The Future Of Fixed Income Investing

You probably heard about the investment fund in Florida that had to suspend withdrawals due to having too much allocated into SIVs. You might have heard about a public fund in Montana going through a similar ordeal. You may not have heard about the Norwegian brokerage that shut down for putting money from four different townships in to similar vehicles.

One by-product from the tech wreck is that some people learned a lesson and now know more about not allocating too much, like 50%, into one sector. Maybe this can be thought of as a back to basics for equities.

The current meltdown of complex fixed income products having to do with mortgages and CDOs levered up and "stress tested" could very likely lead to a simplification of fixed income investing even if just for individuals.

A few months ago I mentioned Nassim Nicholas Taleb's suggestion of putting 90% of a portfolio in t-bills from various countries and then letting it ride with the other 10%.

To take that idea in a different direction there is no simpler strategy in fixed income investing than t-bills. This is also true of foreign t-bills (and notes). Accessing them can be more difficult but the strategy is simple.

The ETF industry is starting to create funds that provide access foreign fixed income products. I believe that that over the next couple of years there will be a lot more funds as investor demand for this segment increases.

I have small positions for some clients in two year (now 18 month) sovereign debt from Norway, the UK or both. Foreign debt, individual issues as opposed to funds, are difficult for individuals to access because orders need to be at least $100,000--so says Schwab.

Where I think this is headed is easier access to sovereign debt from a lot of countries either with funds or brokerage firms making it just as easy to buy foreign bills as it is US bills.

I could see people allocating 5% each to ten different countries and 50% to US debt for example. By sticking with sovereigns investors would avoid having to manage all sorts of different risk issues such as quality and changes in spreads between different qualities and segments.

An obvious concern would be how to analyze and understand countries well enough to feel comfortable buying their debt. Well I believe in learning and then following any country you invest in, developed countries are not a realistic risk to default. Neither are emerging markets--very often.

We all know Russia famously defaulted in 1998, Ecuador seriously threatened to default earlier this year and Venezuela seems to threaten default every couple of weeks (intentional hyperbole). For anyone not liking those odds for emerging debt a blend of individual issues for developed countries and a fund or two for emerging debt seems like it would be a good mix.

By allocating just 5% to a country the risk is mitigated somewhat.

What about currency risk? One thing to remember is that the dollar has been a one way trade against everything of late. That is unlikely to last forever even if the dollar does generally weaken. One way to address currency risk is to take in countries with different economic characteristics. Offset a deficit country with a surplus country or maybe a carry funding country and a carry trade destination or maybe a commodity based country with a service based country and lastly an in-its-own-world country and a very cyclical country.

The bigger macro here is portfolio evolution, a favorite topic of mine. The way I view this, the goal is not to go for the most yield possible; in that case 50% Turkey, 50% Iceland and be done with it. I think some extra yield is available but going with all high yielders would be a lopsided bet.

I actually think managing a bunch of different t-bills is easier than managing a portfolio consisting different types of investment grade corporates, converts, high yield and so on. Anyone investing in individual countries from the top down has already done the legwork. The decision to buy a short term debt instrument is not a reach at all compared to the decision to buy a stock or country fund.
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Roller Coaster

The market is on quite a roller coaster (this picture is funnier than a random roller coaster picture).

Was there despair on Monday? Is there glee now? Is this a bear market or just a dip that should have been bought?

If you have been reading this site for a while you know where I stand.

In assembling a thesis, which I still absolutely believe, it makes sense to think about what will tell you if you turn out to be wrong?

I have a firm opinion that could be wrong. The rally closed Wednesday right at the exponential 200 DMA and a couple of points below the simple 200 DMA (according to BigCharts.com). As RW mentioned in the comments last night a new high made with conviction damages the bear case. Much was made that the lift on Wednesday came from Donald Kohn's comments that seemed to put a rate back in play. So either the rate cut rally is now done (not a good sign) or we get another one if they cut in December (which I would take as a good sign for the market).

One other point I have tried to make a couple of times in the last few days is that this type of rally in a bear (if that is what this is) is far from unusual and actually thus far unremarkable. In 2000 there were several rallies exceeding 10% after the peak in March (sorry Jasper I said one was 20% in the comment but it looks like the biggest rally was more like 15%). From April 2001 to mid May of that year the market rallied from about 1100 to 1350 and from mid September of that year to mid November it rallied from 950 to 1150 as it snapped back from 9/11.

The 62 points from the low close on Monday seems like the kind of move that relieves some people but I don't think it is significant yet. It it turns out to be so, great, but for now I am skeptical.

One last thing is whether you are bearish or bullish making big portfolio changes when the market is this schizophrenic is probably not a great idea.
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Making A List

One term I hate is "making a list." In various interviews the person being interviewed might be asked about making a shopping list of names to buy for when things get cheaper.

While I am being overly critical it seems that many do-it-yourselfers are in to whatever extent they want to be in and so buying some stock when it gets cheaper probably means selling out of something else that might also have gotten cheaper.

"That being said, I do have some thoughts" (that was Austin Powers' line to Stephen Spielberg at the start of the movie Gold Member).

I have been clear that I think the odds now of a bear market are very high, if I am right it would have already started but who knows? If that turns out to be correct that means the bear market will last however long it lasts, I believe 18 months is the norm, and then it will end.

For anyone who is inclined to make any changes ever to their portfolio, the transition from bear to bull would be one of the times to make some changes. I've probably picked out seven names so far to rotate in to the mix which would probably change the overall characteristics of the portfolio by a noticeable amount.

At this part of the cycle reducing volatility (for me that mean more cash, some double short and a larger cap bias) makes sense. Coming out of a bear I would think it makes sense to increase volatility (so I would have less cash, no double short and have a smaller cap bias).

The next question becomes when does it makes sense to make these changes? There are a couple of easy answers but I doubt it will end up being so simple. My hunch about this bear market (assumes for the time being I am correct) is that it will be normal. Normal is 25-30% and we are already down 9-ish%. At down 20% I might make a first, small step to reduce the defense, maybe a little more at down 25% and maybe a touch more at down 30% if we ever got there.

Another simple idea would be to make changes when the market takes back its 200 DMA after a bear market decline. This is a little trickier because I will be wary of any move higher if this does not devolve into a bear so in a way we'll have to see what the market gives. To be clear this is something that, if I am right, would play out over more than a year.

Since there is no way to know what the market will do or when it will do it I think it makes sense to explore and be ready with a couple of different paths you might take, this is if you do any of this.

I mentioned I have about seven stocks picked out for now, the seven may change and I expect there will be more in the next few months. The names don't matter as that is not the focus of this site. I would say is that I am trying to go sector by sector and exploring ways to add beta for whenever the next cycle starts.
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A Good Time For More Cowbell

We are back in the red again for the year. I am not crystal clear on what the tone of sentiment is from various punditry and other sentiment gages so my focus continues to be on what I think the markets are saying.

The most jarring thing, in addition to all the other things I cited last week, from the last day or so has been the plummeting of 10 year treasury yields.

Here and there I see arguments made in favor of this not being the start of a bear market. They could, of course, turn out to be correct but for now my plan is to stick with my defensive leaning in portfolios.

If this is the start of a bear market it does seem to be pretty textbook. There is concern but not panic, I think of the action as being a rolling over and the worst hit area is the one that had the most excess. One strategic item I would say to focus on, if you are one to take any defensive action at all, going down by a smaller amount than the market not your absolute result. Anyone lucky enough to to neutralize a significant amount of a bear market drop will add a lot of basis points to their average annual return over the long term.

That is a difficult concept to grab onto as it is human nature to focus on the here and now but think about it logically for a moment. How important is a 20% decline for money that you need in ten or 20 years especially if at the same time the market drops 25% or 30%? It shouldn't be important.

Before I move on let me be clear about one thing. All the things I write about in this regard are about the attempt to neutralize declines. There can never be any certainty with these strategies.

An interesting comment came in yesterday that I think fits in contextually.

A reader asked about how to boost return up to 12-15% without taking too much risk. I would say that the next time the S&P 500 goes up 25% in a year go 100% utilities--that should get you 12-15% without too much risk.

Apologies for being a smart alec, I couldn't resist. One thing that you can't lose sight of is that in general terms you can only take what the market is giving. This means that in a year that the market is flat you will not be up 15% unless you take a lot of risk or are very lucky. Don't discount being lucky once or twice in your investment lifetime but don't ever plan on it either.

If the assumption is that the market will return 7-10% then I don't know of a way to get 12-15% with low risk.

I've had a couple of posts lately about absolute returns, which in a way is a part of the question. At times it makes sense to go a little heavier with absolute strategies and at other times not. If there was a reliable way to average 12-15% without a lot of risk someone would have figured it out by now.
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Stuff

I read a very thorough article about the water theme and water ETFs on Seeking Alpha over the weekend and I was reminded how bleak the numbers surrounding potable water are and how compelling the theme is. I have owned PHO since its second or third day of trading and while I have thought a better mousetrap will come at some point the actual theme will be a part of the portfolios I manage for a long time to come.

I've made a couple of references to the evolution of of investing/portfolio construction/investment products in the last couple of days. In thinking about the ascendancy of a middle class in many countries where it did not exist and the grimness of the numbers from the above article will make having exposure to stuff or companies that help grow stuff will become increasingly important for investment results.

This includes food, commodities, water, oil, coal, iron ore, manure, timber, cement, grains, soft commodities, agricultural commodities, industrial equipment to plant, grow, harvest and deliver, alternative energy and the list goes on.

In past articles I have noted subscribing to the notion that this will be China's century. Using the same sort of thinking perhaps the last century brought an accelerated evolution in finance, healthcare and technology, perhaps in this century advancements in food and water (for lack of a better term) technology that provide enough of each for more people will be the big thing. This is not to say healthcare and technology will stand still though.

If this theory turns out to come anywhere close to reality it will happen over many years, will be cyclical as it plays out and will be demand driven. I would imagine that in addition to the types of things mentioned above there will be some countries that emerge as proxies for different segments of this idea.

If this resonates with you it's time to start learning. If you have a diversified portfolio that drifts toward narrower products or individual stocks it is possible you already have some exposure to the concept and while I will never think 25% in in such a narrow idea would be the right allocation, having more than 4% probably will make sense.
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Sunday Morning Coffee

Long time reader Leisa left an interesting passage from a white paper of sorts that challenges the assumption that the stock market returns 10% per year over long periods of time.

Asking questions about these sorts of truisms is always worthwhile and something I should do more of on the blog.

Before I get too into this let me say a little something about where I am coming from professionally and personally.

Professionally I am just trying to help people get to where they think they need to be over the time period they need. Because I spend 75 hours a week (my wife's count) on this endeavor I feel like I am doing the best I can to find and understand different asset classes and countries to own. I can guarantee no result but the effort is exhaustive.

I don't care about ever writing a white paper or other research. I deal with people and their money so too much focus on academic issues becomes a distraction from the way I think the job should be done.

I certainly will not have any definitive answers here just how I look at the possibility and as Leisa says, maybe this can spur some good discussion.

Personally we save as much we can, live below our means and I hope to continue my work until the end. If somehow returns from the capital markets are not what my plan calls for I will save more. We have created a lifestyle that will accommodate this should it ever become necessary.

The paper linked to above notes that from 1900 through to 2002 the average return from 16 different countries was 5% before fees and taxes. The excerpt does not disclose the 16 countries but from a kick-the-tires viewpoint I am not sure there is much value in studying all but the two or three biggest markets from the period before World War II. How developed where these markets in the teens and 20's? The notion of evolution and modernization has to matter some doesn't it? For some perspective on this point as recently 1960's the US market closed early on Wednesday's to catch up on paperwork.

Below are the closing levels of the S&P 500 every ten years starting with 1930 according to the Trader's Almanac.

1930 25.92
1940 12.77
1950 20.43
1960 60.39
1970 93.46
1980 140.52
1990 368.95
2000 1527.46

A statistic I recall from my time at Fisher Investments was that stock outperformed bonds over 15 rolling year periods what I believe was 92% of the time.

Above I mentioned evolution. This is a word I have used many times before in writing about investing. Capital markets and investment products evolve. If this is true then it must also be true that portfolio construction must also evolve. I have been writing from the start of this blog that future investing success will have to come from a willingness to own new, to you, investment destinations and new, to you, asset classes.

To the extent the white paper is correct, one focus of this blog has been the exploration of many different investment themes that are somewhat, if not entirely, consistent with the conclusion drawn. To the extent the white paper is wrong challenging generalized assumptions with some real depth should make you more knowledgeable about markets and portfolio construction.

One last point, as you navigate through the markets over time wrap your hands around the possibility that you will need to save more.
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The Big Picture For The Week Of November 25, 2007

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DeCouplification

I am reading more and more commentary that says the decoupling idea, that is that emerging markets would be immune from a recession/bear market in the US, will not pan out and that these countries will go down right along with the US.

I don't think it is so simple as decoupling will work versus decoupling won't work.

The equity market in China is in the middle of a decline of some magnitude. The decline plays no role in the crane count in China. The building and infrastructure modernization will continue if we do in fact have a bear market. I don't know if this continued spending will help stocks or not but the underlying fundamentals could stay very healthy.

As we look at different countries they each have their thing (or things) that make them tick. During a US event some of these places will hold up just fine. The story in Vietnam seems like a candidate for ongoing health, a type of place I have previously described at being in its own world.

During the big bear market at the start of this decade Australia was able to pull away and recover much faster than most other markets. That is the thing to this entire issue. There will be some markets that weather a US downturn better than others. While this is obvious it is also true.

Which countries will be the ones? I mentioned Australia worked on the last go around. Norway not so much last time but if oil stays high (above $80?) it might be a candidate. Norway obviously is a surplus country.

What about another fave of mine, Iceland, which is a deficit country? A reason to think not is the extent to which its banks participate in the global financial scene. Part of the bear case now is not being able to access capital. This threatens Iceland in the short term. A reason to think yes is the move afoot to bring energy intensive manufacturing and data storage to the country to take advantage of the very cheap geothermal energy. Weighing the two I'd say it might not work out for Iceland over the next 18 months. The next 60 months is a different story.

How many countries are you willing to size up and allocate to in order to try to offset a US bear market? Buying EFA wouldn't seem to cut it ( a point I make often).

This is a complex issue. I have exposure to many countries in client accounts, some of them will hold up better and some will not and I may not know ahead of time which will be which. Realizing ahead of time that I will get some wrong is, to me, all the more reason why I believe in using the inverse index funds to try to neutralize a big decline.

Guessing that Ghana will work, Belize won't so I should sell (these are just examples I have no idea how to access either one) seems like a much tougher game to play than just spreading across many countries you believe to be fundamentally sound. I think in that scenario you have a chance of owning a couple of the ones that will decouple.

And there will be some that do decouple even if I don't know which ones they will be.
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Fears Justified

For anyone not comfortable picking stocks this chart of Jarvis traded in the UK makes your case.

According to Yahoo Finance Jarvis is a railway maintenance company, so an infrastructure company of sorts and it is down 70% today on an earning warning.

I'd never heard of the company before its CNBC Europe mention but there you go.
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Turkey Tidbits

A few items on this holiday morning.

Happy Thanksgiving!

I have trouble seeing people driving less in any meaningful way because of higher prices at the pump.

There is supposed to be a point where behavior is altered and for now I think it would be other activities, if any, that are impacted. We'll see.

One reader pointed out that S&P is creating a 130/30 index that will presumably become an investment product at some point.

The index is a little more complicated that you might think. As I read the post it seems that the 500 stocks in SPX is the starting point. Then they will overweight 30 top names (based on S&P's stars system) by 1% and underweight 30 of the weakest names by 1%.

A stock with a 2% weight in SPX, if overweighted would then be 3% or if underweighted it would only have a 1% weight in the index. So where's the short? My understanding is that a stock that has a 0.50% weight in SPX but was an underweight per the model would end up short 0.50%, a swing of 1%. Read the link above if this is confusing and you care.

First things first this really isn't an absolute strategy. It could at times have some of the characteristics but at times it won't. The index, as S&P is constructing it, is obviously vulnerable to periods of time when low quality leads which does happen periodically.

My initial reaction would be to say I would not be a huge fan a product indexed to this index. Thirty overweights and 30 underweights makes for a busy strategy and it seems that the strategy relies on a type of analysis that "should work because..."

I am not a fan of buying a stock solely because its valuation measures are cheap. It relies on what is supposed to happen but the market does the exact opposite of what it is supposed to all the time.

The S&P is in the red for the year, for now. May not stay there, but wow.

From the money never sleeps category; Shanghai was down 4.4% on Thursday.

Now a very bothersome compliance issue. This site is governed by rules involving advertising, testimonials, recommendations or anything that can be perceived as such. The rules were created before the Internet was a household utility and are very much behind the technology but nonetheless.

From this point forward I will need to delete certain types of comments from readers that might fall under any of these categories. A comment from a reader such as "I have 10% in XYZ, 12% in ABC..." can be construed as my making a recommendation (while this is ludicrous to me this is how it is). TomK I need to ask that you no longer post your allocation on the weekends.

My understanding of what is a problem is quite limited so a comment may stay up for a few days until noticed by someone else or may be deleted very quickly if it is one that I can recognize as being either advertising, a testimonial or a recommendation.

As best as I can tell the word "unsolicited" does not exist in any of the paperwork on this matter. There is nothing that you can think of in response to this where I would say anything other than preaching to the choir but this is how it has to be until the rules catch up to the technology.
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Great Quote!

A reader named dWj left the following comment on Felix Salmon's blog.

Gold is for optimists. I'm diversifying into canned goods.

Hat tip to Alphaville.

I would suggest whiskey and shotgun shells for better diversification.
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Just A Taste

When he's not clothing the naked natives of Bantu Besh with the pygmy pullover Jay Peterman might be taking defensive action in his portfolio.

But in case he isn't I am. I increased the double short yesterday with about 83 seconds left in the trading session. The trade added 30% to the existing position.

I am convinced that the market has started to turn down into a bear. One thing is clear the action thus far in the market has been a rolling over. The variable of course is whether this really is the start of a bear or just a run of the mill dip.

I've spelled out my logic before; inverted curves lead to recessions most of the time, the decline in the dollar is a sign of something being wrong, the mortgage/liquidity/credit crunch is a big bad event with serious repercussions, the market being below its 200 DMA is something that I view as a signal that demand for stocks is weak and if this has been a cyclical bull it has been very long by historical standards.

If this thinking turns out to be correct then the decline will take several months and it will make sense to look progressively less like the index.

Over the last few months I have made a few tweaks in this direction, and blogged about them as I went, which have created the desired effect of pulling away from the benchmark.

If this thinking turns out to be wrong and the market rockets higher I would expect to lag but still participate. Given where I am now I don't view this as a real problem. Every time I disclose this sort of action I always say that lagging a huge move up is not a problem but missing one is which is why I move in such small steps.
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Queue The Ominous Music

Back from a 4:55 am wake up call to fight a little fire.

Go figure, a guy dumps a bunch of coals down a steep embankment covered with pine needles and it started a fire. Huh, who'd a thunk?

Now back to our regular programming.

I sure heard a lot of foreboding music on the network yesterday along with graphics such as "Danger for the Dollar."

In the video from November 4 I noted that I felt the chance for something bad coming in the market had increased significantly. While I still feel that way it is too early for that to be right or wrong.

I disclosed slightly reducing emerging market exposure in the face of my increased expectation of a bear market as a means of reducing volatility and to lighten up in a segment that had grown faster than the rest of the portfolio since the summer.

When taking defensive action the focus needs to be the impact on the portfolio. Given that bear markets take several months to roll over and start a focus on this week makes no sense for investors (as opposed to traders) it does not matter.

The thing that should matter is being true to what you are comfortable with. Think ahead of time about defensive action and do not panic. The action last week for me with emerging market seemed fairly simplistic given my opinion. If you think the market is going to down a lot wouldn't it make sense to reduce volatility a little? Do you really need to be that savvy to figure that out? I'd say no. To clarify I sold 1/4 of one position, this was a tweak and not a big bet. A few tweaks can noticeably alter the volatility characteristics of a diversified portfolio.

At this point the market is still up YTD and so if you are reasonably close to the market you are at worst down a little and out-nimbling down a little is a tall order. I've detailed what I have done in past posts in the last few months to reduce exposure.

Anyone interested in reducing exposure into a bear market needs their own time table to do so. My approach will not be 100% correct but the goal is trying to reduce the impact of a big decline.
This is the time where emotions might start to run high. All I can say is that the market is down a little and there is nothing unprecedented about the current market action.
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Maybe This Time

Barron's had an article making a case for owning Japan.

To say Japan has struggled since topping out around 39,000 a couple of decades ago would be an understatement. Throughout this whatever it has been there have been many people that have made the bull case for Japan and this has been wrong for most of the last 15 years.

I should point out that there was a nine month run from summer 2005 to spring 2006 where the Nikkei rallied about 45% which skews the five year comparison versus the S&P 500 in favor of Japan. That nine month rally took the Nikkei to about 17,500. A year and a half later the Nikkei is just above 15,000.

The argument for Japan is always well reasoned and plausible but just never pans out, or perhaps more correctly does not stick.

All those years of zero, or close to it, interest rates and the economy still cannot really get its footing. I don't know the extent to which I could diagnose the problem but there is a problem.

I have never owned Japan nor do I have any plans to own it.

Could now finally be the time to buy in? Of course it could but I don't think so and I know it won't be with my clients money. If Japan really is back do you need to be the first one in?

The simple decision to avoid an area of the market like this can spare some drag and volatility but no Japan requires going a little narrower than what a lot of folks do.

In case you forgot the Maui Invitational basketball tourney starts 90 minutes before the close. I look forward to it every year.
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Sunday Morning Coffee

The tranquility of Hilo Bay and Mauna Kea in the background might lead you to think maybe you should go 100% into absolute strategy funds like the ones that have been mentioned in the comments for the last few days.

By the way the comments about these funds in the last couple of days have been very informative, thank you.

On the surface the idea is very compelling and something I wrote about and explored several times a little over a year ago.

Conceptually the idea of making 6-8% year in and year out regardless of what is going on in the world is appealing. If you are a good saver you can get away with averaging 7% just fine.

There are several caveats, both practical and emotional, that need to be considered. As a matter of philosophy I think too much of anything, no matter how "good" or "low risk," actually becomes a risky proposition.

From a practical standpoint any fund managed to achieve a particular type of result can stumble every now and then. During the summer dip the Schwab Hedged Equity Fund (SWHEX) fell about 13% and there were several others too (feel free to leave any other ticker symbols from this category that puked down in the comments). Whatever went wrong at SWHEX can go wrong elsewhere in the future.

Anyone going heavy on the theme would be wise to spread the exposure out over quite a few different products. Owning one that blows up wouldn't be such a big deal if it was one of many. There is no way 20% of a portfolio should be in one single fund. Its ok to get the desired effect from many different places.

An emotional road block to going heavy in absolute is that the next time the market goes up 30% these funds will get dusted and will not participate that means you won't participate either--if you are very heavy.

If you really only need 7% per year and the fund can deliver that over time (which is not guaranteed) then missing out on a huge up year should not matter but to some people it will. This calls for some introspection or else the chance of chasing heat when it's too late becomes very likely and so the chance for a bad result increases.

Going all absolute is not likely something I would want to do. Like many strategies it has merit and increasing or decreasing exposure at different points in the stock is what makes more sense to me. Not that you should follow what I say but I am talking about a more moderate approach which is how I view all themes, segments and strategies.

I couldn't figure a way to work it in smoothly above but a while back one client gave us a mandate to own SWHEX.
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The Big Picture For The Week Of November 18, 2007

This is a video post. If you are reading through a feed or on a different site you may need to click through if you want to watch the video.
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Nakoma

My article for TSCM about the Nakoma Fund was posted the other day for anyone interested.
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High Yield Bond ETF

Short post this morning.

Either they were keeping it a secret or I just missed it but PowerShares just issued a high yield bond ETF under ticker PHB.

The fund holds fifty bonds with the largest weighted at just 2.36%. While junk bonds sometimes instill fear, only about 1% of junk bonds default. The realistic risk is one of more volatility than you might want in a fixed income product.

The average coupon is 7.95% and the average yield to worst is 8.35%. The fee is 0.50% which might seem high but it is the same as the iShares high yield fund which is ticker HYG.

We have had a lot of fixed income and commodity products come lately which I think is a great development and the trend in this direction will continue.

I am not sure this should be looked at as a way to necessarily get higher returns but I think it is realistic to think that, if used properly, these new tools can help smooth out the ride which is a concept I write about often and is coming to be more and more important--to me anyway.

As these disparate asset classes first become available and then as choice comes to the market in these asset classes it creates the opportunity to capture the real diversification that people like David Swensen are able to achieve.

An obvious (hopefully) caveat is that new products also invite the chance for misuse and/or over use. As is always the case there is no hurry to be the first one in the pool.
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Core and Explore?

An interesting conversation about core and explore developed in the comments of yesterday's post with references to the Pareto Principle. A couple of readers expressed an interest in having the majority of their portfolio in some sort of core allocation that I presume they would want to leave alone and then put a smaller portion (the number 20% was mentioned) into what most would call explore. The idea being that "the 20% of your portfolio which can make 80% of consequences" as one reader put it.

Despite a peculiar comment to the contrary it is very worthwhile to explore portfolio ideas that may not be what you would do but are still valid nonetheless. 80/20 is not what I would do but it is valid.

The 80/20 idea is like every other reasonable idea anyone can come up with; it has strengths and weaknesses. I think the positives were spelled out in the comments. Beating the market over time is difficult, managing a portfolio is taxing (time spent and emotionally) and constructing a portfolio can be difficult too. So in that light a couple (or more) broad-based index funds for the 80% becomes attractive and then the investor would try to add value or extra return or something else with the 20%. It being a smaller portion of the whole pie the consequences for mistakes should be less and since it is less money it should require less time.

The first drawback that comes to mind is the visibility for having to really be right with what you buy with that 20%. What I mean is that if someone has a $600,000 portfolio and they put 20% into some potentially great themes and they are one way or another don't work out you do create a big drag for for the portfolio. Explore-ish themes could easily take a 20% hit if something goes wrong with the story (biotech comes to mind as an example of an idea that could lose more than 20% very quickly).

It makes sense that over any reasonable period of time there would be years where 80/20 would work out great, years where the result is really bad and a lot of years where the result is not much different than anything else.

This is not to say someone should not do this but that every strategy has drawbacks (80/20 has more than the one I touched on here) and before you change course you need to understand the drawbacks in addition to the benefits and weigh all that out for yourself.

An unpleasant administrative note. We are at a point with the hecklers that I get asked about it by co-workers, clients, friends and relatives. Reader responses to the hecklers all try to rationally tell these guys to hit the bricks but the problem is of course that someone who takes the time that these guys do to visit, read and comment so regularly just tell me what an idiot I am or how dishonest I am is never going to do the rational thing. I don't get it, you don't get it, anyone who is rational and respects their own time will not get it.

There are several things I can do. For now I am going to start out immediately deleting the comments from these guys. I mind the store the vast majority of the time so they will usually be deleted very quickly (I get an email when a new comment gets posted and when I look at the blog there is a little trash can icon to quickly delete a comment).

This is a much faster process than moderating all the comments that come in (but it may come to that).

I really could care less what anyone says but it is clearly a distraction for readers which then becomes a time-suck for me. Everyone will understand this except the two or three hecklers who will be confused by this. If moderating comments becomes necessary, well we'll cross that bridge.
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Up To No Good

So I had a unique (I think?) thought about a lazy portfolio of ETFs.

One appeal of a lazy portfolio is that it minimizes the number of decisions that the investor needs to make.

There are those who would say to just buy an S&P 500 index fund and be done with it. Like all strategies this idea has pros and cons.

The S&P 500 is made up of ten big sectors. Forgetting the cost for a moment the S&P 500 could be replicated by buying a proportionally correct amount of each of the ten sectors via sector ETFs.

The unique aspect I am spelling out here requires two decisions. One decision made ten times, so one time for each sector, and then one decision about just one sector.

The idea would be to weight each sector consistent with its weight in the S&P 500, so you are not making any sector bets you would be equalweight to the S&P 500, but for each of the sectors you make a decision about foreign or domestic.

So for example;

Financials 18.59% of the S&P foreign sector ETF
Tech 16.09% domestic
Healthcare 12.14% foreign
Energy 11.76% domestic
Industrials 11.62% foreign
Staples 10.07% domestic
Discretionary 8.93% foreign
Telecom 3.65% domestic
Utilities 3.55% foreign
Materials 3.28% domestic

A couple of notes before I go on. If the percentages don't add to 100 you can take it up with iShares which is where the data comes from. These are not my picks I just alternated between the two to make the idea easier to understand.

So for each sector you would decide foreign or domestic and then decide (ok so maybe there is more than one decision) the best ETF to capture what you think is going on in the sector. I believe that value could be added versus the S&P 500 by getting the foreign or domestic issue correct. This would not require anyone to get the country right, or do stock picking, make sector bets, it would just boil down to foreign or domestic.

Obviously making a decision about foreign or domestic for each sector would require some work but I am not so sure it requires a lot of work relative to lazy portfolios but I won't argue with anyone who says otherwise.

If you are correct about, for example, foreign for a given sector getting the best fund becomes less important than the foreign/domestic issue the majority of the time.

I would think this could be done with other benchmarks too.

The other "decision" which may not even be a decision would involve the financial sector, so we are drifting into a sector bet. When the yield curve inverts reduce the financial sector by some portion of your choosing. Maybe reduce by 25-30%, not a big bet, just recognition that financials struggle when the yield curve is inverted.

One thing to keep in mind is that some theme funds could be proxies for a given sector. For example the SPDR/FTSE Macquarie Global Infrastructure Fund (GII) could easily be a proxy for global utilities--not a pick just an example-- or the new Timber ETF (CUT) could be a proxy for global materials, no doubt there are plenty of others.

Like ALL portfolio ideas this one has plenty of drawbacks. It lacks REITs, commodities, small cap (but that could actually be worked in) and obviously ignores fixed income and there are probably some others that escape me at this early hour.

This post is intended to be academic, hence no ticker symbols which should help me avoid compliance issues. If you play around with the concept and compare returns of foreign and domestic sector ETFs you will see some dispersion in performance and if you look at the components you will see where foreign would be the better choice for some sectors and domestic better for others. Taking it that far would, I believe, allow you to see the extent to which very simple decisions can add value to a portfolio that you might actually implement for yourself.

I think an exercise along these lines would be very constructive for learning more about top down portfolio construction.

Are you watching all of this college basketball that has started? WTF? This is an early start, I think they are scheduling 50 games now. Less than a week until the Maui Classic.
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How Bleak, Really?

A reader left the following comment;

I am down on the year now, F this.\\John

I think F stands for flarg.

At a close of 1439 yesterday, the S&P 500 is up 1.5% YTD. If John is down 0-2% for the year he is pretty close to the market as is someone who is 0-2% ahead of the market.

While I understand if John doesn't want to hear this right now the reality is if you save properly and stay close to the market, either way, over long periods of time you're probably going to have enough money when you need it. There are no guarantees with anything of course so the context is about doing what you can to put the odds in your favor over time.

One thing that I think gets away from people is the extent to which "big" declines are very normal. Hussman said it over the weekend and I have said it very often on this site; 30% declines happen often enough to be considered normal (paraphrase of Hussman).

Despite my having said that and that people know it I don't think they really wrap their arms around it and think about what that will actually be like when it happens again (this not a prediction, I am stating something fairly obvious about normal market behavior).

When the market drops 5% the comments sometimes heat up with worry or nastiness. These are signs of emotion and I repeat, we see this reaction after a 5% drop.

I promise you that there will be "big" drops in the future but you will weather them better if you have some sort of game plan in mind ahead of time.

To that point, yesterday I shaved off a portion of my position in CVRD (RIO) which maybe half of our clients own. I sold most of it very early in the day so I got a lucky price relative to where it closed. The intention with the trade was to remove a little volatility in case emerging and/or materials becomes "the last leg to fall."

To be clear as I know at least one of my hecklers will get this wrong, I sold some only and still own the stock. For everyone else, nothing has changed as far as my belief in the company this is simply a tweak, along with one or two other things I might to that hopefully alters the portfolio's volatility.
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Absolute

A reader asked me to clarify my comments from this last video about possibly allocating more to absolute return if I think a bear market is imminent as opposed to normal benchmarking done by investment managers.

The answer has many facets and this may turn out to be difficult to articulate. The way I view benchmarking, I am trying to add value versus the benchmark we use (the S&P 500 for equities). At times like when the market is going up a lot it makes sense to look a lot like the index and not worry about adding value. This is a point I have made before.

The next time the stock market is up 26%, as it was in 2003, going up by 24% is a great result for helping you reach your financial goals.

The next time the market goes down by 26%, this is a normal bear market drop which is a point I have made many times and I see John Hussman mentioned it in his commentary dated Nov 12, it makes sense to look very little like the market.

The obvious dilemma is knowing when the market will do either of those things. As it is not knowable big bets become very risky. A point I have made before is it does not take much to change the behavior of a portfolio.

My preference would be to sell as little as possible in the face of a bear market, rather I would prefer to simply neutralize as much of the decline as possible. In practice this means selling a little and adding in some more double short which I have been very glad to own these last few months.

Additionally, adding in a couple more absolute return products, or as I have sometimes referred to them in their own world products that might go up 3-5% and pay out 4-6% or otherwise move independently of the stock market could also help offset declines. I have some cash raised to do this.

I have no expectation of being down zero during the next 30% decline regardless of when it comes. Miss a chunk or smooth it some out are a couple of phrases that describe what I would hope to do and the things I have done far have helped thus far.

To reiterate a point from before certain stocks going down a lot in a bear market would not be the concern, especially if they pay good dividends that are safe from being cut. My concern is with the overall mix.

If someone could guarantee you that a portfolio of ten stocks would be up 30% (compared to 20% for the market) but that one of the stocks would drop 80% (and you couldn't know which one), would you care about the one that dropped 80%? If your answer is yes then my ideas are not right for you.

Again the idea is to add value which during a bear market is to protect that bottom number on the position page as much as possible. As I think the odds of a bear have now increased I am more focused on protection and defense as I think about what's next and at some point the focus will shift to looking more like the index and going more on offense.
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Sunday Morning Coffee

Has China already burst?

The Shanghai Composite closed Friday at 5315 down from a high of 6124 which is a 13.2% drop.

Petrochina (PTR) is down 24% from its high.

Sinopec (SNP) is down 23% from its high.

China Mobile (CHL), which I own for one or two clients is down 18% from its high.

CNOOC (CEO) is down 19% from its high.

Sina (SINA) is down 18% from its high.

Baidu (BIDU) is down 20% from its high.

China Life (LFC) is down 21% from its high.

China Digital TV (STV), a recent IPO, is down 40% from its high.

Aluminum Corp of China (ACH), aka Chalco I believe, is down 37% from its high.

iShares FTSE China 25 ETF (FXI) is down 17% from its high.

To repeat from the other day; zoiks. I rounded off the pennies and the highs measured are all intra-day highs. The high for all of these names, including the Shanghai Composite, occurred in the last month. The only other stock I looked at but did not include above was ctrip.com which is not even down 5% but that would make the above less dramatic;-)

I have no idea if some sort of mania has ended, I have no idea if this is just a dip that should be bought but at this point I am not sure it is possible to do any sort of forward looking analysis to even make a decision. The story of China is still in tact but the stocks are like a Girls Gone Wild video.

You all know that many Chinese stocks started going parabolic a while ago, I noted this along with many other people. I disclosed getting out what turned out to be way too early. Despite a tidy gain, I left a lot on the table.

Recently a reader said that my not owning China was lunacy and that I have cost my investors dearly. I'm not sure selling something too early is lunacy and we'll know in a few months, maybe, how costly it was but for folks not interested in making fun of me when I don't top-tick a sale (which I don't do very often) you will own parts of the market that become too hot for your comfort.

This goes with diversification. I still do not think bubble is the right word for China but China was a mania last spring when I sold Sinopec at about $103. At the time $103 was a huge gain and I felt the China theme had already gone parabolic.

I did not feel that a stop order would work and given the $10 price movements a lot of these names are now capable of having on a given day (back then the moves were $3-4 per day) I think that was right. So then it boils down to trying to figure out how to protect a gain. You can only do what you can do.

From here no outcome should be surprising but unless I am missing something the declines thus far don't seem to have gotten much attention--that is people don't seem to be worried. That seems similar to the first 20-30% down in tech stocks. People were not worried at that point either.

If you think you should still own China go for it but I would suggest moderation, which has been the point behind all of these China posts in the last few months.

The church above was built by Father Damien in Molokai.
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The Big Picture For The Week Of November 11, 2007

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Gold Jerry, Gold

This post has nothing to do with Kenny Bania but he's always good for a chuckle.

Just a few random items today. The Claymore timber ETF is supposed to list today. It will own stocks, not lumber traded on a commodity exchange somewhere.

I could not find the index constituency on the ClearIndexes site or on the Claymore site but I think I have seen the list somewhere before, I think it is heavy in Weyerhauser (WY) and Plum Creek Timber (client holding), the Claymore site should be updated after the open. Timber is a low correlation play, if the index is created in such a way that it still has a low correlation it will probably offer some utility but we'll see.

The turnaround yesterday was a good example of how the market can just turn at any time for no reason at all. While I would be shocked if that was the end of it yesterday but maybe it will offer some reprieve for a few days? Or not.

Bernanke's answer about the dollar was god-awful. It almost seemed like he knew his answer was bad as he was saying it but that he had nothing else to say. I don't actually believe this, I'm just saying that is what it seemed like.

While we are at it, someone needs to fill Dennis Neale in on why a weak dollar is bad--low confidence, high inflation, higher interest rates, slower growth. I met Dennis three years ago on my first, of two, appearances on Forbes on Fox. We was very funny and very friendly.

I have written a few times about the volatility in the Chinese stocks and the new tech fab four (the New Originals for Spinal Tap fans). These types of stocks are moving in huge amounts on a daily basis and I think it is similar to the last few months of the tech bubble. Do you remember how much CMGI, Commerce One and Ariba moved on a daily basis?

I have said many times I do not expect the market to get taken down 50% if/when this unwinds but it makes a great case for cutting back any long held overweight exposure. The China theme has been going for a while, the broader emerging theme even longer than that. Zero is not a bet I would make but I wouldn't be heavy either.

The contrast to energy is that it isn't moving 10% a day.

I am due to have the Nakoma interview today three hours into the stock market day. Hopefully I will have something here or at TSCM sometime next week.

Finally, the writers' strike is hitting home. I heard yesterday that the now tired and predictable, but still loved, "24" has been pulled/delayed from its January start.
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Zoiks

Things in the capital markets seem to be a tad askew.

Taken as a microcosm Wednesday's decline seemed to be very text book when looked at sector by sector or theme by theme.

However serious this whole thing will will turn out to be, the financial sector gets a lot of the blame and it got hit much harder than the market.

Staples did better, foreign (as measured by EFA) did better, gold and forex did better, utilities and telecom did a little better (but not that great) and healthcare did better.

Materials did a little better depending on where you look, energy got crushed, emerging lagged noticeably.

That there is a textbook element here could be construed as comforting. I have been writing about certain stances I have taken in client accounts because I expected certain things to happen. All of the strategies I have written about are chapter one things and easily doable by anyone who goes narrower than SPY and EFA or growth/value.

For months we saw a parade of investment managers come on the tee-v favoring financials. All throughout that time I expressed concern about the slope of the yield curve as an obvious signal to lighten up. The arguments favoring financials were all plausible but wrong. Ideas like underweight financials, overweight staples and overweight health have worked. The benefit of less financial exposure is obvious and while health and staples have not really outperformed they have had a smoother ride which is where I want to be late in the cycle.

This post is not a brag about being smart it is a brag about owning the textbook, there is no original thought described here. The concept is more common sense than anything else, common sense can apply to the other sectors too and does not require too much keen insight. I made these types of moves ahead of time (and wrote about it) and will do the same thing as the next cycle ends.

Trust me, on the next yield curve inversion smart people will come on the tee-v favoring financials and will again be wrong.

How much time, effort and potential decline do you spare yourself realizing now is a bad time for such and such a sector? Then you can get to the tougher stuff like country analysis, stock selection and the like.

Maybe a Dilbert cartoon with a work smarter not harder caption would have been a more appropriate image for this post.
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Reader Input Needed

The folks from the Nakoma Absolute Return Fund (NARFX) got back to me and I am interviewing them Friday morning.

Since I first heard about this fund in the comments of this blog it is only logical that I turn to readers for help formulating a list of questions.

I do not know if I will turn this in to TheStreet.com or not, it depends on how the interview goes. If it does go there (as opposed to on the blog) it will be free to access for those who care.

A short while ago TSCM started running all of my content on the free site, I was told they want to give me wider distribution. I hope that is right.
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Heat

So oil is closing in on $100 and maybe it will head higher but, and this is the point, when there is a big move in a thing people tend to project the trend to simply continue indefinitely.

This tends to be a behavioral thing. I have written about this before WRT to oil. About a year and a half ago I noted everyone being on the same side of the trade when oil first got to $75.

Shortly after the post linked to above, I was on a radio show in California and the two money managers/hosts very excitedly were calling for oil to get to $100 quickly-again this was mid 2006. These are smart guys they just hopped on a very popular bandwagon which is easy to do.

Last winter when oil went back down quickly to $50 a lot of folks came out of the woodwork calling for $40. Today people are looking up to $150. The next time it goes down people will call for it to keep going down. This repeats over and over with all sorts things. Gold is another one and the dollar too.

This is not a directional call but I would say to not get too caught up with this sort of chatter.

The path that I think supply and demand is on for oil leads me to believe it is the right place to be. If you agree you probably have oil stock exposure too. Oil at $96 today or $76 next month would not change my long term view.

Gold plays the role of a diversifier for me in an equity-based portfolio. It has had a good run, if you own gold for its diversification properties and it has grown too big for your own liking you should sell some. When someone calls for $600 or $1000 that probably does nothing for the diversification angle. The dollar has some fundamental problems that make the case for it to go lower, clearly it could trade higher at anytime for longer than anyone might think but if you think the fundamentals point lower, well you know what you need to own.

This is not helpful for people who trade because obviously comments from the right people help create volatility that you want to see. The dollar has had such a one way trade for so long it seems clear that it will rally (probably just counter-trend but who knows?) fast and big-ish enough to shake out plenty of dollar bears.

The takeaway would be that there is a lot of heat and heated commentary around all of these things and if you describe yourself as long term you probably should not trade off of heated commentary and just stick to simple a simple exit strategy which hopefully doesn't have you trading too often, again if you are long term.
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Hubris

Sunday night at around 6pm another firefighter and I responded to a call for an unattended fire that someone had going in a barrel. When we arrived, he was in the house and came out a few minutes later. I asked him to put out the fire, he asked me to cite an ordinance requiring him to do so and I said there was no ordinance just that I was asking him to do so. We have had a fire going a few miles away that threatens an evacuation, point being conditions for a fire are much worse than normal for November and this guy did not care.

Ultimately he declined my request on the basis that he knows what he's doing. Actually he does not know what he is doing but there was no convincing him.

There is a parallel here to investing. The fire starter was way too overconfident in his knowledge and ability. Plenty of people are too overconfident in their investment knowledge and ability.

All of the quirky strategy ideas that I employ (and write about) are predicated on my being wrong and that I have more to learn.

To me certain mistakes are forgivable and certain ones are not. The best example here is how much weighting goes to hot parts of the market. China is probably the hottest part of the market. While I don't own China anymore on a widespread basis I would not fault anyone who does, even if it crashed tomorrow. Owning a possibly overheated sector that blows up is forgivable. Allocating 20% to such a segment after a monster run with the expectation that "I'll know when to get out" or "I can handle a dip" drifts into the realm of unforgivable.

Overconfidence leads to all sorts of problems in many aspects of life. I read signs of overconfidence in comments on the blog, commentary from other writers (fair enough for anyone to tell me that I am overconfident) and it is one of those things where there is no telling them, no saving them from themselves.

Investing can be very simple, especially when you manage your own money and there is no one you need to report to at quarter end. Just stay diversified and do not make big bets, that's it. If your idea about how to diversify produces a result below what you expect (some people don't need to keep up with the market, remember) for too long you need to make a change.

How do you diversify? Own all sectors, own other asset classes (not just stocks) and own foreign. You already know this. Have a simple game plan, have discipline to a strategy (I believe every strategy I have ever written about to be very simple) and just as important you need to buy a Trader's Almanac (or equivalent) so you understand how the market works.

I get no compensation, not even a free book lol, for repeatedly mentioning the Trader's Almanac.
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End Of The Road?

News accounts have Petrochina (PTR) now having a $1 trillion market cap. I am not sure if that is accurate given the selloff in the Hong Shares and the ADRs but is it the end of the road?

My immediate reaction to this news, and I have seen the same elsewhere, was to think of Cisco when it was the largest company in the world with a $500 billion cap for about ten minutes in 2000.

I don't know if it is the end of the road or not but it does seem to be similar to the tech story.

Before anyone gets on me saying the fundamentals of China yada yada, the "fundamentals" of tech were just as compelling back then.

The picture actually is the end of the road, Highway 137 on the Big Island, which was overtaken by lava near mile market 22.
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Dust Up

If you haven't heard, the headline in the picture sums it up.

Pakistani President Musharraf has called a state of emergency and has imposed military rule which could delay elections by a year, according to one report I read. At the same time Benazir Bhutto is calling shenanigans (a term I am borrowing from Barry who I believe took it from Stan Marsh on South Park) and vows that her party will act.

It certainly sounds messy, regardless of what the real impact turns out to be. And it might not be so bad given that the KSE 100 only fell 4.5%.

Pakistan gets a lot of attention, including from me, as an investment destination of the future. It is one of these 100 million people-plus countries with great growth numbers and a young population that will ascend to a better standard of living (still may not compare to any developed markets but still).

I pretty much say the same thing about all of these places. I try to learn some of the numbers, a little about what makes the economy tick, a little about the stock market and a couple of companies and then monitor it. All this lays groundwork for the future. I think following a country like this for a few years before an eventual investment will likely mean fewer surprises.

A new frontier index from S&P, that everyone (including me) thinks will become an investible product at some point, allocates 28% to Pakistan mostly in banks. Fast forwarding a little bit to when this is a fund (remember it is not now nor has anyone even filed), I can envision people owning too much of this, then similar news comes along to derail, even if just temporarily, one of these countries. Maybe the next one won't start in Pakistan, maybe it will be a gas issue in the Ukraine, something military/political in the middle middle east (UAE and Jordan combine to make up 36% of the S&P index) or something else somewhere else.

When these markets are hot, doubling in one year is not a tall order. Allocating 1-2% will be sufficient if the time ever comes. Getting a double out of a 2% weight, then add in a couple more percentage points in overall dividend yield means the rest of the portfolio does not have to do much else to keep up with the market in most years.

It should be obvious that frontier and emerging markets can also crater at any given time.
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Sunday Morning Coffee

A reader left a question about how NARFX (the fund I just wrote about) and PVFIX (some fund the reader knows but that I have not studied) manage to achieve their low octane result (assuming the reader has it right about PVFIX).

He wonders if the result comes more from the shorts than the long positions.

Obviously I don't know about these funds but the way I tend to view things I would say the answer is neither the longs nor the shorts; the result comes from how it all blends together.

I have touched on this before and while the idea of the blend achieving a desired result is something I am very comfortable implementing it is difficult to articulate. If you only use broad-based products I don't know how to makes this relevant for you. The concept of precisely managing things like volatility, yield and various market exposures comes from blending narrow products together; things like individual stocks, sector funds and/or sub-sector funds.

As things come and go from your portfolio, regardless of the frequency, you probably have a rough idea the extent that you make a portfolio more or less volatile. If you add 2.5% each to Research in Motion (RIMM) and Intuitive Surgical (ISRG) you probably know you are making your portfolio more volatile even if you cannot quantify it.

Adding stocks like these (to be clear I don't own either one) at that type of weighting is not unreasonable but it does change the make up of the portfolio and so by extension changes the behavior of the portfolio. If a portfolio has half the volatility of the S&P 500 and those two stocks are added it will cause the volatility to go up a lot, I think it would still be less than the market however.

The way I view things I am concerned with the impact on the entire portfolio. No one buys a stock they think will tank but when the market endures a decline (fast or slow) the more names like ISRG and RIMM in a portfolio the tougher time it will have weathering the decline. Whatever the fundamentals behind these two stocks are they did not change in the middle of August yet both stocks dropped twice as much as the market.

If owning the two names I am using as my example (or any other names) is a real big priority but too much portfolio volatility is tough to handle then the two hot potatoes have to be offset one way or another to bring the overall volatility down to a level that is comfortable.

This blending is the whole point. I think software or some sort of website service is needed for anyone looking to quantify. I prefer to quantify this to better understand the impact that any little tweak or big change will have.

Its starting to get cold here. The picture (a kind of where's Waldo) is from a few winters ago after what is for us a big storm.
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The Big Picture For The Week Of November 4, 2007

This is a video post, if you are reading this through another site you may need to click through to watch.
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Kick and Stretch

Is it time to buy financials? That is the question in many an interview on the network (not the one interviewing the personal chef). Bill Miller just chimed in with a maybe.

This is tough but just wait. Is it time? How about now? Just wait.

All along I have been saying the same thing, there will be more news and that it makes sense to wait until the yield curve normalizes.

This is not to say anyone should be zero weight. I am and have been underweight for a couple of years, a touch longer actually. Of the five stocks I own as across the board holdings in the sector, two of them have been pasted, one is down 10%, one is up a little and the fifth one is actually up a lot since June (it is Canadian so the loonie has helped with this one).

That two of them are down a lot is less important than the weighting they have in the portfolio. The decision to underweight, which I have been writing about for ages, is, IMO, where lagging is spared. Further, as the two in particular are down a lot, from this point forward more selling in the sector will have less impact than three months ago as the weighting has now reduced itself.

The future work is getting back in and where to get back in. The when, for me, is clear; when the curve normalizes.

Clearly there are better ways to have navigated this but it could have been worse too.

Yeah, the picture has no relevance but it is funny and I have wanted to use it for a while.
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Looky Here

I write a lot about trying to smooth the ride out in the portfolios I manage. There are several reasons to pursue this. Investing is important, we all have a lot at stake and since money worries get to just about everyone's core, a smoother ride, if achieved, can mean a little less worrying.

Further we are most apt to make an investing mistake when our emotions are elevated. Fewer periods of elevated emotions could mean fewer mistakes.

Additionally from my standpoint I would rather spare a client undo angst if I can.

There have been quite a few comments left on the blog about the Nakoma Absolute Return Fund (NARFX), charted to the left.

It attempts to produce an absolute return regardless of market conditions by going long and short individual stocks.

It has not been around that long (the chart captures when Yahoo says the inception was) but you can see the fund has offered holders a much smoother ride than the S&P 500 during both dips.

There was a comment left criticizing the fund for its weighting in Taser (TASR), which according to Yahoo was 3.32% as of August 31. As another reader noted the fund has owned TASR for a while and it is possible that the stock has grown to the August 31 weight but of course due to way mutual funds report the stock could be long gone too.

I am not sure it is wrong for a low octane fund to own high octane stocks. Really I don't see the problem at all. I think that given the objective and the result it has had in its short life it is safe to say the manager has an inkling.

In general terms the portfolio result should be more important than the result of any individual holding. If it has held TASR all this time, well that looks like some good (or lucky) stock picking. At the same time the fund was (or maybe still is, no way to know) short energy stocks and I found some commentary on their website saying that the energy shorts were a drag on the portfolio.

Most diversified portfolios are a mix of winners and losers (or maybe just laggards). If the stock market was up 20% one year, I was reasonably close either way and a stock or two dropped 30% along the way I wouldn't care in the least (regardless of whether I had sold).

There is no way to look forward and know that NARFX will be able to keep performing as the chart shows but the idea of smoothing out the ride in this manner resonates with what I try to do. To be clear this is not a recommendation.

Amusing anecdote: I called the fund to ask for an interview for either TSCM or the blog. I was told that if they were interested someone would call me back. Maybe I shouldn't hold my breath.
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Mish Mash

This is interesting. It is from the crew at Bespoke.

So I guess China has quite a few more points to add on before imploding and at the rate it is going it should be there next week (humor attempt).

I was in transit when the GDP number printed. When I saw such a big number versus what was expected it seemed that something was not right. Barry called shenanigans on the whole thing, this is a must read. When a number is very far from what's expected something will be strange. Maybe you can't figure out what but others will.

By now you know the Fed cut by 25 beeps, tried to talk tough in the statement and after hiccuping, the market whizzed higher. This is an interesting market these days. There are countless signs of weakness.

The Fed obviously doesn't cut rates because things are ducky.

Crude oil at $95 probably isn't helping too many people (save for the oil companies and the people who own the shares) but even in the oil patch there is strangeness with gasoline not keeping up with crude, this is something you should have read about by now.

The dollar is at some shocking levels against GBP (close to 2.08), AUD (above 0.93), EUR (flirting with 1.45) and the loonie which is below 0.95.

Earnings growth is slowing way down, again not a sign of strength.

Despite these issues plus a few others the market does has not cared about any of them, so far. Maybe that will change in the future or is changing today?

This reiterates that the market can go big in either direction regardless of what the fundies would seem to dictate. I am plenty long (not 100% as I have mentioned many times) and plenty confounded. There are plenty of people out there to make the bull case and I am not sure if they are actually right or right for the wrong reason but for now they appear right. I don't really care, I just need to focus on staying somewhat close, which is what you need to do also. I am not sure how many times I have said this but it is true; there is no harm in lagging a monster rally but missing one is bad news.

I picked up the book Black Swan by Nassim Nicholas Taleb for the plane ride to Arizona. I only made it half way through. It is not an easy read so far. The half I have read seems to be more about base building for what might be coming in the back half. He is incredibly well read and intelligent but based on what I think I know about his beliefs I am not converted yet but it has been very insightful nonetheless.

Last week when social networking site FaceBook was making a lot of news I decided to join to see what it was all about. Well I joined but am not really sure what it is about. Generally I am not too into this sort of thing, email is good and I have no aspirations for being upwardly mobile so it is not crystal clear how I will use it but I know a lot of people do.

The reason for the picture of the few "friends" I have is the bottom row middle guy. He just showed up in there. I find this very amusing. I fuzzed out the other names in case this sort of thing is not ok to do.
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