer. These stocks, well ANZ more specifically as I know that one the best, tend to have very high yields low volatility and just sort of chug along higher. I think they are great holds for the long term. The nature of the way they trade seems to be they do nothing for months and then will shoot up 10-15% in no time at all.

According to Stockpickr.com George Soros recently bought International Rectifier (oy, that name), Dish Network and several energy related names. I find that I am interested in what Soros does and has to say.

Thanks to the Marketbeat page at WSJ.com for picking up my recent comments on the dollar.

Kudos to Mebane Faber for getting some lengthy coverage on BusinessWeek's website in an article by Aaron Pressman. Mebane does some very intelligent work on his site.

I was saddened to hear that Dennis Johnson from the Celtics of my youth died very young of a heart attack.

On a humorous note; yesterday I spoke to someone from an ETF provider for a TSCM article while this person was on vacation in Florida. My wife delivered the line of the week when I told her that the guy was on vacation and she said "what is it with you people, you never stop."
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Diversification Reminder

Every so often I like to put up a post to reinforce the extent to which proper diversification can make managing your portfolio a little easier. Over the last month or so gold, as measured by client holding GLD, is up about 7% compared to about 2% for the S&P 500. I have written about gold a zillion times and I tend to say the same thing; I am no gold bug but I do believe owning some makes for good diversification.

By being properly diversified there is less need to be specifically correct about what will do well in the short run.

By the same token I still stick with health care despite its general lag of the market. In the same time period that GLD is up 7% another client holding, Johnson & Johnson, is down 4%. At some time health care will provide leadership to the market and chances are most stocks will participate. By sticking with the sector I don't have devote time to picking when is the "right" time to get in.

The concept is more for people who do not want to trade a lot, people who just want to have enough money when they retire without going on a roller coaster.
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Thurday Tidbits

Richard Kang has a good article up at Seeking Alpha about the new WisdomTree Earnings ETFs along with some commentary about the potential consequences of too many ETFs. I don't tend to worry about too many ETFs; the danger is more to the issuer than to the market in my opinion. If 50 new funds are created that all invest in large cap value the most likely outcome would be that many of the 50 would simply fail, close and return the money.

If there are two, for examples sake, ETFs that each invest in two different wildly volatile areas and one area does very well this year while the other does poorly and then the two have the opposite fates the following year; this would not be an indictment of the ETF industry.

Kevin Divney from Putnam made a good point on Asian Squawk Box about the current state of the US stock market. One thing that contributed to the tech bubble was that tech grew to 30% of the S&P 500, which is too much for any sector in SPX. The current sector make up has been about where it is now for several years. While this guarantees nothing the fact is the index is not distorted as it was the last time it was in the mid-1400's and rising.

Italian PM Romano Prodi resigned and the Italian stock market does not seem to be negatively impacted. I'm not sure what that means.

Ben Pedley from LGT bank was on Today's Business Europe calling for the Australian dollar to go up to $0.83 attributable mostly to the dovish talk from the Bank of Japan. The consensus after Japan's hike and statement seems to be full steam ahead on the carry trade. I have to wonder if this becomes all the more reason to reign it in a little bit due to repeat of last spring coming out of nowhere for no obvious reason.
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Its Inevitable, Unless It Isn't

A reader left a comment wondering if the dollar can possibly go up in the next few years, everyone says it is going to go down. The reader raises the possibility of taking the other side of this trade and going long the dollar one way or another.

Fundamentally there is absolutely no question the dollar should go down. This has been the case for a while and will likely continue to be the case for the foreseeable future. Just because it should go down is no reason that it would go down. Should and would are two different concepts and the two diverge regularly.

As far as taking action to fade a dollar decline; I guess I would ask how it fits in with your portfolio and financial plan. If the idea behind the idea is to speculate that the consensus will be wrong; is the type of trade you usually do? If the idea behind the idea is a counter strategy of some sort; is this the type of hedging you normally do?

My use of currency ETFs for clients is about diversifying the cash portion of the stocks/bonds/cash allocation. As I am a US based, mostly equity, investor I feel very little need to go long the dollar.

From the above you might conclude I am saying to always go with the crowd but I am not. The fact is the currency market is a different animal than the stock and bond markets. Most active market participants are better suited to fading consensus in the stock market than with currencies at least I feel that way about my own investing.

If the reader in question is new to currencies and feels that he has to do the trade I would urge moderation; start small. To be clear this is not a trade I will be doing.
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Wowsy Wow Wow

This might be what the gang at Schwab was thinking when they first got wind that eTrade was upping its commitment to foreign investing for its retail customers.

eTrade will be providing direct access to stock markets in Canada, France, Germany, Hong Kong, Japan and the UK. I don't know if this means that things like the commodity ETFs from ETFSecurities and GDRs (a type of foreign listing not available to US retail investors) would somehow be available or not.

Account holders will also be able to trade and hold British pounds, Japanese yen, loonie, euros and Hong Kong dollars.

That these markets are now easily accessible may not be the thing but what this portends for the future might be. I think an obvious evolution is being able to access markets all over the world from one account. I don't know how many years it will take for this to unfold but it is a first step that the other discount brokers will have to match.

This move by eTrade really steps on Schwab's toes. Schwab can help you access many markets but it is a couple of intermediaries away from being direct access plus Schwab is much more expensive in many instances than the $20 eTrade plans to charge.

To Schwab's credit I will say that the people who answer the phone on the global desk are usually very knowledgeable but for trades that cost $100 or more you have to assess whether that knowledge is worth $80 or more (stocks below US$1, which is how low some country's stocks trade, can cost hundreds of dollars). Also not helping Schwab is that when you call in you have a 50/50 chance of getting someone who will be quite impatient with you (sorry guys but its true).

While I expect that in the future you could have a Pakistani stock, some Polish zloty and Hungarian forint in your account you won't need all that. But the idea that in looking for a frontier investment you would not need to devote time to research what is accessible could be a boon. If the one frontier thing you want is bank from Cyprus you should be able to just buy it.

A further note about Schwab is that this demonstrates that yet again they are not first to market anymore. They used to be very innovative but that ship seems to have sailed, at least that is the perception.
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Dollar Up Dollar Down ETFs

DB Dollar Up (UUP) and DB Dollar Down (UDN) are now on the market. I am not sure how popular they will turn out to be amongst retail investors. If you want to bet on the dollar going up well maybe UUP is the way to go (not saying so definitively just saying maybe). But if you want to get long foreign currency for whatever reason (hedge, diversification or speculation) I have to wonder if the CurrencyShares from Rydex might be better.

The dollar index, which underlies UUP and UDN, is 57% euros, 13% yen, 12% GBP, 9% CAD, 4% Swedish krona and 3% Swissi. So really, the euro is driving the bus. I think some of the single currencies offer better diversification.
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ETFs To Close?

Market downturn could force some ETFs to liquidate - MarketWatch

This should not be a shock as many funds have not attracted enough assets to break even. I tend to think an ETF provider needs to give a fund at least two or three years to have a decent chance but a point I have made many times in the past is that some new funds will fail. Those that do fail will close.

This strikes me as normal capitalism; successes and failures.

It makes sense to think that an ETF provider will have a small number of big hits, most funds being so-so and a few that fail to gain any traction.

The article speculates on a few potential funds that could close but whether those guesses turn out to correct or not there will be some closures.
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Uranium A Bubble?

Why not, it has more than tripled in the last couple of years. Didn't the Nasdaq do something similar? The Nasdaq was at 1500 on opening day 1998 and it peaked at 5000-ish 27 months later. Seems pretty similar to me.

As Lee Corso might say; not so fast my friend. While the price action is similar the all encompassing nature of how many people are participating in this market is not the same as the Nasdaq.

Do you own any pure plays? Do you know anyone who owns any pure plays? I actually own two and my weighting is quite large; 4%. I don't own any for clients. If you have 5% or less you are not recklessly levered to this space. I'm not sure exactly what number would equal reckless; certainly 20% would and I think even 10% would be way too much but these numbers are nothing compared to what people were doing with Internet stocks back in the day.

The worst case scenario with uranium is that it is a mania which is not a bubble. Bubbles simply do not occur a few years apart. Once a generation is probably more like it.
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Lazy Frontier

This is a little follow up to the lazy portfolio and the frontier market posts from Monday.

A question came in on why no REITs. First off, maybe there should be but this is multi-faceted. One reader noted that REIT exposure would help reduce correlation to the S&P 500. Well, depending on how lazy you want to be you may not want your correlation to be too low. The market goes up the vast majority of the time and one of the underlying currents to lazy is generally going along for the ride, generally.

Further I do think that the gold exposure helps out a little bit to reduce correlation. But if you are trying to keep things very simple you are going to have a few gaps.

I think if investors can be a little less lazy and maybe up the number of holdings to a dozen you will fill in a lot of gaps, probably won't hit any home runs but over long periods of time you'll be pretty close to the market give or take.

Reader TomK called out several things with the lazy portfolio. He noted a big tilt to large cap value and no international small cap which he thinks is more important than gold/commodity exposure. Fair enough to be sure. As I look at the many LPs that Charles Kirk listed I only see one LP with international small cap. So this seems to stray outside of what most people think of for this type of portfolio.

As far as swapping this for gold; using WisdomTree International Small Cap (DLS) as a proxy for this part of the market it has a 0.60 correlation to the S&P 500 while Gold has a 0.03 correlation. I used client holding GLD as a proxy for correlation because it has some track record. While I had not thought about international small cap and can't say it is a bad idea of course I think the idea of a completely different asset with such a low correlation would be more important to me.

As far as the tilt to value, more than a tilt really, value outperforms growth the majority of the time but more importantly it reduces volatility a little bit which I assume that someone who wants a portfolio like this is looking for, maybe I have that wrong?

One reader questioned why only having 2% in frontier markets thinking 3% is about the minimum for a holding. I tend to weigh most stocks at 2 or 3%, I don't think 2% is too small. The context of 2% is that emerging markets are, I believe somewhere around 7% of the global market (correct me if I am wrong, but I do think of that number as equal weight). So 2% in a frontier stock/single country fund/broad-based fund is obviously around 1/3 of the allocation.

When I first bought the Vietnam Fund (VTOPF) that I have written about a zillion times I felt it had the potential to double. If correct, a 2% weight adds 200 basis points to the total portfolio which I think is a lot and is what I'm going for with something like this.

It came close to doubling I scaled back to about 2% and still think it can double but I have no idea in which direction the next 30% might be.

Most of the frontier markets seem to have that kind of potential but clearly where that potential does exist so too does cutting in half exist as a real possibility.

There are individual stocks and a few LSE traded vehicles that are kind of like closed end funds available too. There are three NYSE CEFs that invest in Russia/Eastern Europe that you can check out, CEE, TRF and RNE. The each have their quirks and are not ideal but they are easy if that is what you are looking for. TREMX is one OEF I have heard of but know little about. I think Templeton has an OEF that might fit the bill but I could not find it on Yahoo or Morningstar.

If you want this type of exposure I think you need to be prepared to roll up your sleeves to find and then get to know the choices.
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Deluge Of Snow

If you see no post Tuesday morning it will be because we are snowed in.
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Bloomberg On Frontier Markets

Here is a good article on Frontier Market investing. I have been on board with this for many months and continue to believe this asset class has a place in a diversified portfolio (more components than a lazy portfolio).

Personally I can't read enough about this stuff but as far as its weight in a portfolio; 2% is probably sufficient.

On a personal note UPS called and the new laptop will be here this afternoon, thanks to readers for all the help from a couple of weeks ago.
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A Lazy Portfolio?

After reading Charles Kirk's lazy portfolio work I felt motivated to take a stab but I wanted to do it with a slightly different twist. I did not want to just come up with something that had similar weights in similar funds found in other variations on this theme. I also I think it is constructive to encourage the exploration of different funds.

I can't offer a three fund mix but maybe seven funds can fit the bill? I feel like we need a minimum of two funds to cover domestic equities, two for foreign, one for commodity exposure and two for fixed income.

We have a problem already for some; no REITs.

First the list;

iShares DJ Dividend Select Index Fund (DVY) 25%
Rydex S&P Small Cap 600 Pure Value ETF (RZV) 15%
WisdomTree DIEFA High Yielding Equity ETF (DTH) 25%
BLDRS Emerging Market 50 ADR ETF (ADRE) 5%
DB Gold ETF (DGL) 5%
iShares TIP Fund (TIP) 20%
Advent Claymore Convertible Bond Fund (AVK) 5%

Now some commentary;

The first assumption is that whatever cash for emergencies or the three to six months worth of expenses is already set aside. I also wanted to try to spread around exposure to different ETF companies.

According to PortfolioScience the standard deviation of this mix is 6.28, the correlation to the S&P 500 is 0.86 and the beta is 0.74. As I figure it the yield of this mix could be 3.32%. As long time reader SLMasker noted the other day TIP's payout is quirky and the trailing yield may not be the same going forward. For DGL I assumed 4% but I think at current rates DGL might pay out closer to 4.5%.

Morningstar notes a very heavy weighting to the financial sector. I'm not certain if the 34% cited by Mstar is right but the sector weighs in at 35% of DVY, 18% of RZV, 42% of DTH and 15% of ADRE. As I figure it that works out to 22.7% of the total portfolio and 32% of the equity portion. The mix is light on healthcare, energy and tech and very heavy on telecom and utilities.

These skews just go with the territory of using broad-based products like the ones listed here.

I chose DVY because I use it for a few clients; it has a good track record compared to other similar ETFs. Small cap value does better than broader small cap over long periods of time. I chose RZV here because it has done well compared to its peers and introduces a different fund company into the mix. DTH has smoked iShares EAFE (EFA) with about twice the yield. ADRE (personal and client holding) has smoked its competition but it only owns 50 stocks so you should expect more volatility than from funds with hundreds of stocks.

For the fixed income portion I believe in the inflation protection concept. As noted above the pay out for TIP (client holding) is quirky but an underlying assumption is that this is for a person not yet investing for income. AVK is held by a lot of clients. I think this is a great part of the market for some exposure but I could have just as easily gone foreign which would have been client holding Aberdeen Asia Pacific Fund (FAX).

I included gold so as to have one thing that has an obvious chance of going higher if something bad, terror or war wise, ever happens again. The reason for DGL as the choice is for the potential that it could pay some interest. I am giving this some time to season before actually buying it for clients.

Lest anyone adds two plus two and gets 22 I have not implemented this for anyone nor am I going to. It ignores a lot of themes that I believe are important for the next several years and that I think will add value. All lazy portfolios ignore things like Chindia, water and the other things I have touched on and other similar themes that I do not mention and don't invest in.

In the last few days we had some chatter on the blog about the portfolio put forth by John Serrapere on IndexUniverse. His portfolio is nothing like a lazy portfolio; just wanted to avoid that confusion.

Lastly, if you want to use this type of portfolio fine but I would still advise a little bit of follow up time. Maybe a lazy portfolio investor could devote one or two Sunday afternoons a year to look for better mousetraps and to square away the occasional rebalancing that might need to be done.

You should feel free to offer your own lazy portfolio or maybe some tweaks to mine.

Glad to hear so many readers are dog people too.

The above picture is from our last trip to Kauai in 2003. It is the Hanalei Bay at sunset.
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Sunday Morning Coffee

I've had a tough time keeping up with reader questions. I'll knock a few out here but don't want to turn this into a 2000 word post either.

One reader noted that out of concern for a toppy market he has replaced some portion of his portfolio with call options, an ETF substitution type of trade. He noted that options are cheap.

While this is not bad it is not for everyone either. He gives up dividends but these could be offset by the amount of cash he is now earning interest on. One thing that could happen here is that if the market does correct more than say 10% it is likely that his equity exposure will decrease as a function of delta reducing.

If you buy an option with a delta of 0.95 you have a good proxy for the underlying. If the delta drops to 0.60 (a 0.95 delta usually goes with a deep in the money option) you now have less exposure. So then do you want to actively manage this?

Back to the Serrapere article. A reader asks for some elaboration on John's Portfolio A along with a specific question about low quality and high quality. How do you know when to rotate between the two.

The second part is easier to answer. I do this but I think tangibly about volatility as opposed to quality. The two overlap a lot in this context and I think volatility is easier to think about. In November I disclosed selling BP in favor of WisdomTree Energy. There were two motivations for this trade. I did not think BP justified the extra risk of holding an individual name and I also thought that based on how crude looked it might be wise to reduce volatility. Almost by definition a stock will be more volatile than a sector fund, almost.

To the dissection of Portfolio A in the article; this will be more difficult as some of the article is tough to read and I can't glean exact percentages. First he is short Rydex Equal Weight S&P 500 (RSP), Nasdaq 100 with an inverse fund and short iShares Emerging Market (EEM). So I take these positions to mean that he thinks smaller and more volatile parts of the market will lag more boring parts of the market like the two health care funds, telecom fund and staples fund he is long. He is in the bomb shelter a little bit with streetTRACKS Gold (GLD, client holding) and the GDX mining ETF.

He likes energy and Japan with two ETFs each. He is long Templeton Emerging Market Income (GIM, a couple of clients own that one) yet short EEM. Liking energy would seem to be at odds, sort of, with being short EEM. Chindia needing more oil is a leg in the energy bull stool. He also has two CEFs that have big yields and fairly low volatility. Ooh, I forgot about the Currency Harvest ETF (DBV) which is a kind of absolute return play similar to the results sought after by the two CEFs.

There are some obvious questions I would have about this mix but I have to note that this is quite sophisticated and I believe is going for an absolute return and not a relative return but I could be wrong about that. First he has two health are products, PPH and VHT. I am not sure why both are necessary as the overlap is extensive and the correlation is 0.844 (according to PortfolioScience). I also am puzzled by owning OIH and XLE the holdings are not similar but the correlation is 0.939.

Further there are many parts of the market that are missing or are too small to influence the portfolio like utilities, discretionary, financials (this sector is in the two Japan ETFs but not sure their weighting in the portfolio), tech or industrials (this sector is in the two Japan funds too).

The foreign exposure seems quite limited as well.

Pretending for a moment I have dissected this correctly you need to have an element of real science embedded into your DNA to implement this on your own. This could be a great mix but it is not simple even if it appears like it is simple. There are a lot of effects and heavy mental lifting underneath the surface here. Perhaps you can wrap your hand around this or maybe not but if you think it is simple you are very likely not getting it all. I'm not being condescending; I don't think I get it all.

A couple of personal items. As I made this week's video Tater (big dog) and Cappi were asleep at my feet.

We took our pack test (3 miles in 45 minutes carrying 45 lbs of weight) for Walker Fire on Saturday, always glad to have that behind me.

Last night my neighbor and I went to see the Arizona Sundogs smoke the Odessa Jackalopes. Not exactly old time hockey but it was fun. The hockey was pretty good and the fans were really into it but I have a tough time philosophically booing a 19 year old kid pursuing his dream.
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The Big Picture For The Week Of February 18, 2007

John Serrapere article on Index Universe.
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Must Read

The Kirk Report : Lazy Portfolios

A few readers mentioned this post, thanks RW for the link.
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Yen Quantification

A few weeks ago I posted concern that if the yen were to strengthen in a meaningful way it could cause problems of some magnitude as the cheap, cheap money in Japan greases a lot of different wheels.

Turns out Dr. Brett did the heavy lifting to quantify yen's impact. A strong yen, as Brett qualifies it, has lead to an average S&P 500 decline of 40 basis points. You need to read his post to get the full context.

I doubt a hike to 50 basis points in Japan will destroy the carry trade and cause any LTCM-like blowups but it could be a trigger point for something normal in the way of a correction. If not, great, but this bears watching as the yen has strengthened in the last few days.
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Friday Morning Nuggets

Quite a while back a reader left a comment about what I thought sounded like an interesting fixed income product; SLM CPI Linked Note (OSM).

While I can't be certain that comparing OSM to iShares TIP Fund (TIP) is the best possible comparison I want one inflation product for clients and I would pick one over the other, I chose TIP. Structured products, which this sort of seems to be, have a lot of moving parts and are very difficult to fully understand. I am not sure why OSM is lagging and I am not sure if I could figure out why on my own and you probably don't need to spend time figuring out.

The important thing is that I heard about it, I watched it for many months and concluded it is not for me. It matures in ten years and probably matures at its $25 par value but if you want to own it for that you need to make sure about the price at maturity and you need to be willing to hold it as I suspect it could still go down.

Yesterday a reader asked what the term overbought means. Well as I think of it there are two meanings. Whether something truly is overbought comes from looking at oscillators, not something I do. With a tip of the hat to Helene Meisler at RealMoney the term is used a little more often that is really applicable. Most folks, me included, will say that a stock or a market or whatever is overbought after it goes up for what seems like longer than normal.

The reader asks how can something overbought because for every buyer there is a seller. Well not exactly. Part of being a specialist or market maker is the expectation that you will need to commit capital to facilitate trades every now and then, maybe more often than that phrase implies. Maintaining fair and orderly markets means stepping in on either side of the market at any time. Further if a stock starts moving up (to keep the context all the same) a lot during the day there are more buyers as buyers are willing to pay a higher price thus clearing out the sellers for the time being.

Yesterday's Land of the Lost Post certainly drew more attention than I would have expected. Thank goodness for bad television, eh? For the last couple of months I have been TiVo-ing Kung Fu every Sunday on channel 255 on Directv; talk about bad television! All things considered Kwai Chang Cane never should have snatched the pebble from Master Khan.
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Land Of The Lost Market

Wow, this is a dull day.

There is no action in the market, I'm finding very little to read and Barney Frank is still cantankerous.
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Sentiment Versus Action

The market is off to a big start for 2007.

The more it goes up the more bearish I become in thinking that it is over extended, over due for a drop, and there are anecdotal problems (like sub-prime) that all point to trouble coming.

I have more equity exposure now than when the quarter ended, I am ahead of the market (as measured by the generic portfolio I maintain on Yahoo Finance) by a noticeable amount so far and the trend has been to move higher.

On the way home from Phoenix I heard Pisani on Kudlow say that the bears keeping talk about three things that they are waiting for to crack this market; derivatives, disruptions in the spot price for rhodium and solar flares (I may not be quite right on those last two).

My sentiment is bearish. The market is much higher than when I first, incorrectly as it turned out, became bearish. The defensive action taken last summer was far from extreme and I am less defensive than I was a few months ago. Technically speaking we are closer to the next correction than we were six months ago.

The point here is one that I try to make often. If I had made a big bet on a correction last summer client accounts would be smaller than they are today. You and I are not smarter than the market and since the market goes up the vast majority the time you should not have too much in cash relative to your allocation very often. Rarely it makes sense to raise a lot of cash, as opposed to some cash, and in those times go for it but those times don't come along too often.

One last point about Pisani talking about the three things bears are worried about, whatever the three really were, I believe that when the market turns (not a prediction just the acceptance that at some point there will be a correction or bear market), the actual turn will not be caused by anything in particular it will just happen and then pundits will, after the fact, tell us what caused the turn. The pundits may get that part of it right but big turns tend to just happen. The tech bubble could have easily peaked six months earlier or later. There was no reason for it turn in March per se it just did.
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Buying Foreign Stocks

Um, yeah, this is going to be real expensive is how Bill Lumbergh might answer the question.

A reader left a comment asking about very expensive commission for foreign stock trades.

The reader notes paying 5% commissions for shares traded locally on foreign markets through Fidelity.

Schwab charges a lot too. I can tell you as of about a year ago Ameritrade charged me the same $10 for a foreign stock but I had to tell them how to place the trade.

Where you really will feel some pain, commission-wise, is if the stock trades below US$1.

I'm not sure why it is so unfriendly but it is and I have no idea if it will get better or not. I get a little bit of a break being an RIA but I have to say I would not pay such large commissions. I would rather tell Ameritrade how to place the order.
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The Central Bank Fund?

Barron's Online had an interesting article about the possibility that central banks in China and South Korea are considering allocating some portion of their reserves with portfolio managers to invest in several asset classes including equities. Singapore already does this.

This is an interesting development. First, the article points out that central banks generally have a poor track record for big decisions like this. As the article also points out, the general purpose of a country's treasury is for things like crises or other shocks. In that light the money needs to be liquid.

Also a concern, not mentioned in the article, would be the moving of this money from where it is now to where it will end up. China has over a $1 trillion and I think I remember reading somewhere that Korea has $250 billion.

Clearly no country is going to invest every nickel into stock but there is some number that if exceeded would be disruptive. There is also some number that would just flat out be too much to not have immediately liquid.

I'm not sure what the right numbers are but I do think that something like 5% implemented slowly would be neither disruptive to across multiple markets nor reckless on the part of the investing countries.

One unintended consequence could be some big chunk of the investment pool going into a country where is does not fit, for example it would be tough for a fund to buy a couple of $ billion in Vietnamese stocks.

Either way this is fascinating and I'll try to follow it.
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Various Kroners

Nicole Elliott from Mizuho, a technical analyst that I have a lot of respect for, was on CNBC Europe today talking about USDNOK, USDISK and EURSEK currency rates. Below are charts I made that are similar to what she brought on the air.


She thinks the Norwegian krone could strengthen to 5.25 which she said is a level not seen in decades.









She thinks that the Icelandic kronur could go back to 60, where it was about a year ago.










She is least constructive on the Swedish kroner which she sees hovering between 9.0 and 9.3 for quite a while to come.

For my own more fundamental bent, Iceland is exposed to any correction in the yen, Norway is viewed favorably by most folks but the last CPI report was quite weak and Sweden is getting smacked hard today over concerns about fewer future rate increases.

UPDATE UPDATE

I may have seen a bad quote on the Swedish kroner as it appears to be up on the day. Jyske Bank expressed some concern about the Riksbank news due out on Thursday though.
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Tuesday Tidbits

I wanted to follow up a little on the First Trust Water ETF (FWT) that is on the way soon. This chart compares the index that underlies FWT to the PowerShares Water ETF (PHO) that I have owned since a day or two after its listing.

Well, not much difference is there? For me to want to make a switch I would need to believe that going forward FWT will do better price-wise or if somehow it yielded a lot more that would be a reason to consider switching. I doubt FWT can yield a lot more because of the overlap but we'll see.

StateStreet has a bunch of ETFs in the hopper including the Emerging Europe SPDR (GUR) and the Middle East/Africa SPDR (GAF), according to IndexUniverse. Well those would certainly open some frontier markets to the mainstream.

And now a couple of public service announcements. My wife Joellyn has made a fulltime job out of volunteering for a local animal rescue called United Animal Friends. They just got their new website up and running, hopefully you will check it out.

Today happens to be Joellyn's birthday and a friend of ours gave her a kind of self-help book called The Secret by Rhonda Byrne. The basic premise is about getting back what you put out. If you put positive thoughts out in to the universe (not in a hopped up on prescriptions way) they come back to you and the same goes for negative thoughts. The book says this can pertain to work, relationships, goals, every day life and so on. If you visualize positive things happening to you then those positive things will happen.

It turns out Joellyn and I have been doing this sort of thing from day one. You can either buy into it or not but I do to a point. We have a lifestyle that we wanted many years before we were able to start living it. I would say this working out for us was a combination of planning and believing it would happen.

We each have family members who are generally negative and their lives are much harder than ours. This might lead you to a chicken versus egg debate which is fair but as I said you either buy in or you don't.
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CEF Premiums

According to this article from Seeking Alpha an index of closed end funds maintained by Thomas Herzfeld moved to a premium for what might be the first time ever (the article is not clear whether this has happened before or not).

This is another anecdote about how much liquidity there is in the world these days. Too much liquidity creates risks. There may or may not be a consequence to this risk but it exists nonetheless.

This has been on my mind for a while but not something I have yet figured out how to reconcile. Clearly if this turns out to be a harbinger for bad things it could still be several years before the liquidity issue causes any harm. And again nothing may come of it ever.

I just think there is something to this but I'm not sure exactly what.
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Weighing Gold

A reader asked me to post about the role gold plays in a portfolio. This is something I have written about a lot in the past but it is worth revisiting. I have been a big believer in owning a little gold, one way or another, in a diversified portfolio for a long time.

The important decision is to have some exposure, how to have that exposure becomes less important, IMO, because at different times the metal outperforms and sometimes it is the miners. For most clients I maintain exposure with the streetTRACKS Gold Trust (GLD). On a related note most clients have at least one large diversified mining stock or ETF that owns mining stocks. The focus on the miner for me is not so much gold but mining all sorts of things including gold. Were it not for GLD (or IAU) I would own a narrower gold mining stock. I used to own Anglo Gold (AU) but sold it last February.

The goal with this part of the materials sector is lowering the correlation of the portfolio to the S&P 500 and having a holding or two that has a chance to go up in the face of crisis. These holdings are part of a counter strategy (not a term I invented).

So how much gold? The materials sector (I think of GLD as part of the materials sector) only comprises 3% of the S&P 500. Thinking of gold as being part of the materials sector is not what a lot of people do so you certainly may not want to take my lead here but this is how I think of it. I am overweight materials at around 6%-7% of the portfolio. I might have 2%-3% in GLD, 2% in a diversified mining stock which I sort of think of as being partial gold exposure, and 2% in either a chemical stock or timber REIT (depending on the client).

In accounts where it makes sense to only have two materials positions, either as a function of account size or some other circumstance I might have 3% in GLD and 3% in iShares S&P Global Materials Fund (MXI). I prefer MXI to other ETFs because it has more miners and less chemicals than the others.

On an unrelated note First Trust has filed for a water ETF that is proposed to trade under ticker FWT. According to the paperwork they just filed on February 9th so it could be a couple of months before it lists. I hopped on the PowerShares Water ETF (PHO) right away as I buy into the theme but I would not hesitate to sell it across the board in favor of FWT if I thought it could be a better mousetrap. You can click here to take a peak at the underlying index. There appears to be a fair bit of overlap at first glance but there is no need to solve this now. For the time being, if you care about the water theme just know that another ETF is on the way. I owe a hat tip to IndexUniverse for the heads up here.
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Morning Coffee

A couple of items this morning.

I received two books in the mail from Wiley written by the InvestmentU folks; one about China and the other about Uranium. I was surprised they sent anything to me after the review of another Wiley book a few months ago.

Each book is about 40 pages. The first couple of pages in each book appear to be the same as do the last few with maybe the middle 30 being unique.

These seem to be more like reports than books but somehow they are priced at $29.95 on the back. I think you could knock these out standing in the business section at Barnes & Noble in a few minutes.

Each book has four picks. I'm not sure if it is OK to say what the picks are but all four of the uranium stocks are very obvious to anyone who has spent at least five minutes researching the theme and three of the four China picks are quite obvious too.

I think the info about the themes and the stocks is good but I'm not sure if its $30 good and there was very little you haven't found elsewhere.

One reader left a question about how to blend lowly or negatively correlated assets expressing concern that the portfolio ends up not moving at all.

Based on the tone of the question I think the reader might be starting from the bottom up and I think that viewing this from the top down is easier.

Assuming the portfolio in question has more than five holdings in fact let's say there are at least 20 holdings. If you have 20 holdings constructed in such a way the portfolio is similar to the market in terms of volatility and correlation you know that you will track the market fairly closely. That is the mix will track the market. If you then introduce a 5% weight a mining stock then the overall mix will drift away from the market only slightly; depending on the stock maybe not at all.

If instead of a mining stock you add 5% in gold and 10% in a double short the mix then starts to act noticeably different than the market, maybe even dramatically different. Maybe this mix only goes up 5% when the market goes up 10% but maybe the numbers are the same to the down side too.

In this example you may still have some growthy stocks that go up a lot but the mix is unlikely to look the market. The bigger context is the proactive decision to have a portfolio that does not behave like the market for some period of time.

A little bit of gold serves as a counter strategy but a lot of it serves to change the make up of the portfolio. If you are going to implement this you need to know the difference.

One other comment asked for my take on the G7 noting that not much appears to have been said about the yen. I guess I am a little surprised it wouldn't have come up (I have not yet read or heard any commentary about it). Realistically if a big stink had been made it probably would have only accounted for a small move to start. Maybe the tone in the market will shift to when will someone say something about the yen, today, next week, when? I suppose that sort of anxiety could evolve into something really market moving.

My guess would be that if the yen ever goes the other way again it will start for no reason at all and will catch a lot of people off guard which of course is how most corrections start.
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The Big Picture For The Week Of February 11, 2007

I never got to the amusing story in the video; right before the Bogle interview on CNBC I emailed Dylan to say that I would love to hear Bogle talk about whether the problems with ETFs he sees are more about human behavior or structural with the product. Dylan emailed back and said it was on his list of questions and he actually asked about it.
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Pisani On Hedge Funds

Bob says hedge funds are over rated because most of them don't beat the S&P 500. Fair enough but how many of those funds benchmark something else like a bond index, commodities or something else unrelated to stocks. How many are market neutral?

A more appropriate context would be how many do or do not beat their benchmark. From that standpoint maybe they are over rated?

I am not a fan of hedge funds but they play an ever larger role in the markets and though I can't envision a scenario where I would start to use them, that does not mean that we should know nothing about them and simply accept incomplete thoughts like the one Bob tossed out there.
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Currency

This morning on Foreign Exchange Boris Schlossberg from DailyFX raised an interesting point that the yuan has rallied against the yen and that and some point it creates a competitive issue for China.

I don't know what the fallout will be but we could hear more about this in the next few weeks.

If you don't know, the G7 is meeting and the yen's weakness could come up in the talks. Again it is tough to know for sure but the move of late has been swift and Schlossberg noted that it is very oversold.
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Too Funny!

Jim Cramer had a video the other day saying, well you can see from the image what it said. I wrote an article taking the other side of Jim's argument and this is what they put on the site.

Hearty chuckle.
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Odds 'N Ends

So HSBC is getting a lot of attention today because of problems in the sub-prime lending area (someone correct me but didn't they buy Household a while back?). I wrote negatively about HSBC a couple of years ago because I did not see how a zillion very small accounts in China could be very profitable. I have never been a fan of sub-prime lenders because of the blowups that come along every now and then. While I would not call HBC's stock a blow up the action in New Century (NEW) is a blow up. Novastar (NFI) is another one capable of blowing up now and then and is down 10% today.

I wrote about the mortgage REITs here in 2004; never been a fan. For disclosure one client asked me to buy NEW a while back, I could not talk him out of it but I sold it today at the opening print.

A question came in asking whether increased ETF issuance will mean less people owning individual shares resulting in less shareholder activism and knowledge. My initial reaction would be to wonder whether ETFs take more from the traditional mutual fund business as opposed to individual stocks. While I suppose it is possible that there could be less activism I have to say this is low on the list of things I care about. If the management of a stock I owned started really screwing up I would just sell. I don't have the time or the inclination to solve problems of this nature.

Another question came in about how to find assets that have low correlations to each other in the context of portfolio construction. Part of the equation is history, living it or reading it. I talk about using PortfolioScience.com which has a free seven day trial (I do not get paid for mentioning them and I have to pay for my subscription). The folks at SPDR have a correlation calculator too. Each one seems to have their own quirks.
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This Would Be Interesting

I found this little nugget on Index Universe about a new index from STOXX to eventually become an investible product called Dow Jones STOXX EU Enlarged Select Dividend 15 Index. The index has just 15 stocks and it captures high yielders from countries that were part of the Eurozone expansion.

The countries represented are Poland, Czech Republic, Romania, Slovenia, Malta and Hungary. Financials are the largest sector by far followed by consumer, energy, industrials, materials and telecom.

According to Index Universe the yield of the index is 4.85. The article points out a couple of potential flaws and it is clear that the current version of the index is narrower than most other indexes you will see.

According to the PDF linked to above the index is priced in several currencies including the US dollar which paves the way for a US based product.

It will be a while, if ever, for this to become an ETF but STOXX didn't create the index for its health. It would open the way to European frontier markets in a transparent manner. I have written a fair bit about frontier markets and I think they have a small place in a diversified portfolio. I think 2% is probably about right for people for whom they are appropriate (to be clear this segment is not for everyone, just some folks).

If this ever becomes an ETF and it is well received it will open the door for other frontier market products.

A big theme that I have been harping on since the start of this site is ETF innovation. A product that invests in frontier markets whether it is this index or something else a few years now will be a big step toward new access.
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Adding PBW

Another reader rightly pointed out the PBW is a good one to look at too in relation to the previous post on PZD.
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PowerShares Clean Tech (PZD)

A reader asked for my two cents on this fund. I am not a huge fan of this sub-sector. I have one client who has asked for small exposure and for this I use individual stocks that total about 1.5% of the portfolio.

As a matter of perception I think think these stocks add volatility but I find it difficult to get too heavy because of the feast an famine nature of the underlying business. If oil went to $50 and stayed there forever oil companies would make money and investors would lose interest in concepts like clean tech.

That being said I was surprised to see that PZD has been less volatile than the broader sector as measured by iShares Energy (IYE).


I included the iShares Industrial (IYJ) because almost half the fund is in this sector. You can decide for yourself which one PZD is a better proxy for.

One last point that makes this difficult for me to embrace is that it seems like there will always be more talk than action in arena. I buy into the need big time but don't buy into the progress some say is coming.
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How To Watch A New ETF

A reader asks;

re: GII..the new global infrastructure etf. The concept of this appeals to me, and when a new etf comes up that has merit for me I like to plug into my data base another ticker that can be used as proxy. Do you have a suggestion of something that I can watch trade to see how closely the two moved together?

I think the answer is very open ended. He is asking about the new Macquarie Global Infrastructure ETF (GII). I wrote a profile of it for TSCM which you can read here. To me, GII seems like more of a foreign utility fund than anything else. If you think that is true it would make sense to track it with WisdomTree International Utilities ETF (DBU), the two have a lot of overlap.

Leaving it at that probably falls far short of completing the task. After looking under the hood you will see a lot of utilities. Usually this sector will be less volatile than the broader market which makes an argument for tracking versus the S&P 500 or some other broad-based index. I realize there is a lot of foreign but I would want to know how volatile a new ETF is relative to the index I benchmark against. In adding something new to your portfolio it either adds volatility or reduces it. GII should reduce it but it needs to be watched for a while to know. Maybe iShares S&P Global Utilities Fund (JXI) should be added to the study?

Then what about common stocks? Sticking with GII as a proxy for utilities; I generally prefer individual domestic stocks for this sector. So part of my thought process has to be will GII be, IMO, better than any of the common stocks that I currently own.

Another possible aspect to consider is should utilities be a sector where I start to add foreign instead of another sector. I have foreign in every other S&P sector except discretionary (and utilities). Maybe I should have foreign exposure here too.

All of this is for perpetual study for the way I do my job. I have written many times about studying new products as they come. I don't use what I would say are a lot of new products but occasionally I do integrate something new into the mix.

I'm supposed to head down to Phoenix today but I may be late. OK, this will be the last of the Swiss ice pictures.
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More Retirement Stuff

My post from the other day about BusinessWeek's retirement planning section drew a lot more comments than I would have expected and I can see a lot of click throughs from other places that have picked up the post.

From the comments it seems like there may be a little confusion about some of the basics which is a surprise to me. One reader got very hung up on growth rates, inflation and the like. Another reader left a complicated actuarial question.

My original statement tried to be very concise and blunt; whatever you have, don't spend more than 5%. That's it.

Filling in some detail; this 5% idea pertains to not outliving your money. The idea of having your check to the undertaker bounce is one I don't get. What if you live ten years longer than you plan for?

You can make this as black box as you want but market up 20% this year; don't take more than 5%. Market down 20% this year; don't take more than 5%. In a way this is a big simplification but starting as simple as you can and then building in the details of your life seems logical to me.

Another aspect to this that I believe is potentially crucial is the notion of different income streams; meaning working after you retire. It is possible that you will not be able to work after you retire and a plan that hinders on working in order be successful is risky but those caveats aside some sort of part time work gives you money, gives you purpose and means your portfolio has to do less.

One neighbor of ours is 75 and can have as many hours as he wants doing backhoe work at $60 per hour. His backhoe is his toy so after expenses maybe he makes $40 per hour to play in the dirt on his toy. How many hours at $40 would it take to relieve your portfolio?

If you have crap that people want, eBaying can be a hobby that generates income. Finding the right crap to sell is not that easy I have to say.

Prescott (the city where I live) is two hours from Phoenix so there are a couple of shuttle services to the Phoenix airport. Most of the drivers (the ones we've had) seem to be retirees working two days a week. With wages and tips this could add up to $1000 per month. For someone that needs $4000 per month to live on $1000 is significant.

One more comment came in, as I was writing this post, deriding most web planners for assuming all expenses have to be paid for from your nest egg (never say nest and egg in the same sentence). This is not bad conceptually. It is more of a worst case scenario which I think is more prudent where planning is concerned.

My bottom line take on this is to be overly conservative at every turn and do what you have to to make the numbers work. Spend less, work a little longer, whatever.
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More Double Short

This picture has nothing to do with this post but still kind of neat, it is from Switzerland and will probably get forwarded to you soon if it has not been so already.

ProShares finally listed its ultra sector ETFs. They go double long or double short 11 sectors or sub-sectors, you probably know this by now.

I wrote about a possible market neutral trade involving these a while back and I had an article run on TSCM over the weekend that captures the idea with more detail.

The basic idea, using the utilities sector as another example would be to buy, say, $20,000 into Wisdom Tree International Utilities Fund (DBU) and $10,000 into ProShares Ultra Short Utilities (UPW). Conceptually you are only taking spread risk which should be much less than market risk.

Since DBU's inception it has outperformed iShares Utilities (IDU) by a surprising 800 basis points. The reason for this chart is that IDU and UPW track the same index such that $2 in IDU would be offset by $1 in UPW, save for the tracking error.

Using the dollars above DBU would be up $3200 and UPW might be down $1600. The dividend in that time from DBU might be 0.92% or $184. In this scenario (there are plenty of caveats) the return might be $1784 for the $30,000 or 5.9% for about one calendar quarter. Another nugget is that the double short ETFs could pay interest because they use derivatives to create the exposure and have cash that earns interest.

The move in DBU versus IDU is larger than what I thought could be possible when I first wrote about this. I think if the trade had been placed as theorized back in October it would need to be rebalanced fairly soon, depending on how true the holder want to be toward market neutral.

This type of trade is certainly not going to be a market beating trade very often, something to keep in mind. The double short funds have only been trading for five minutes so we can't be 100% certain they will do what they are supposed to, not that I doubt them but the MacroShares is a good lesson about not jumping in to a new fund right away. There will likely be some sort of tracking error too. Also the goal of UPW is double the inverse on a daily basis so over a year it may not look like twice the inverse.

Obviously this theory could also lend itself to pairing an individual stock and a double short fund too.

Much to my amusement I got an email from someone at ProShares who liked the concept, go figure.
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Hussman Must Be A Bears Fan

Double entendre.

This week's Hussman post captures the bear case very bluntly;

If the parents or the children of Wall Street analysts were to ask for wise investment advice, would the first thought of these analysts really be to encourage stock purchases at a multi-year market high, in a long-uncorrected and strenuously overbought advance, at a multiple of over 18 times earnings on unusually wide profit margins, with wages and unit labor costs rising faster than inflation, while interest rates are rising, bullish sentiment is unusually high, and corporate insiders are selling heavily? Would the potential for further gains in that environment exceed next inevitable correction by an amount that would make the net gains worth the risk? Would they encourage using trend-following systems in an overbought market, even though a decline to simple moving averages already implies substantial losses?

That is enough to make you swear off stocks forever but don't.
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More About Selling

The reader whose study prompted my video on rebalancing left a follow up question. He asked about my sale of half the position in Vietnam Opportunity Fund (VTOPF) that I disclosed in a video post a couple of weeks ago.

Specifically he wants to know if there are certain triggers I use to decide when I think a position has become too big.

There is not really an exact trigger. As a matter of philosophy I am not a big fan of absolutes like always selling after an X% gain or loss. From the view point I take, longer term usually, I don't think it makes sense for me to sell after a 15% gain or an 8% loss, am I not talking about discipline that needs to be exercised by a shorter term trader.

I need a little more information about the move in price to know whether to sell or not. With the Vietnam Fund I bought in last spring. I had been watching it for a while before I bought and have obviously been watching since I bought too. It has behaved a certain way in that time and then a couple of months ago it started moving higher in a manner that was uncharacteristic of the last year or so. This caught my attention. Finally it went parabolic and having seen this movie over and over my gut said sell half. So far it was a good sale but to be clear I still own shares and so hope it goes higher.

Another example of a sale that was not as good was selling a half position in Stryker (SYK) last summer at what I believe was $42 (it may have been $41 or $43 not sure). The idea behind the sale was to reduce volatility in the portfolio. The fact is it did reduce volatility no question and after hanging around near where I sold it the stock went on a tear; it closed Friday at $62.41.

In a way it was a bad sale, yes, but it achieved the objective. The sale was not a function of my thinking the stock was broken, I did keep half, but the effect I thought the stock would have on the portfolio. I think judgment on this sale could be spun either way.

A third example of a stock sale is from a couple of years ago where I did get the stock wrong and I sold because I did think it was broken; Symantec (SYMC). You know the story; it is compelling but did not work. I bought it almost across the board at what I think was about $30 (I did not look up the number). Shortly thereafter it announced it was merging with Veritas and the stock gapped down to about $24. I gave it a couple of weeks for the dust to settle thinking it might snap back some but it did not. I sold the entire position at either $21 or $22.

This was bad because the loss was about 1/3 but it was good because it went to the mid-teens after I sold. Again it could be spun either way. I did not look up the exact numbers because it is unnecessary, the magnitude was it was.

All three examples involve multiple ingredients. If you invest longer term I think this makes sense but if you trade short term not so much.
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BusinessWeek

Last night as Joellyn watched all of her shows on TLC I caught up on the last couple of issues of BusinessWeek. I was amused to see articles on several topics that have come up as posts here recently.

There was an article on the Currency Harvest ETF (DBV) that I mentioned selling, personally. The trade was more about managing exposure to one outcome as opposed to trying to make a big call. I think that if the yen made a fast move to 108 or 109 that it could disrupt a lot of things and I had too much exposed there.

There were several short pieces about various aspects of retirement planning. One of which was about retirement planners on brokerage firm web sites. I have a different take than most of what I read. Basically whatever you have saved; you can only take 5% out per year. Actually a reader left a comment on this topic ages ago saying it is closer to 4.2% but 5% gives what I believe is a 92% chance for success.

Another point I differ on is the "plan on needing 70% of your pre-retirement income." How much will your expenses decline when you retire? Expecting an instant 30% decline in expenses, which what I think that cliche is saying, doesn't really add up to me. If you do some planning such that your final mortgage payment and final car payments come the month before you retire, it is possible your expenses could drop by 50% or maybe more. If you will still have those expenses where will the decline in expenses come from? Well fewer lunches out, less drycleaning and less commuting cost seem like possibilities but is that 30% of anyone's expenses?

Notice in that last paragraph I said nothing about income (save for quoting a cliche). Some people spend less than their income and some spend more. Relative to your income you either spend to much or you don't. If you do, well something is going to give at some point. So back to "whatever you have you can't spend more than 5%." If that is not enough you will have to do something fix the equation; either keep working or spend less and maybe you have another idea you can share.

Another article in this retirement series was about whether to pay off the mortgage early or not. It is very rare that numbers work out such that paying off the mortgage early makes sense. That being said, we paid off our mortgage a couple of years ago. The emotional benefit, which the article does touch on, is huge. When I am asked about this I tend to say the same thing which is it makes no sense moneywise, it is an emotional decision that needs to be made by the individual.

The last article to mention was one about the Dakar Rally. The Versus Channel (the old OLN) has a show about it tonight. If you have never seen this it is pretty cool and worth the time (I'm TiVoing it because of the Super Bowl).

An acquaintance of mine does this race every year, wild stuff.
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