The Long and Short Of It

Before today's post here is an official transcript of my interview this morning on FBN.

Alexis: So Roger what do you think?

Roger : Um, der, well, gerflack.

Alexis: Back to you in the studio.

Just kidding, it went fine.

WSJ had an article yesterday about long/short mutual funds having a better run lately than during the market beat down from last summer. According to Morningstar there are 162 long/short mutual funds but if you look at the last and take out all the multiple classes of the same fund the number is closer to 53, at least that is what I got when I counted.

The idea of owning absolute return is appealing and probably more so than it was a year ago. It might be so appealing that some folks may want to switch to more of these in their portfolios. This could be a good idea but doing so after a big decline, like we've just had, and before the comeback that will happen at some point is probably a bad idea. There will likely be some big rallies when the new cycle starts, whenever that is.

Speaking of Morningstar they have some new ETF coverage in a blog they are calling Basis Points. So does this mean they are moving the direction of offering useful content? Based on the first real post... no.

They found a filing for some fixed income funds that apparently dive into credit default swaps and maybe some other fixed income derivatives too, not sure about that. After an attempt to explain how the CDS markets work (not critical of that, it is a good summary) and a rehash of the risks mentioned in the prospectus the author concludes "long story long, these funds look like trouble."

Writing a summary that attempts to be a detailed study they need to explore the uses of these funds especially since, IMO, they never met a new concept they liked and don't have much cred in analyzing ETFs. I have not studied the CDS ETFs, I may not be able to even understand them if I did study them but a one sided exploration doesn't really do much. The issuer has something in mind and I am quite certain that like most products there are probably positives and negatives and anyone considering them should be able to rely on getting the pros and cons to make their own decisions.

Read more!

Here Comes The Funny!

I will be on Money For Breakfast on Fox Business Channel tomorrow morning for the whole three hours.

They wanted an Arizona based person on the show and that appears to be me, lol.

Its a nice 4am 6am start time so I am going to bed now.

As I understand it there will be three or four one segments during the show that I would participate in.


Hopefully you will set your TiVo's and check me out.

(slight change in the plan)
Read more!

Fundamental Indexing Dead!

How's that for a sensational headline?

IndexUniverse has an article up that recaps 2007, it notes that fundamental indexing like the RAFI ETF (PRF) and some of the WisdomTree funds lagged the cap weighted funds. This was more of a domestic phenomenon than with foreign.

The article even quotes Bruce Lavine from WisdomTree offering some explanation. The article attributes the following quote to Lavine "There are some unique characteristics about the U.S. market that have just been tough this year. That had to do with getting let down by companies that had solid fundamentals on paper."

The article concludes that it does not really mean much as it is just one year and the author posits that subprime could be to blame.

I don't think the article looks at quite the right thing and I would say there is not enough of a look forward.

Most of what happened with domestic fundamental indexing can be explained with a this-is-how-the-market-works analysis. If you read any of my TSCM articles (here's one from August, 2006) about any of the broad based WisdomTree funds you will probably find a word of caution because they are heavy in financials and with the curve flattening/inverting (depending on when the article was written) the funds could have problems.

That's right, yield curve, it all reverts to the yield curve. Fundamentally weighted funds tilt to value. Value lags growth with a flat or inverted curve because debt offerings (the manner in which more mature value companies access capital) are not as easy to price and value companies can't issue stock as easily as growth companies because it is too dilutive.

Growth also beat value in the late 1990's and the curve was flat on the way to an inversion back then. This is just how capital tends to flow and during periods of steep curves value leads. This is how the market works, or has worked anyway.

Subprime is a little too narrow of an explanation. The inverted curve created a poor environment for financial stocks which hurt the fundamental products, especially where WisdomTree was concerned.

In terms of looking forward, blaming subprime isn't quite right because it will never happen again. Now is the subprime event, there won't be another (here I am not saying how long it will take subprime to work itself out and be over) but there will be future yield curve inversions and when it happens again growth will beat value and fundamentally weighted products will very likely lag cap weighted.

This fact should not make fundamentally weighted any more or less attractive. If value continues to outperform growth as it usually does over long periods of time then it makes sense to think fundamentally weighted funds that are properly constructed should outperform cap weighted indexes, future lags when the curve inverts notwithstanding.
Read more!

Feeling Good Billy Ray?

Over the last couple of weeks I have made several references to feel-good rallies. If this is a bear market there will likely be several feel-good rallies along the way and we could be in the middle, or maybe the start, of a healthy feel-good rally.

Some examples;

On April 14, 2000 the S&P 500 hit 1339 intra-day. A week and a half later on the 25th it closed at 1477. Thats 10.3% in no time, think people were feeling good that day?

The next low was on May 23, 2000 at 1373. Two months later on Jul 19 it closed at 1510, a less dramatic 9.9% over two months.

On April 3, 2001 SPX had a low of 1100. On May 21 it closed at 1312 a 19.2% rally that no doubt felt great.

I'll skip the rally after 9/11 as that was an external event.

July 23, 2002 SPX traded at 797. On August 22 it closed at 962, a 20.7% lift.

Some folks will try to trade these, and be successful, and some should leave them alone. As I still believe this is a bear market I want to be less volatile than the market, this has been my positioning for months. Given the bear market context, I would be thrilled to be up 5% versus a 10% feel good rally and only down 5% versus a 10% drop. This of course would be a smoother ride which, again, late in the cycle is exactly where I want to be.

For some context of where a feel-good rally might go; the 200 DMA is up near 1485 (that would surprise me), there are also several resistance points along the way up to 1485 including 1350 which is about where it closed yesterday.

You should decide for yourself if this is a bear market but if it is, we should expect several rallies as part of the bottoming process, it is very normal.
Read more!

The Need To Explain

Ben Stein in an article in the NY Times yesterday seems to focus on the extent to which "traders" control the market and that the market won't go back up until the "traders" want it to.
I don't really want to dump on Stein nor do I want to debate him on this point but this most recent NYT piece brings up a point make by Nassim Taleb in the Black Swan book about the need to explain things. You should read the book to get his full meaning, I can't possibly do it justice but essentially it would be like saying "stocks were down today because..."

Stein's article tries to make an explanation or give an accounting of the current market. On some level perhaps knowing that Fed action, or bit of unfriendly data or a bad earnings report is to blame for what the market does can make us feel better. But an explanation given, though maybe plausible, may not be correct.

I have actually tried to make a similar point in the past, mostly in the context of discussing fast declines. The reason that most fast declines end is no reason, they just end with no need to explain.

It makes sense that other market action needs no explanation either, or maybe very little explanation. When I first started to express concern about the slope of the yield curve a couple of years ago I made no attempt to try to guess what would happen or when I just cut back on financials.

Stock market cycles end. They tend to give certain signs of ending, even if it is tough to know exactly when it will happen, and the reasons why are less important than the fact that it will end. Couldn't the inverted yield curve only have resulted in lousy earnings for the banks leading one to conclude that the index would not do well without its largest sector? Only expecting and bad fundamental environment was enough to be right. Being underweight financials was likely more important than knowing how much they would go down.

In this context there was no need to see the magnitude of the liquidity crunch/sub prime crisis. The simplicity of heeding a signal like the yield curve is all you need to do to have a chance of going down less.

In finding things to write about I am probably as guilty as anyone of trying to explain things when no explanation is necessary but a lot of the portfolio decisions are made around how the market works based on normal cycles (which have not been repealed) without, I believe, over analysis.
Read more!

Sunday Morning Coffee

I stumbled across this link via Seeking Alpha about David Swensen with a specific spelling out of his allocation for the endowment and also a proposed allocation for retail investors that would presumably allow do-it-yourselfers to get close.

The Yale endowment as follows;

Real Assets 27%
Absolute Return 25%
Private Equity 17%
Foreign Equity 15%
Domestic Equity 12%
Fixed Income 4%

The Retail Mix;

Domestic Equity 30%
Foreign Developed Equity 15%
Emerging Market 5%
Real Estate 20%
Short Term Treasuries 15%
TIPS 15%

Before I go on I can't vouch for the numbers in the article. It looks like the endowment numbers add up to 100 and every other article I can recall about the Yale endowment the allocation adds up to more than 100 (meaning the fund is leveraged) but whatever.

I'm not too focused on the exact numbers so much as the concept as a means to try to learn. All of the categories in the Yale Endowment are accessible in retail products. Real assets obviously can include any or all of the commodity products (all those ETFs and ETN) that exist.

There are plenty of absolute return open end funds some better than others. If you do a search you'll fund articles talking about the various long/short funds that have done poorly during recent market panics but there are some that have done very well and do add value in this context.

Private equity is a little tricky. The ETFs do not cut it. The holdings all blend together in such a way that the correlations of those ETFs is pretty high to the S&P 500, much higher than the components of the funds. There are various pools of capital that are listed on the exchanges that create the effect. Obviously anyone interested in this area needs to decide for themselves whether the space makes sense for them and then whether any of the choices are suitable but the space is accessible with choices.

The other three categories are what we are all used to investing and so there doesn't need to be top much discussion about them.

There could be reasonable debate as to how appropriate this concept is for do-it-yourselfers but then the point is not that anyone should run out and implement this on Monday but its safe to say that Swensen knows more than all of us and he didn't assemble the portfolio to look that way (from whenever those were the numbers) because he thought it was a bad idea.

Maybe this will draw out some discussion from readers about what they think of Swensen's idea.

The picture is from some ruins past the Enchantment Resort in Sedona that I think are about 1000 years old.
Read more!

The Big Picture For The Week of Jan 27, 2008

Um, make that 1330.
Read more!

Reader Comments

I had two questions come in that I thought would be good to answer in a post.

The first came into my Street.com email account. I wrote an article that made a mention of the PowerShares Buy Write ETF (PBP) as being a low vol proxy for large cap US stocks and included this chart to illustrate the point.

The reader said in his email that YTD PBP was down 7.8% while SPY was down 8.75%. I can't vouch for his numbers but we can assume he is correct. Based on those numbers he said it is not clear to him that PBP offers any advantage WRT to the volatility. I'm not sure I would be so quick to dismiss 95 basis points in three weeks but I guess that did not resonate with him.

The above chart covers two years. As you can see, over the two years the lows are not as low and the highs are not as high--less volatile. However you can also see that that for short spells of time, like two-three weeks here and there, it offers no real difference.

During a brief bout of crazy market action, I think this month (the past week in particular) counts as crazy, it is very difficult to draw conclusions about too many things. Over a period of a few months there will be some difference and that difference either matters or it doesn't--that is for the individual to decide.

Another reader seems to disagree with the notion of that panicking out Tuesday at the open. You can click here to read the comment as I might be mis-reading him. He starts out with "i don't think it is necessarily panic or foolishness to severely limit one's exposure to the stock market in a highly uncertain time. "

He also makes a point that I would paraphrase as people should have respect whatever they had to do to get the money in the first place that I agree with completely. He is critical of "this generation" for its willingness to put capital at risk with no guarantee of getting it back--perhaps an homage to the Will Rogers quote about return of versus return on.

Well I think there are a couple of good things to point out. One part of this that I think he is missing is proper asset allocation. No matter your age if you are alive 15 years from now your expenses are going to be 50% higher than they are now.

Unless you have $10 million today and only need to spend $50,000 per year (or similar numbers) you need some growth. Only having cash and bonds won't give you the chance to keep up with inflation. If you are 75 and you make it to 90 but don't plan to make it to 90 you will have a problem.

I am not trying to minimize the the anxiety that stocks create, I know it is real but no matter what anyone's tolerances are our expenses are going to be 50% higher 15 years from now, that is just how the numbers work.

Another important aspect to this issue is how the stock market works. It has an up year almost 3/4 of the time. It averages about 10% per year which includes all of the booms and busts along the way. Anyone investing a lump some into equities on Friday October 16, 1987 has long since forgotten about that or they would look back and chuckle at the timing.

Remember a proper allocation has some portion of stocks, bonds and cash. If someone's target for stocks is 65% and they are close to that when equity calamity hits they should be able to weather it if the plan was constructed properly.

If you put all of your equity allocation into SPY and never make a trade you'll average 10% over reasonable periods of time. Now, to the extent that value can be added with some sort of well planned defensive strategy thought out ahead of time all the better and frankly a lot of ink is spilt (intentional mis-spelling) on this blog on trying to add value/smooth out periods of down a lot.

And with all due respect to the reader, if he is green-lighting selling stock into a sheer panic, that strikes me as the exact opposite of how to navigate markets. V shaped declines and their subsequent snap-backs happen more often than bear markets and it is during the V's where the biggest mistakes get made because they create the most emotion.

The rolling over from October to year end was the time to make changes (I feel my past blogs from that period give me the credibility to say that now). The start of this bear market, assuming that's what it is, was very typical. The current panic that seems to have subsided maybe a little atypical but recognize the beginning of the week for what it was; panic.
Read more!

Won't Get Fooled Again?

The Big Picture | Fed's Folly: Fooled by Flawed Futures?

It seems that the Soc Gen fraud unwind is the cause of the craziness from earlier this week.

I had a similar thought earlier today but Barry beat me to it ("damn your eyes" "too late," anyone know the film?).

How many people panicked out on Tuesday at the open or Wednesday at the open and booked losses or otherwise missed the ride up due to panic or overtrading?

I disclosed fading this on a small scale and while that went well most folks were better off doing nothing. A well devised plan probably would not have included selling into these panics but how many people don't have well devised plans?
Read more!

Market Viewing

That was some wild ride in the market yesterday. The type of crazy up and down we have seen in the market this month has been getting crazier, the VIX closing at 29.02 notwithstanding, which I take as symptomatic of a bear market...along with lots of other things.

I have disclosed some of the luck I have had over the last few months in the portfolio so it is right to disclose that the last couple of days I have lagged noticeably, due mostly (well I think mostly, anyway) to the pasting taken in the foreign markets plus dollar appreciation. Additionally the names I own that are higher beta (which includes a couple of foreign stocks) have also been pasted.

Obviously lagging for two days means nothing but it is a microcosm for longer periods of time. I say this a lot but it bears repeating that a normal money manager, and also individual investor, will have periods where they beat the market and periods where they lag. Lagging now and then, at a minimum, is part of the equation, it goes with the work.

I posted before about mentally preparing for a bear market, well you should mentally prepare to lag the market as well. I don't sweat lagging the market as I know it will happen now and then if not more. From where I sit if I can smooth out the ride when there is turmoil I will be quite pleased.

Hopefully I am conveying a lack of emotion after a couple of relatively poor days the same way I do after a couple of good days.

I took a little more action yesterday during the last hour (you know, the most important hour of the day) yesterday. I went back into the double short ETF with about 40 minutes to go at a price of $65 (I sold at the open on Tuesday at $71.35) and I also sold an industrial stock with a little more beta that quite a few, but not all, clients owned.

I will say I went back in quicker than I expected but I am convinced this is a bear market and I would rather be wrong in the direction of lagging a rally.
Read more!

This Is The Business We Have Chosen

Finding a picture of Hyman Roth with a shirt or not getting shot was tough to do.

Markets occasionally have nasty periods and depending on your mind set or mental preparation can obviously cause anguish.

Personally I view these times with a (perhaps warped) sense of excitement. Regardless of anything, neither capital markets nor capitalism are broken.

If you are older than 15 years old you have clear and vivid memories of past market nastiness. If you are younger than 110 you will very likely go through future market nastiness. This is just how it works.

I have been writing for three and a half years that people should have a get-defensive strategy planned out ahead of time that they stick to when things hit the fan. At this point if someone has done nothing, doing nothing from here is probably not the worst thing possible.

I have no idea where the intermediate or long term bottom will be but I guarantee there will be people that sell into that bottom and that they will miss the ride up whether that starts today or two years from now.

The moderation I suggest (preach about, is that better?) means you don't have to be correct. Someone who is 15-30% in cash right now will capture a lot of the move off the bottom and has a reasonable chance of going down less.
Read more!

75 Beeps

So Bernanke lived up to the nickname with a 75 basis point cut before the open.

There are plenty divergent opinions about every aspect of the cut and how effective, or not, it can be.

My own take is that the Fed is unlikely to be bigger than the market for more than a day or two.

In the last few months Greenspan's image or legacy or whatever you want to call it has taken a beating.

The market's faith in Bernanke erodes visibly by the hour. Credibility seems like it would be an important thing for a central bank and its big cheese and I'm not sure the Fed has enough.

Candidly I am not sure what the consequence really is. Fed or not there will be recessions and bear markets so does this mean it'll be a little worse? Should "a little worse" matter to most people? If the market bottoms out with a 35% drop instead of 30% before going back up will it matter three years from now?

My initial thought is that this would hurt the US dollar more than anything else. A weaker dollar dominoes into other things like higher rates, slower growth and higher inflation. Maybe not much higher rates, much slower growth or much higher inflation but it could be noticeable.

Some folks believe the Fed had to cut rates and some say otherwise. When the economy starts to slow down the Fed cuts rates but the action taken Tuesday seemed more about global equity markets than economic growth rates. I don't know if that is true but that is how it seems which is one of several things that impedes their cred.

Unfortunately their is no resolving anything with this post because there are so many variables with the Fed in terms of the market's perception, some of the clearly reactionary actions they have taken and the massive lack of faith in their ability to get anything right.
Read more!

Action Jackson

At the open today I sold all of the double short ETF I own for clients. Actually I hit the button four minutes in.

For the first hour it looks ok but the thought process is a little different than that. I decided over the weekend (before Asia opened on Sunday night) that I would sell SDS if there was a down open on Tuesday.

When markets go in one direction for so long with such emotion they tend to correct back one way or another.

If the move turns out to be wrong the sale takes me to 20-25% cash for most clients. That sort of cash position riding down more decline gives a good chance for me to continue the streak of going down less but clearly if we plummet from here it would have been better to hold the SDS.

A common thread to action taken at points like this is that there may be discomfort with these moves. That is just how it works.

The reason I did not post this a little earlier is that I obviously cannot front run what I do for clients. The trade is long since executed and if there were any issues with it they should have arisen by now so I am able to disclose.

For long time readers I doubt this trade is a surprise.
Read more!

Which Doc Are You?

So it looks like things are going to kick up a notch at the open. Are you more likely to react like Dr. Zaius or Dr. Smith?

I say this when things are going well and I say it when things are going crappy; have a plan, stick to that plan and do not get emotional. There has been worse market action in your life time.

For some the best plan is no action, to simply ride it out. Maybe that is you , maybe not, but you need to decide for yourself and hopefully you decided ahead of time which if you have been reading this site for any length of time how could you not have at least thought about the subject?

From here things could get better or they could get worse but I know that there will be those who panic who end up making it worse than it actually needs to be.

Plenty of folks on the teevee tell us not worry and not sell but I don't think that is the whole story. Selling something into this is not a sign of panic but selling everything, as one reader commented yesterday is a panicked move.

Lest anyone be confused or be a new reader I am all for defense but starting to take defensive action after a 20% decline is usually not the best time to start.

Hopefully this post conveys the lack of emotion I feel and hopefully you can stay calm throughout.

Now a dog PSA. The puppy we just brought home, Trixie, came down with parvo which is a virus that dogs get from other dogs or from the soil where infected dogs have been. Dogs with parvo throw up, have diarrhea and do not want to eat. This was the second time we have taken a dog to the vet on day two with parvo. Trixie is just fine. Puppies eat like fiends. Get your new puppy to the vet right away if it does not want to eat. Left untreated for even a couple of days parvo is deadly, jumped on right away, I mean right away it does not have to be. We are two for two catching it and treating it.
Read more!

A Night With Nikkei

Much to my wife's delight we will be spending the entire evening with CNBC Asia.

The norm is for me to watch until 6pm (AZ time) and then just check in occasionally.

One little nugget I heard, although not fully captured in the chart (Tuesday's drop is not included) is that the Nikkei 225 is down 30% from July.

Every year we hear from people who say this is the year for Japan and I never understand why.
Read more!

Holiday

I wasn't going to post anything today, it's a holiday, I slept late, we are going hiking but there were at least three markets in Asia with 5 plus percent drops and at least six markets in Europe with four plus percent drops and a couple more that are close.

A reader left two comments overnight saying that SPX futures were well into the 1200's.

At last look I see 1282.

We'll see if it carries over to Tuesday or not.

While this might trigger an emotional response, take the time remember that whatever is happening now or will happen in the next few months has happened before. You may not find it pleasant but there is nothing new.
Read more!

Sunday Morning Coffee

There was what I will call an odd article in the NY Times that was mostly interview with a touch of profile of Tobias Levkovich from Smith Barney.

I have tended to be critical of his thought process and his use of what I'll call the compliance crutch for never naming names--other people in similar positions from other firms are able to give the occasional name.

No doubt I may be overly critical, even biased, as I am very underwhelmed every time he comes on. Maybe I am totally off base but it doesn't strike me that he is right very often. Am I wrong?

To quote him from this NYT article “The hit my portfolio has taken has become a significant loss by anyone’s measure, I feel crummy.”

Despite what anyone may be feeling the S&P 500's drop from the peak does put it in the category of down a lot. At just over 15% I will concede it has gone past down a little but down a lot? No.

So either the chief US Equity Strategist of a major wirehouse firm is badly lagging the market in what I presume is his own portfolio or he is having an emotional response to a 15% decline. What is anyone to make of this? As I said above I just find this odd.

If you read the article you will get an inkling of why I don't think much of his analysis, at least the analysis he talks about publicly. There is a point in the article where he spells out what I would describe as a sort of bottoms up analysis that focuses on earnings declines that he thinks are priced in and a variation of the Fed Model along with a stat about how often the market has been up in the past with similar circumstances.

Of his SPX 1675 target for year end 2008 he says “I’m sticking with it for now because I don’t have an analytical basis for changing that view.” I will say that he could turn out to be right for all I know but what are Smith Barney clients paying for? Any broker there following Levkovich's advice has apparently taken clients on a painful ride as I think he is telling us he did not see the decline coming and has ridden it down with no action.

I am not critical of a client being emotional but I am critical of a anyone who is a professional who gets emotional in this sort of circumstance.

The types of earnings stats he mentions in the article and when he is on TV does not appear to ever be forward looking and further I believe his approach brings up a forest for the trees analogy. He focused on the little picture while the big picture was very obvious.

I believe I have the credibility to say it was obvious as I expressed concern for the financials and the broad market when the yield curve first inverted (here is a link from two years ago that recaps a debate I had on RM Columnist Conversation with another writer where I said inversion mattered and the other writer explained why he felt did not matter). To be fair I was early as far as when I thought it would come home to roost.

Mr. Levkovich's approach does not strike me as being simple, the article actually says "the actual math gets pretty complicated..." To be clear that is a quote from the writer of the article not a direct quote from Levkovich.

It should be obvious than a strategist of any sort at a firm like his is very smart and knows a lot (there is no way I would ever be considered for this type of position, not false modesty I know enough to know this is true) but for whatever reason he looks at the wrong things. Cycles matter, cycles end and they often end with roughly the same set of variables, issues and indicators and I have never heard Levkovich ever pay heed to them.

So my wife has been volunteering fulltime for an animal rescue for about a year now and we've gone this long without bringing a dog home until yesterday, lol. Trixie.
Read more!

The Big Picture For The Week of Jan 20, 2008

My recollection of Norway was incorrect.
Read more!

Flat Panel TVs

If there is any truth to the size of the proposed rebate I think everyone who does not have a flat panel now will go out and get one.

We bought our first flat panel a few months ago from Costco.com. It was manufactured by the Estonian subsidiary of the Sheinhardt Wig Company so it was very cheap.
Read more!

Rough Road

Well that was some puke down yesterday. I have conflicting ideas about exactly where we are and what to expect in the immediate future.

Is there a lot of fear out there? Yesterday the Stallion chided (maybe he was joking, I don't know) Don Schreiber from WBI Investments for not being aggressive enough and for having boring stock picks. He went on to declare that he thinks a recession will be avoided. Is Bob a proxy for sentiment or an outlier?

The S&P 500 is down 10.9% since the close on Dec 26. That is an awfully fast decline. The market action feels more like summer 1998, clearly though there is pretty much nothing fundamental in common with that time.

If similar market action matters then we could see a meaningful feel-good rally coming. This would not change my thoughts about a bear having started.

I'm not planning to play a bounce with clients' money (or mine for that matter) and I might use a big lift to sell another name or add to my double short but I think mentally bracing for anything is very important.

Yesterday's post tried to convey why emotion needs to be off the table. I have been writing about a bear coming for so long now that hopefully even if you took no action you have mentally prepared for it. Thinking about something like this ahead of time and knowing it is normal is a way to lessen the blow even if there was no action taken.

The MarketBeat Blog noted several breaches on the way down that foretell of ominous things coming. On the other hand the crew at Bespoke put together a table of every time the market closed more than three standard deviations below its 50 DMA. Most of the time that this has happened the market has been higher 50 trading days later; 3.12% on average.

Maybe this matters or maybe it doesn't but one thing that I was struck by was that when this happened in 1982 the market rallied 31.84% over the next 50 days. I have talked in the past about rallies coming from nowhere when no one expects.

The people that try to go all cash would likely miss that type of move which is a perfect example of why I don't believe in having huge cash positions. Lagging something like that in the name of caution is not a bad thing but missing it would be.

If you have been reading this blog for the last few months and seen my thinking on all of this unfold you hopefully have gleaned that most of the opinions formed and decisions made were predicated on how things have historically worked. I assumed this time would not be different and I simply hoped to be down less. This seems like an easier path to take.

I looked back and the first reference I made on this blog about getting defensive in light of an inverted curve was October 10, 2004, about two and half weeks after my first post. I made a reference to the 200 DMA before that even. Point being that I spelled out a couple of simple ideas that I felt were important and then stuck to them when they started to matter and as others in the business offered up reasons why they did not matter (here talking more about the yield curve).

I don't think copying me is the right move but keeping it simple and staying disciplined is.
Read more!

Ooof

Does the market feel like Homer looks?

At SPX 1351 we are down 13.6% from the closing high in October.

If a normal bear market bottom is down 25-30% we are about half way there in magnitude but I would be surprised if we are halfway there in terms of time.
Read more!

You Said It Was A Bear Market, I Didn't Say That

If Nathan Thurm was an equity strategist that is probably what he would say.

My prediction for the S&P 500 for year end 2007 was 1350-1375. I was off by a couple of weeks. The importance of this is of course nil. The market could bottom out a few months from now at 1100 or the bottom could have been yesterday, either way Jan 16 will not be meaningful or memorable, its just a date.

I was struck by how many comments there were in response to my crack about not drinking soda. To my perhaps disjointed way of thinking it brings up a point of balance in our lives. It is natural for people to derive stress from their stock investments. One of the themes to my writing is that you should train yourself remove emotion from the equation.

Someone who takes the time to read stock market blogs, like you, is closer to their portfolio than most folks. One hand this could mean you are more in tune with the cyclical nature of the stock market so managing emotions is easier but on the other hand you see the ups and downs of your balance more frequently you might be more prone to emotion.

If you have been reading this site for a while you have hopefully noticed that my mood is not impacted by the stock market. As opposed to what they say on TV a down day in the market is not terrible it just is. I don't sweat bear markets because they are a normal part of the cycle, we know they will come. As an investment manager I don't sweat lagging the market. Part of the job, assuming you aren't the single dumbest participant, is that there will be years where you beat the market and years where you lag. I know there will be years I lag so there is no point in stressing out about it.

If you are having trouble, remember there is more to life than watching your account tick up and down. Hopefully you can train yourself to remove emotion from what you do but if you can't you should either spend less time on your portfolio (and more time exercising, balance right?) or make some strategic changes.

One idea for a low impact portfolio is to put some in the PowerShares BuyWrite ETF (PBP), put some in the Merger Fund (MERFX), buy a foreign dividend ETF, buy an absolute return or managed futures fund and do something with your fixed income along the lines of Nassim Nicolas Taleb's idea of owning a diversified basket of foreign short term debt (no percentages given so we can keep it compliant).

If you need to go that route to keep your sanity or health just know the drawback which is you will lag big bull markets (which are guaranteed to come back at some point) and you will probably need to save more than you are saving now.
Read more!

Currency ETFs Heating Up

Apparently the lava danger on the big island is ramping up (but this is an old photo). Relative to the lava zones this is no where close to our house but this is from Kalapana which is in easy driving distance and where the one picture I posted of the road being lava'd out is from.

Any-who...I got an early call on Tuesday looking to interview me about the new filing from WisdomTree for currency ETFs. Yawhatnow?

WisdomTree has filed for the following;

• Australian Dollar Fund
• Brazilian Real Fund
• British Pound Fund
• Canadian Dollar Fund
• Chinese Yuan Fund
• Euro Fund
• Indian Rupee Fund
• Japanese Yen Fund
• New Zealand Dollar Fund
• South African Rand Fund
• South Korean Won Fund
• Developing Market Fund

That last one will be a basket that will own ten emerging market currencies but as I read it I think the ten could change. In the filing the ten for the Developing Market Fund are Brazil, Chile, China, Czech Republic, Hungary, India, Poland, South Korea, Taiwan and Turkey.

Two big omissions, one more glaring than the other. I am surprised there is no Norwegian krone. Norway is a commodity based, surplus country which would make for good diversification versus the other funds filed. The other one I would have thought would be there is the Singapore dollar. The Sing dollar is viewed by some, like Jim Rogers and as written up in Barron's over the weekend, as being one of the world's soundest currencies.

I have a theory as to why they might be avoiding this which has to do with the Monetary Authority Singapore's (MAS), the central bank, management of the currency. Instead of lowering and raising interest rates, MAS will act in the currency markets in response to changes in the economy. This is different and perhaps is germane to whether or not an ETF is a good idea for their (here I mean WT) business.

While this is very interesting there does need to be a mention of how many funds WisdomTree has had in registration for ages that have not listed. According to page three of the IndexUniverse ETF Watch, WisdomTree has 25 other funds filed. To be fair some other providers have more long standing but unissued filings but I think the odds of all them listing is remote. Of course I hope they do all list.

I believe the utility of more foreign currency access, easily obtained, will become more important for US based investors over the next few years. This is also one of several potential areas that could allow for more sophisticated strategies to evolve or simply be available for retail investors.

Why couldn't someone with a generic target allocation of 70% stocks, 20% fixed income, 10% cash put 30-40% of their cash into several foreign currencies of their choosing?

I don't mean necessarily trading them but maybe blending together one surplus currency, one carry trade destination and maybe an emerging market currency to capture real diversification versus the US dollar.

This sort of approach doesn't require the investor to be that right. During times of crisis you might see surplus currencies do a little better than carry trade/deficit currencies. Owning one of each is diversification. It does not take too much skill to be aware that some commodity based country is at a different point in its economic cycle which is again diversification.

Analyzing currencies is not easy and is probably unfamiliar to a lot of folks but an argument can be made that there are fewer moving parts to currency analysis than single stock analysis.

If these funds come some folks will use them incorrectly and hurt themselves but that should not be your problem--at least hopefully not.
Read more!

SPX Chart

I put up a similar chart to this one twice before in the last couple of months. The other two times I just used the green line. On this one I have drawn in two other trend lines I think I see plus I included the 200 DMA.

First things first the 200 DMA is up near 1490 versus a close yesterday of 1416. I view the 200 DMA as a line of demarcation for healthy demand or unhealthy demand so we are a long way from healthy.

The green line seems like it has been more important since the peak than the 200 DMA. The orange line, which may not be important, seems to isolate smaller congestion points that, if relevant, would imply some resistance up near 1450. And lastly as I read the purple line, if that one matters, I think it says we stopped at resistance at the close yesterday it could serve as support if we close above it which seems unlikely for now thanks to the Citi fallout.

There are many ways to look at the same chart and perhaps it would be better to look at a longer term chart than just one year but I would not be surprised if we went up to some of those higher numbers before doing anything else.

I am still in the bear market camp and I think the chart sends the same message about this as it did when I posted it previously but even if I turn out to be right about a bear market there will be stretches where the market goes up and people start feeling better. This is what it means to rollover slowly as I always say is the manner in which bear markets start.

If I am wrong that a bear market has started, when one really does start it will rollover slowly and have feel good rallies as it does rollover. Trying to trade around this sort of thing (buy the strength and sell the weakness) is likely to go poorly for most folks. I actually sold a discretionary name at the open that most, but not all, clients owned--so it was a case of selling the strength. To be clear though the stock is way off its high like most discretionary stocks.

On a personal note a friend of ours is going through a very rough medical issue and so as he is in our thoughts I will say I hope you exercise a lot, don't smoke and (here's one you don't hear often) don't drink soda. Not that I have researched this but I think the number of people that create long term problems for themselves because of soda consumption will end up being more than with cigarettes as this century moves on--just my own opinion.
Read more!

Analogy

Last week we had a pretty big snow storm (the picture is from a storm from a couple of years ago taken from inside our dog pen with the woodshed on the right). Yesterday we took the dogs on a pretty lengthy hike but there was still a lot of snow on the ground which made hiking much more difficult than normal (kind of like walking on the beach for five miles).

While this makes for a great workout it makes for a poor investment process--the making things more difficult than they need to be which has been a recurring theme here for the last couple of days.

I wrote an article for TSCM four months ago that explored each of the ten S&P 500 sectors and whether to overweight or underweight them in a bear market. In looking at what I said about each of the ten it looks like I went 9 1/2 for 10 for the four month period which is nice but there was practically no analysis in the article. As I try to stress all the time just knowing how the market usually works when it is slowing down and then when it starts back up can make the job much easier and easier is better.

Unfortunately the people that just use broader products like the market cap, style or total market funds have no way to access these rules of thumb. Despite what some MSM sites would have you believe sector funds are not tools of destruction.

A portfolio that is 50% in SPY and 50% in EFA (this is overly simplified of course) would have 22% in financials (SPY is 17% and EFA is 28%, divide each by two and add them together). So putting 22% into a financial sector fund would be the exact same exposure. From there the idea of going 17% financials or 27%, based on the stock market cycle, is also not an insane speculation. A specific overweight or underweight may or may not end up working out of course but a moderate approach to this can be quite prudent.

The person who would weight 40% to a sector that has a 12% weight in the benchmark would no doubt make this type of mistake with proportion with other products. For every approach there is reckless and there is prudent. I am convinced that prudent use of sector weightings can smooth the ride out considerably and the myriad of different sector products even offer that chance for adding more value than just sector alone--assuming picking stocks is not ideal.
Read more!

Sunday Morning Coffee

I had a small awakening of sorts yesterday. I stumbled across a message board on Motley Fool that is devoted to small cap stocks.

A couple posters lamented what sounded like huge declines from the peak (not sure if they meant the peak of their portfolio or the peak of the market). We are talking mid 20's for some of these folks. Yikes.

I have said many times that the combination of new products and time well spent would empower do-it-yourselfers to have a better chance at success.

After reading through this thread I did not draw a favorable conclusion about the knowledge or skill level of the folks posting. The comments were not too specific on whether they all focused on small cap stocks (which was the theme of this particular board), stock picking or whatever.

Small caps, from the top down, is the wrong place to be at the end of the cycle. In the last three months iShares Russell 2000 is down 16%. SPY is down about 10%. The guy who kicked things off on this thread said he is down 26% from his peak (which of course might be different than the market's peak) and says he is currently only 18% invested after his "systematic sales." So down 26% and 72% cash?

Yo, dude, somethings gotta change, like now.

There were also a couple of walking in your footsteps comments too. Cheese O Pete. One thing that I think I glean from these posts is that these people do put in time working at it. I figure anyone who has systems, whatever that means, and takes the time to not only read Motley Fool but also post on a message board is probably putting in a lot of time. Despite my having written for TMF in 2004 I never got the sense that things like risk management or market cycles were a big priority there but things may have changed since then.

So while my empowerment theory may not hold water I still do believe that investing can be as simple or as complex as you want to make it. I am well aware that good bottoms up stock pickers can have success in any environment but in case that is not you and you are not paying some who can do that you might want to try something else.

People seem to like to make investing more complicated than it needs to be. The message board I am referring to and some of the comments left on this site make that apparent. I am not trying to be insulting I am hoping to convey that saving properly is more important than beating the market. Avoiding one or two things (here I mean underweighting) every so often can go a long way to less pain than in the broad market, during the occasional down swings that is. Remember the US stock market has an up year about 3/4 of the time.

I say this a lot but all of the top down stuff I write about regarding sectors, growth versus value, cap size and the like is very elementary and requires no analytical skill whatsoever. Looking for a bunch of small cap stocks to own when history says small cap will lag seems like a colossal up hill struggle and it's even worse for the people trying to just that who don't know when small cap is likely to lag.

Lazy portfolios are right for many people for a reason, they get the job done. Whether they beat the market or not they keep you close which is plenty for, intentional repeat, people who save properly. If you can actively manage your portfolio without blowing up much worse than the market, great, but know whether or not you can and then pick the right strategy for your skill, temperament and time you can spend.

That was a bit of a rant, wasn't it?

The picture is near mile marker 20 0r 21 on Highway 450 on Molokai.
Read more!

The Big Picture For The Week of Jan 13, 2008

No video this week.

This chart is a YTD comparing SPY to the healthcare stocks I own for clients.

The names are irrelevant and I doubt these names are any better, collectively, than any other six healthcare stocks.

This strikes me as more of a confirmation, or if you prefer an uh-oh, of what more and more people are coming around to; that the chance that a bear market has started is much greater than it was a couple of months ago. Obviously I believe a bear has started but that could still turn out to be wrong.

I also looked at a chart comparing SPY to a couple of tobacco stocks and a food stock and SPY lagged them too.

Two weeks of this sort of rotation either matters or it doesn't but if it does it is consistent with the type of rotation that usually happens at a time of fear about the economy.

Conversely four out of five of the industrials I own for most clients are lagging the SPY YTD. Again, nothing out of the ordinary there.

In trying to navigate what might be a bear market it doesn't matter that the industrial stocks I, or more importantly you, have are down what matters is how much industrial exposure you have. This is not a time for an overweight exposure, at least I don't think it is.

The cyclical nature of sectors is a pretty reliable over time. It may not work every time which is why my focus is on overweighting versus underweighting as opposed to zeroing out a sector.

This is not the easiest thing to get a hold of but stocks go down in a bear market. Finding the ones that that will somehow go up is difficult to do. So if you can realize that the stocks you own will go down in a bear market you can then focus on cutting back overall exposure as opposed to finding the equivalent of the tech stock that went up in 2001.

The obvious question that always comes to these types of posts why not get completely out. I think this is a huge bet. A couple of bets actually. One is you are betting that it really is a bear market. Another bet you are making is that you will know when it is over and so will know when to get back in. It is these turning points in the market where crucial mistakes are made. Avoiding extreme bets in either direction takes this type of mistake off the table.

From the always planning ahead file Todd Harrison (with a hat tip to Charles Kirk) is predicting that there will be a one week 10% drop at some point during 2008. That sort of narrow prediction is way outside my wheelhouse but if he is right that would cause a lot a fear, probably set the stage for a very fast and big snap back, even in the context of a bear market, and so I expect I would come out of my double short position if just for a couple of weeks.
Read more!

Friday Thoughts

There is a debate of sorts floating around that started when Morningstar put out an article called The Worst New ETFs of 2007.

There have been follow ups from ETF Trends, IBD and IndexUniverse. That last one includes what could sophisticatedly thought of as a pissing match between the Morningstar author and yours truly that is kind of funny.

The Morningstar foray into ETFs can be summed up with the following.

One of the worst funds for 2007 was the SPDR China (GXC). The article says "These markets (he means China) have been smoking in recent years. Not surprisingly, they look rich to our eyes." Ok well in past dumpings on these guys I have talked about their applying bottom up as belying a thorough lack of understanding of how to study and use ETFs.

So China looks rich? Was it rich when Morningstar gave iShares China (FXI) the thumbs down on January 4, 2005 when they said the "Chinese market is coming off a hot streak and that's often the wrong time to invest in an emerging market." Their next report on FXI was on 11/22/05. Between those two FXI was up 14% versus 6% on SPX. In the 11/22 report they gave it another thumbs down. The title (you can click through to see it) says it all and they suggest buying PowerShares China (PGJ) or Fidelity China (FHKCX) if you have to own China individually which they didn't think was a great idea.

From that report to the next report on 12/28/06 FXI went up more than 80%, PGJ was up 55%, FHKCX was up 30% while SPY was up about 12%. On that 12/28 report the thumb down was that "China aficionados should note that impressive economic growth and clout don't always translate into superior fund performance." The report then cites some three, five and ten year data for Asian funds which strikes me as wildly irrelevant for the China theme. From 12/28 to the next report on March 30, 2007 (which also reads as being very negative) FXI finally lagged the S&P 500 dropping 9% in that three month period but of course FXI was up about 50% in calendar year 2007 even after a brutal ride down from the peak in October.

(Administrative note: the M-star article links don't work you can click here for the FXI archive)

Despite the sheer madness of buying a country fund none of these reports contain, you know, information about the actual country of China. In deciding yeah or nay on a country I think you might want to take a peek at some data on the economy, growth and whatever else you think is relevant to, I don't know, the economic fortunes of China before you focus on the expense ratio or the number holdings of some fund.

Bottom up has never made a lick of sense to me for ETFs. The above example with China was the first one I looked at and I doubt it is the only one where they swung and missed repeatedly. I do not know if Morningstar has a motive for drawing the same conclusion so often on volatile funds or if their understanding is really this bad. One thing is clear that with their resources they should and could dominate ETF coverage and commentary. I don't know if the crew they have needs to be taught how to look at these things, replaced altogether or whether they should stop trying and just buy IndexUniverse.

If you read the links above from the other sites weighing in on the original article you will see that the general opinion of Morningstar is very low. They don't get it. There is no telling them they don't get. Any encounter I have ever had with anyone there (two or three time only) there has been no introspection as to the possibility that they might be missing something. I will repeat, this is a space where they should absolutely be cleaning house but instead they are frittering away the opportunity.

I was saddened to hear of Sir Edmund Hillary's passing. Any mention of Hillary is incomplete without mentioning Tenzing Norgay.
Read more!

Iceland Update

I write all the time about a portfolio being a mix of things working out well and things that are not. The blend of the two gives you your result.

Some things go down because whatever part of the market they are in is going down. Other things go down because of their own problems. Or lastly a combination of the two.

I have disclosed having exposure to Iceland for a couple of years. I have an account at Kaupthing Bank with some kroners and an ETF. I also own a few shares of the Stockholm listing of Kaupthing personally and for a couple of clients--we are talking very small positions.

Based on the last six months or so I may have been better served to sell but I didn't. I view Iceland as a long term idea that is vulnerable to global problems in the financial sector. In the time I have had exposure there has been more than one wild ride. This may seem a little different but I really view this as a multi year commitment, similar to Vietnam, and while taking a trade earlier on, in hindsight, would have been better (and to be clear I have done that once or twice but it has been a long while since doing that) the drop does not phase me even slightly.

I view it as a multi year hold, as I said, but just because I have unyielding faith that does not mean Iceland will work out. I could be wrong and it may not work out. In thinking really long term, which everyone says but I think few people do, some ideas will work out and some will not. Two years is too soon to be right or wrong.

If my conviction in Iceland is wrong and my original 2% position goes to zero over a period of several years that will be too bad but a 2% position from 2006 that ends up going to zero (to be clear this is not my expectation) won't mean too much in 2010 or 2011.

A portfolio that includes three or four concepts like this, each in very moderate proportion, is certainly not right for everyone but is far from reckless.
Read more!

Rough Go

Looks like the market picked the wrong year to stop sniffing glue.

Barry offers some ominous things he was able to dig up. Gulp.

If you do a lot of reading and watching you will likely find plenty of very pessimistic commentary. I would say to no be so caught up in the pessimism that you deviate from whatever strategy you believe in for defensive action--if you even believe in any.

For anyone new this is not a Pollyanna-ish post, I have thought a top was in for the cycle for a little while now, the point is that now just because things are looking a little worse you should not start to panic. You should stick to whatever you hopefully devised when all was well with the market.

Bear market or just a short lived dip this has happened before and will happen again. There is no reason to get emotional about something you know is a normal part of the stock market's cycle.

I put out a quick note to clients the other day noting that the goal of what he have done thus far WRT any defensive action taken or anything we might do in the future, is to be down less not zero, if I am correct that a bear has started. And to be clear this could still just turn out to be a dip that bottomed on Tuesday. I don't think that is the case but I could be wrong. No one wants to be 75% cash when the market has a surprise 20% rally.

To that end I made a small sale on Tuesday for most clients. In the video I disclosed buying Monsanto in October and having been stupid lucky with it. I sold about a quarter of the position, subject to rounding, at about $122.30 in the middle of the day. I think the stock and theme are both great but the stock has been so hot and there have lately been so many people touting it that shaving it down a little just made sense.

The notion of being lucky came up quite constructively in the Dick Davis Dividend book I mentioned in the video from a few weeks ago. It is a concept to never lose site of.
Read more!

And We're Back!

A reader left a question asking what I would be looking for to think a bear market has ended and to become more bullish. He seemed to want to know if the reversing of the things I cite as reasons to get bearish would do the trick.

The short answer is mostly yes.

The slope of the yield curve is an important determinant for the fate of financial stocks. A part of the equation (so not the entire explanation) in the blow up is that a flat curve made normal lending less profitable. This caused banks to be willing to take more risk--I'm sure there is some element of Hy Minsky in their too.

When the yield curve normalizes things should get better for financial stocks and the broader index will have an easier time going up if its largest sector is healthy.

When the market is below its 200 DMA it is signaling a problem with demand for stocks. Perhaps we can figure that problem out or maybe not but still, demand problems is a reason for defensive posturing.

The manner in which the market has danced around its 200 DMA for the last six months or so requires looking a few more pieces of the puzzle which is where things get complicated and so the risk of being wrong is clearly on the front burner which is why I always talk about not making big bets.

One contributing factor to my near term outlook has been the length of the current (or recently ended?) bull market. If I somehow turn out to be right and we have a normal bear I would start to expect a bull market to start in 12-18 months if not sooner. So if the market were dancing around its 200 DMA after 18 months of bear market I'd be inclined to think a bull was starting.

As far as sectors, yes, the sectors I am overweight are generally ones that should do well at the end of a cycle (expect for energy which is obviously doing very well and media which should be doing well but isn't probably because a lot of it is likely to die; BTW I have no exposure to media). By the same token I would expect to be overweight things like discretionary when the bear starts getting long in the tooth.

I have disclosed being underweight volatility for quite a while and I would expect to increase exposure at the start of the next cycle.

Let me reiterate that these changes that I expect to make in the future will not result in huge lopsided bets. Most of the changes can be accomplished with a few tweaks. Shaving off two staples stocks in favor of one or two discretionary names, as an example, would not be a lot of trading. Swapping out a big pharma for a small biotech can make a big difference on the health care exposure of a portfolio.

That reminds me, I would be looking to reduce the average cap size of the overall portfolio when the next cycle starts. It only takes selling a couple of mega caps to make fast progress in this regard.
Read more!

Power Outage

Roger is snowed in without power. Normal blogging will resume when power is restored.

FYI...they still have not found the downed line, so it may be a while yet.

-posted by Roger's faithful co-worker/assistant
Read more!

ETFs and Blogging

A reader left a comment asking if I have a timetable for checking back on on ETFs mentioned in past posts. The implication being that something comes out, I offer up some sort of first impression of the fund that turns out to be right or wrong.

The short answer is no.

The longer answer is that if you have read this blog for a while you have probably noticed that most of the posts are very reactionary. Most of them are either about something I just read, an opinion about current market events, a reader question, a new product or something to do with investment process.

Charles Kirk and Trader Mike (the permalink does not work, scroll down to the post called Balance & Options) each have posts up that offer some introspection about their blogging and how it jibes with their trading. Both guys have fantastic sites and devote far more time to blogging than I do. Most posts take less than half an hour to 45 minutes and even then I have one eye on the teevee and may detour to read something. Answering questions that come in throughout the day take about a minute or two and it all easily fits into what my wife says is a 75 hour week.

So when I mention an ETF I am doing so because I found it somewhere (most likely IndexUniverse or from Tom Lydon) and thought it might be of interest to readers. Ones that are of interest to me for possible use for clients, which is not that many, get added to MyYahoo page and I watch them. For example the three ag/soft commodity ETF/ETNs have all been of interest.

The way it goes I might decide at some point to do something on a widespread basis with, for example, nuclear/uranium (for now just a couple of clients have exposure to this theme). First the top down decision of wanting exposure gets made. From there what is the best way to not only capture the theme but also integrate it into client portfolios. Buying a uranium miner might mean selling something else so there is not too much exposure to materials. Maybe one of the Japanese industrials that are in the Market Vectors Nuclear Fund (NLR), if so, do I want Japan and if I do do I need to sell another industrial? Maybe the fund itself, NLR, is the best way to go. It is heaviest in miners and industrials so buying it might mean making a little room in both sectors.

This is just an example but illustrates why I am not a fan of all-ETF, or all-one-particular-thing portfolios. If you decide you want a specific theme you then also need to decide the best way for you to capture that theme. It makes no sense that the best way to capture every theme is always the same type of product.

Back to the reader's question, if you want my input on an ETF regardless of whether I have mentioned it before feel free to ask. I'm not going to give you a buy, sell or hold on it but I do answer most questions either back in the comments or in a devoted post.

Unfortunate news from the racing world. The 2008 Dakar Rally was canceled because of threats from terrorist organizations.

The Versus Network (it will always be OLN to me) will be showing highlights from the 2007 race for the next couple of weeks. If you have never seen the Dakar it is worth checking out once.

There are three classes; motor cycles, cars and trucks like the ones pictured to the left.
Read more!

Book Review

I was introduced to Richard Ferri, the author of The ETF Book at the World Series of Indexing. Despite his channeling my mother in telling me "you're no one until you've written a book" I think The ETF Book has a lot of utility.

I'm not sure if this is intended this way or not but I think it will be most useful as a reference book. The first couple of hundred pages is a soup to nuts text book of everything you could think of pertaining to ETFs that isn't already stale.

There is also a fair bit devoted to all sorts of strategies using ETFs. The strategy section though did not strike me as anything but text book but the book is comprehensive in this regard. It provides the building blocks to then move on to more advanced concepts.

There is a big section with sample portfolios that although not innovative again provides building blocks.

If anything is missing I would say there is not much in the way of conclusions drawn. There are some conclusions and forward looking thought but not a lot.

One little pet peeve is that there are several references to using currency ETFs to hedge a vacation to Europe. I may be totally wrong on this but hedging a vacation seems like something no one is going to do. I think most people pay for vacation on a credit card or as they go out of their checking account.

Although the tone of the review may seem negative the value as a reference book is very high.
Read more!

Sunday Morning Coffee

A quick peek into how out of touch I am before dissecting the market from the past week.

I got my first iPod this week as a gift along with $15 for the iTunes store. This thing is a little bigger than a quarter and holds about 240 songs. I loaded most of my CDs used most of the gift card and have only filled up 3/4 of the iPod.

Welcome to the 21st century.

So by now you know that the past week was the worst first week of a new year for the stock market in something like 1000 years. In a note I put out for my colleagues to send to clients I noted that other than the calendar there was nothing this week that hasn't happened before.

I have been clear as to what I think is happening. If you have been reading this site for a while I hope you have begun to really grasp the fact that bear markets and the declines that they bring are a very normal part of the stock market cycle and so there is no reason for emotion to ramp up in the face of very normal.

Further anyone reading this site for a while who believes in at least some active management of their portfolio (point conceded that this is not right for everyone) should have some sort action plan for defensive action that they devised long before the market started rolling over.

While it's unlikely that a blog post can really convey how unemotional I get about these things I hope that in writing over and over how normal this is that you will come to believe it and only act rationally in response...if it even is a bear market which of course is may not be.

Part of my thinking as to why this is a bear market is that we are two and a half months from what I think will turn out to be the high, the drop has been gradual and I feel like most of the commentary on TV and in print is denying the severity of the problem although it seems like that is becoming less true.

The picture is from Iceland about an hour outside of Reykjavik.
Read more!

The Big Picture For The Week of Jan 6, 2008

Read more!

Stubborn

I have gone on at length about why I think a bear market has started. At this point there is no convincing me otherwise.

However no matter how strong anyone's conviction is about anything they could be wrong.

Just because there is no argument to convince me a bear has not started doesn't make it so. The market is down a little over the last few months, it could turn up on a sustained rally at any time for no reason at all. The ingredients that so obviously say bear market could just be wrong, again no reason is necessary.

Although there have been no recent comments along these lines, in the past some readers have shared having very large cash positions. Some of those comments were timely and some were not. No matter how sure of an outcome you are making too big a bet, like 100% cash, can have dire consequences. Anyone still scared of equities in 2003 missed a big chunk of this decade's snap back. Most decades (the 1990's as an exception) only have a couple of years of up 20% or more. How many people do you think missed the 31% rally 1975 after stocks cut in half the previous two years?

Making big bets, like 100% cash, is ok for some folks but unnecessary for most. Going down sometimes goes with the territory of participating in the stock market. While I strongly believe in some sort of trigger point for taking defensive action, being able to endure normal declines is part of the bargain. There can be no realistic expectation of topticking a turn in the market cycle but gradual defensive action based on a well reasoned strategy planned out ahead of time gives a good chance of not having to absorb the full brunt of down a lot.

The goal should not be down zero it should be down less, where down a lot is concerned. However, misfiring on a defensive strategy is not the worst thing that can happen. The market has gone down a lot before and come back. Regardless of when the next bear market is it will come back after some period of time--if that period is longer than you'd like that is too bad but they do come back.
Read more!

Barry's Baker's Dozen

Barry has a post up that gives some highlights of his most recent RealMoney article. He provides 13 bullet points for investors and I thought I would add my spin to a couple of them.

First let me say that the utility from this sort of post from someone who clearly knows and understands more than the average guy is very beneficial. Why Billy Mays you ask? No reason at all.

The first one is Simple is Better Than Complex. Trying to keep things simple is one of the major themes for my site and strategy. Simple means different things to different people. For some it might mean three index funds and for some others it might mean 100 stocks.

My starting point is a diversified portfolio with no big bets and no black box concepts that rely on what should work. I tend to agree with whoever said (I think it was Peter Lynch) that you should be able explain the thesis for what you own to a child, or words to that effect. Sounds good to me.

P/E matters less than you think. Amen. This is a point I have been making for a while (here is one post from a year and a half ago). I tend to fall in to the camp that says P/Es help with valuation but are not predictive. Stocks can stay cheap or expensive for years, check out a long term chart of Walmart as an example of this.

Nothing is more costly than chasing yield. Adding yield to a portfolio is not chasing yield. I think of chasing yield, for example, as adding 15-20% into the royalty trusts because of the yield. "If they drop 10 or 15% it'll be ok because of the yield." A year ago they got crushed on news of tax changes. The person who owned one at a moderate weight had a bad day or two, the person with 20% of his portfolio in them may have undone more than a year's worth of gains. Check out PWE and PGH as examples.

Risk management matters. Hello! It might be correct to say I have bludgeoned readers over the head with this point in 2007. Barry's meaning might be a tad more trading oriented than mine but whatever you do in your portfolio you take some sort of risk--that is to say you are vulnerable to certain things. Know what you are exposed to, have something planned out ahead of time to address that risk and then stick to it.

Good stuff Barry, thanks.

Did I hear correctly that service jobs in the ADP report was up 71,000? Anyone know if they breakout seasonal hires at retail stores from that number?

Read more!

Paul Farrell Article

There is a very good Paul Farrell article that you should read dated December 31. It is a combination of his very dour outlook for the next couple of years combined with what he thinks investors should do in the face what he says is the bear/recession of 2008-2010. He thinks it will be as bad as 2000-2002.

He spells out in detail why he thinks all of the excesses of the last few years leave the country in very bad shape with bad things to follow.

The article has a tone, but I may be wrong about this, that seems to devote thought to why we are where he thinks we are. This is of course natural but why may not be the best use of time. Are you going to be able to solve these problems?

I would rather devote time to how to manage around the problem. I think it makes sense to understand the problems, assess what impact they might have, figure out a strategy to navigate through and think about a counter strategy in case your conclusion turns out to be wrong.

There are a lot of very troubling things in front of us right now but that is often the case. And while I believe a bear market has already started I think it will be a normal bear market which is more like 25-30% down as opposed to a repeat of 2000-2002 which was when the S&P 500 cut in half. A market doesn't usually cut in half twice so close together. We'll deal with it if it comes but I do think it is unlikely, if that is what he means.

During the last bear market there other countries that bottomed well before our market (after much smaller drops) and other markets that continued to exist in their own world--both types I have written about many times previously. That will happen again during this bear market (as it will if this is worse than a normal bear). I don't know if it will be the same countries or not but it makes sense, as I have been saying for a long time, to learn about other countries and invest in them. The world will still function even if the US turns into Japan or has some other bad outcome and even there is a global reaction for some period of time.
Read more!

Observations Before Football

You gotta love the blue turf! I think some people call it smurf turf but I am not sure.

I found this article on IndexUniverse noting that growth swamped value in 2007.

You know how I talk about the "textbook" of investing? Growth beating value during a flat or inverted yield curve is in there, probably a chapter 2 type of thing.

This has to do with how value companies access capital (via debt) versus how growth companies access capital (secondaries). The earliest instance I found that I wrote this was two years ago, I know I mentioned it earlier but did not want to spend all day looking for it.

I write about these things a lot because knowing them makes the job easier.

Moving on... there were quite a few markets around the world that did not have a great 2007. Ireland was down 25%. That is a significant haircut and I have to think the vast majority of the selling is done. If you believe that stock markets move ahead of the economy there could be more economic issues in Ireland that surface to be sure but I would be surprised if there is a lot more downside for stocks there. For perspective though I started with a 3% allocation to Ireland that is now smaller--point being I have moderate exposure that did not crucify me.

Sweden is an interesting one. The market there was down about 8% but most of that can be attributed to a 40% (in dollar terms) decline in Ericsson (ERIC). I have one Swedish stock that although way off its high was up about 20% this year (that includes a small tailwind from SEK strength).

The FTSE 100 was up about the same as the S&P 500 in 2007. I disclosed recently cutting back my exposure here as the economy looks like it could be rolling over but stocks have not started to do so.

The New Zealand market was up 20% in 2006 and flat in 2007 but all of the structural problems notwithstanding the kiwi was up 10% against the dollar this year. My hunch is that New Zealand index has a good year but for now I am not considering exposure for clients.

The S&P 500 was up 3.5% in 2007, add in the dividend and we get 5.2% total. I thought we would be down a little this year, between 1350 and 1375. Going below consensus was the right idea but the magnitude was off considerably.

I think this year will be below consensus again and I suspect we will be down for the year as a function of normal market cycles. We have not had a down year or a bear market in a very long time. As noted frequently I do believe a bear market has started, if correct it would be unlikely that it would end and then bounce back all the way by next December 31.

As noted many times the rolling over in the market of the last couple of months is how bear markets start. We are only down a little and I am still very long after making a few defensive tweaks.

I am not sure I am in the big-rally-in-gold camp, for 2008 anyway. Gold is up 30% over the last year and 60% in the last two. Taking a rest for a while seems plausible but I own gold for clients and would welcome another 30% lift this year. If a flat or down year for gold pans out it could make owning soft or agricultural commodities all the more important.

I thought the yield curve would have started to steepen meaningfully in 2007 but that did not happen. I guess I'll stick with that idea for 2008. It seems like the Fed will do some more cutting. Hopefully the middle of the curve and further out will move up in yield. This would make lending money more profitable and so the financials more attractive. Generally speaking it is pretty tough for an index to go somewhere with out its largest sector.

So this post evolved into a 2008 prediction of sorts. A diversified portfolio is a mix of things that are doing what you expect and things that are not. A list of predictions, like last year and the year before, are mix of things that are right and things that are wrong. Of course none of it matters or at least it shouldn't matter. If you are not a big risk taker you might tilt to certain outcomes but not bet the ranch. You know from reading this site I favor moderation at every turn and never losing of sight of the things that could go wrong.
Read more!