Mid Morning

I've never understood the concept of window dressing or more correctly how anyone can get away with it, assuming it actually goes on.

A manager this quarter who bottom fished at the wrong time in financials and made a big bet on Ford (F) and GM is going to have horrible numbers for the quarter. When the results are reported to clients and they show a 10% lag (just to make up a number) for the quarter with no financials and no autos I think an investor might be more concerned.

"How did you do so badly with energy and materials?" Is there never that kind of questioning? My hunch is that it would be easier to explain a bad result by explaining what went wrong with the parts of the market that were doing poorly.

Maybe it does go on but perhaps that extent to which it occurs is overstated.
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Going New School?

Over the weekend as I was putting the finishing touches on an article for TSCM I stumbled across a concept that is probably not new, relative to this site, but that I did (by accident?) articulate a little differently.



Over the last eight or nine years one could argue that domestic indexing has not worked. Since the start of 2000 SPY is down about 10%. Since inception (mid 2000) iShares Russell 2000 (IWM) is up a hair under 40% which works out to about 5% annualized.



While very unlikely, what if indexing fails again over the next eight or nine years? Allocating too much to index funds that go nowhere for a decade and half creates a real headwind for reaching financial goals. As I find portfolio construction, and its evolution, to be an interesting topic...



What if indexing doesn't work or more correctly what could you do if you think it might not work? One solution could be some sort of combo of absolute return/low volatility vehicles and potentially more volatile narrow themes. The ratio of absolute to narrow would depend on the investor but the combo chosen would need provide a chance for long term success and allow the investor to sleep. Putting it all into agriculture stocks would create too much volatility and putting it all into a carry trade ETF would not provide enough growth (at least I don't think it would).



Unfortunately this would require a lot more work for folks who are accustomed to indexing but if indexing does not work then indexers need to do something different.



As an example, if a portfolio was constructed to have seven themes weighted at 4% each and then 72% in absolute/low volatility; the selecting of the themes would take a lot of work. It may not take long to come up with seven (or six or eight) ideas but it would take some work to study and make sure they are not too closely related and thus vulnerable to the same thing. For example it is a good bet that Vestas Wind (VWDRY) and Vietnam are not vulnerable to the same things but Potash (POT) and Monsanto (client and personal holding) probably are. To put it in Internet bubble terms having a B2B stock, a data farm stock and a search engine stock does not make for a diversified portfolio.



Examples of themes could be commodities (broad or narrow), emerging markets (broad funds, narrow funds, or individual stocks), certain parts of infrastructure, alternative energy (broad like GEX, narrow like FAN or individual stocks), agriculture, some big SPX sectors (like energy now or other things later), certain developed countries and there are plenty of others.



You could buy the ones you like with the hope of holding them forever but I think there needs to be a willingness to sell or at least reduce exposure when they go up a lot. There must also be a willingness to admit to yourself when you get one wrong and sell that as well.



Some examples of absolute/low volatility might include, long short equities, some of the managed futures funds, carry trade funds, other currency products, Canadian hydro funds, certain parts of infrastructure and maybe farmland stocks.



I actually think the theme portion would be easier to manage. You already know what sorts of things fit there (this comment has nothing to do with anyone's ability to pick which themes to buy). It seems there are fewer categories to choose from and of course when there is a crisis the notion of absolute/low volatility may stop working for a while.



I'm not certain whether hydro funds belong in this conversation or not but during the crisis many of them got hit very hard (debt-intensive businesses) and they also got hit before that in the fall of 2006 when the change in the tax law was announced. The shock is in, the move down made and it is unlikely that they would be prone to yet another shock but if a shock does come I would expect them to go down a lot again.



I think that most of these sorts of things (those that are potentially in the absolute/low volatility category) will go down less than the market during bear cycles and up less than the market during bull cycles but every so often the will deviate from this expected behavior. As with themes it would be very important to spread the risk. Managed futures funds probably have different vulnerabilities than a Canadian income vehicle.



This post was obviously a theoretical exercise. Long time readers will know I work in a couple of these sorts of things into client portfolios because I think they help manage volatility.



Did you watch any of the UEFA Euro Championship yesterday? Wow that was a lot of Scottish broadcasting and only one of them was Scottish.

This will be the last Fenway picture for a while. Obviously this is the Red Sox dugout. Hopefully you have enjoyed them.
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Sunday Morning Coffee

 

Things have obviously been quite stormy in the market of late so what better time for Barron's to interview Peter Schiff. I generally agree with him directionally but do not agree at all in terms of magnitude. The US has quite a few things to overcome, clearly, but I think the consequence of that is simply below average growth. It is too soon to know whether the idea of below normal is right or if Schiff's idea is right. I say too early because decade long round trips to nowhere, which is all we have so far, is not unprecedented.

Does anyone get any benefit from his continual pounding of the same idea? I do not. However on the rare occasion that he actually talks about stock picks, it is always very interesting and useful. The Barron's article was about 90% sparring match which could be summed up with the following;

Barrons: Wouldn't such and such make a difference?

Schiff: No it wouldn't.

Just the last little bit was about stocks and there was no depth to that part of the interview.



Taking a slightly less dramatic approach to this there is precedent for and current evidence of the big boy on the block becoming a little less important a destination and a less rewarding destination. This is something I have been writing about for a while and investing around longer than that. Anyone without decent foreign exposure during this bull market has had a much harder time making this decade work for them.



So we are somewhere in the middle of what I think is a normal bear market--that will either turn out to be right or wrong. While I am not a believer in decoupling in the way most people use the term there are countries that will go down less than the US or turn around sooner than the US and when the bear ends many of those countries will have much larger bull markets than the US has. This is exactly what happened in the last bear/bull cycle that ended last fall. You can check Hussman for the exact figures but the approximate doubling of the S&P 500 in the five years ending October, 2007 is pretty anemic for a bull market.



In that same time however Australia, as measured by iShares Australia (EWA), which I own, was up 250% and Brazil as measured by iShares Brazil (EWZ) was up 1400%. So you need foreign exposure.



Tech had a bubble that it has not recovered from, but it did do better than the S&P 500 in the post bubble bull. If the thing unwound with the banks is a bubble (for now I believe that is the wrong word) then it is possible or even likely that the recovery will deliver subpar returns. If tech and financials do in fact deliver below normal bull market results when the next bull starts then investors will have a problem.



This is where themes or "new" sectors can come into play. I have written about a few of these things like farm land, airports and hydro funds. The thing I always say is that no matter what is going on in the US market our financial plans call for some number and we all have to give ourselves the best shot of getting that number.



The picture is from about 90 minutes before game time at Fenway when a nasty storm blew through. It is taken from the third base line right next to the entrance of the Pavilion restaurant looking through the stairs to the seats. 
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The Big Picture For The Week Of June 29, 2008

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Mid Morning

As you know there have been all sorts assets exhibiting heightened volatility of late. While that has been going on there have been a few things doing close to nothing which in a down 10% in five weeks world is not a bad thing.

I think owning things that don't do much makes sense in the context of a diversified portfolio but it is important to have the correct expectations for this sort of hold.

One example of this might be in the currency ETFs. I have personally owned the British Pound (FXB) for a while. I bought it with a $195 handle and most of the time since I bought it has traded in the $196s or 197s--spending just a little time at $194 and all of a sudden it is at $200 now.

A $5 range for a $195 product over several months is not a big range obviously. A hold like this is a cash proxy and so most of the time the recent action is what should be expected.

Every so often they will have a big move. FXB was at $211 once and I expect it will move $10-$12 again at some point but those are far and few between.

If you hold anything with these characteristics you are probably glad you have it now. However the next time we have a huge bull run you may become impatient which would be a mistake. A diversified portfolio should maintain some exposure to both steady eddies and hot potatoes, the balance probably needs to change over market cycles, but still some exposure to both is what makes the portfolio diversified (among many other characteristics).
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Foul Territory

That was a foul day for the market yesterday with all sorts reasons cited as to why but I don't think I heard the reason that makes the most sense to me which was there was no reason.

Sure the Goldman comments, oil, the dollar, some earnings news and the like were negatives and obviously contributed but I think the story is simpler than that.

I have been saying the same thing for ages; this is a bear market (a normal one in my opinion) and bear markets go down a lot over long-ish periods of time.

Often the fundamental catalysts for bear markets have similarities but the market action is very similar time after time.

So far in this bear there have been a couple of nice feel good rallies which have so far ended up getting unwound. While there has been denial on the part of some market participants about the bear there has also been a real fear of how different this go around is. Both sentiments contribute to my opinion that this will be normal.

One recurring comment I have made for many months is how text book this bear market is turning out to be. While big declines often trigger an emotional response I would think people prone to emotion might find solace in the text book nature of the decline.

For ages I wrote about thinking ahead of time about what a bear market would look like and what it might do to a diversified portfolio. The idea was that by thinking about and realizing that that at some point the market will endure a bear market again and when that happens stocks will go down and doing so at a time when markets are doing well allows for an emotionless plan of what to do or at the very least lessen the emotional response.

I try to do this with clients and I think it has helped. I also wrote about planning an exit strategy ahead of time and then sticking to it when things hit the fan. If you've done this then you have probably avoided some pain and prone to fewer panic sells.

If you did not do any of this on the current go around you will get the chance in the next bear market. The reason why I wrote about this topic some many times over the life of this blog is for periods like right now. Market cycles are inevitable, planning ahead of time for defensive action is easy to do and does not require being right about about too many things.

I said ahead of time that the market warns investors when demand becomes unhealthy. If demand is unhealthy then it makes sense to expect that to be bad for equity prices. This process probably read as being very simplistic when I first wrote about it (here is one link from 2004 on the subject) but you can decide for yourself the effectiveness. I would add that while I do this quite faithfully in my practice I didn't come up with any of it, the point being that anyone can do it.

I guess the take here should be keep it simple, do what you have to to remove emotion (so plan ahead) and be disciplined.
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Mid Morning

While I was away there was a tidal wave of new product launches.

iShares launched a Global Timber ETF under ticker WOOD. I believe that ticker symbol is a bit of a play on words, ahem.

iShares has had a fund trading in London that underlies the same index. You can look at it with symbol WOOD.L on Yahoo. It has tracked closely with, but done a little better than, the Claymore Timber Fund (CUT).

The info sheet on the iShares site for the US version of WOOD had no info but you can get it from S&P here and you will see a lot of overlap. I have not yet dissected it to see what the differences are and then see if I think the differences end up favoring one over the other.

Also out are two more currency ETFs from WisdomTree; the kiwi with ticker BNZ and the South African rand with ticker SZR. The kiwi offers the chance for a long term ascendancy in global relevance but short term (6 months or so) it could be a tough hold. There are also some sophisticated strategies now easily accessed when used in conjunction with one of the Aussie dollar products.

The rand is obviously a great proxy for whatever gold is doing because we all know that a lot of gold comes from South Africa. Not so fast my friend. Despite that being an easy conclusion to draw it has been wrong since at least November. Take a look at a chart that compared GLD, which is a client holding and ZARUSD=X on Yahoo Finance. ZARUSD=X is not the normal way to quote the rand but it makes for an easier chart comparison. The relationship between the two ebbs and flows and lately they seem negatively correlated.

This will change at some point and when it does the rand could be a very high yielding proxy for gold. If that is not you cup of tea I would leave that trade alone and FWIW I am very unlikely to use SZR as a gold proxy for clients.

Next up was a slew of narrow based commodity ETNs from iPath that covers sugar, coffee, cocoa, lead, tin, cotton and a few others. Oh and also global carbon. Go to Mebane for all the tickers. Mebane wonders whether this is the top. Let me tell you why this time is different. Oops.

The way I use commodities (and have written about them) it doesn't matter a whole lot if this is a top. I use commodities with a small portion of the portfolio to create zig versus the equity market zag. The consequence of going berserk with 5% into some sort of Jimmy Rogers commodity combo and getting it very wrong would not be very dire.

A little gold and something related to food is probably good for most folks again in moderation and with the intention of creating the zig zag effect.

There is a restaurant in the centerfield wall at Fenway Park called the Bleacher Bar. We hung out there for a few minutes in the afternoon. I call that picture Boy In Bar, lol.
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Riding The Storm Out

Little bit of a late start on a very gloomy day for the market.

I flipped on CNBC and there is a confluence of news fronts that are all working to hit the market very hard at the start. Not that it matters but but it would not be shocking to see some sort of meaningful bounce back, relative to the open but we'll see.

A reader left a comment asking about something he read suggesting buying Pfizer (PFE) to get what the reader said was a 5.6% yield then selling long dated calls to pay for put purchases so that any downside is protected.

Well I have not liked Pfizer going back before I wrote about the stock for Motley Fool four years ago. I did not expect it to drop by 40% which it has but more like not go up at all.

There is no way I think it makes sense to buy a stock in this context unless you think it can go up and to be clear maybe it will (but it would be without me) but you need to think it is going to go up.

The idea of putting a collar on a stock (that is what this trade is called) is not bad in generic terms for anyone willing to add that layer of complexity (not rocket science but still) into their portfolio but this is not how I play defense. The stocks I own are all good proxies for the respective sectors, countries and whatever else (of course that is just opinion which is either right or wrong) and I don't might if the price drops because I use other tools manage the volatility of the bottom line.

The picture was about an hour or so before the first pitch but the weather blew out and obviously we had a game.
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The video is pretty much useless from a stock market point of view but kind of fun anyway. My brother Larry and I went to Fenway Park to see the Red Sox against the Diamond Backs. We bought SRO tickets on the green monster and also seats up high along third base. I took a ton of pictures that I will post in due time.

A friend was one of the umpires and another friend connected us to one of the players which got us onto the field and into the locker room after the game--no pictures allowed in the locker room though.

Very cool.

Earlier on Tuesday I was interviewed over the phone by Smart Money Magazine about energy ETFs.

I thought it might be useful to relay those comments here.

The context was what, if any, energy ETFs would I use and why.

Well I am not a fan of the volatility that goes with owning USO and the like (USO being one of the products that owns actual oil not some segment of oil related stocks). In general terms the energy sector is an easy place to add foreign exposure and so my preference is the Wisdom Tree Foreign Energy ETF (DKA), some clients own a similar iShares fund that I generally held onto so as not to incur a gains tax for swapping into possibly a very similar fund.

I was asked if I liked any other ETFs to which I replied that for the rest of the sector I use stocks. I mentioned Statoil, also a refiner that I own and a pipeline stock I own for a few folks. The writer shared his opinion that refiners were being squeezed and wondered what my thoughts were there. Well Statoil is 75-80% unhedged so it feels just about every move with oil. If oil goes down a lot then so will Statoil but it makes sense to think that given the current state of affairs a big drop in oil would benefit the refiners and offset some of the drop that would come to Statoil.

The writer also asked why I prefer stocks over ETFs to which I tied in the above about potentially offseting one stock against the other and what are generally better dividends with certain stocks than you can get from ETFs.

For people willing to do a little stock picking within a sector using a sector product for most of the exposure and rounding it out with one or two stocks is probably a good way to go.
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Economist's View: Sovereign Debt Risk

Economist's View: Sovereign Debt Risk

A good read via Mark Thoma about emerging market debt.

Without getting into whether the thesis is correct (because I don't think it matters) it is a great example of why moderation matters.

Emerging market debt is a great asset class, potentially, and there are funds that allow you to access it but just because it is easy to access does not mean you should access a lot of it.

A modest portion of your fixed income allocation? Sure. 40, 50% because you can get a high yield, that scream watchout for the future, or if you read the article it screams watchout for the near term.
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Just Curious

Um, where or when is the bottom for financials.

I guess they dropped on Monday due to the Goldman downgrade? From the top, around $38, XLF is down 43%. While 30% might be normal for the broad market during a bear phase, 43% doesn't seem like a lot for a down on its luck sector.

While not a prediction about financials, we know that tech (well tech as measured by the Nasdaq) dropped about 80% from it's peak.

I had trouble finding an index to be a proxy for energy but when energy went from 30% of the S&P 500 down to mid single digits in the early 1980's Exxon Mobil dropped from about $5.50 down to about $3.00; about 45%.

The thing here is that sector meltdowns, I mean real meltdowns, have come along every so often in the past and this will repeat in the future. The financials are, IMO, the easiest to spot...the curve distorts/inverts and trouble's a comin'. Another reliable tell is how big a sector grows to in the index. Tech was close to 30% at the top, energy too (as mentioned above) but I don't think 30% is necessarily a magic number, only because it doesn't happen very often, but this is worth following.

Five years ago, so before I started writing and long before the inversion, I was a tad underweight financials because of the slightly more than 20% weight for the sector. That, 20%, was just a little more than normal.

Energy has recently increased its weight (iShares has the energy weight for IVV at 15.15% but I thought it was more than that) in the S&P 500 but it is not necessarily problematic. If it gets above 20% I think that would be cause for concern and regardless of the fundamentals I would probably want to underweight. By underweight I mean 17 or 18% versus something like 22% but I would not let the weight grow to 26% in a 30% energy world.
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Foreign Stocks; Deteriorated Environment?

There was an article in the NY Times Sunday titles "For Foreign Stocks, The Sure Bet Is Over." As is often the case the headline writer sensationalized the article a tad but there are some important things to think about if you are one to invest in foreign equities one way or another.

A few years ago there were some especially cheap areas in foreign and emerging and many of those areas are no longer cheap. I saw elsewhere that Petrobras (PBR) used to trade with a mid single digit PE ratio, then a couple of years ago it had close to a US market multiple and now it's higher than the US market. This isn't necessarily a reason to buy or sell the name, if oil does go to $200 in short order, as some think, PBR is likely to go along regardless of the valuation.

PBR is an example for many emerging market stocks that are no where near as cheap as they used to be. This should not be a shock to anyone, in the last five years emerging markets, as measured by iShares Emerging Market (EEM), are up by 250% versus less than 50% for the S&P 500. The risk for emerging markets, obviously, is greater after a 250% run.

Zero exposure creates a very big bet but if you have any exposure now you are taking more risk than five years ago and so should you have more or less exposure than you did five years ago?

Developed Europe appears to be economically vulnerable, very vulnerable, these days. The housing problems in some places might be worse than in the US, the rolling over of some economic data from the continent seems worse than the US, many commentaries paint the UK as being in dire straits making the pound an obvious sell. One commentator very amusingly said if he could figure out how to do it he would sell the pound against the pound.

The Shanghai Composite, as most folks know, is down over 50% in nine months, generally worse than other Asian markets. Is China an outlier, in terms of magnitude, or a leader of sorts and so other big declines will soon follow?

In simple terms there are maybe two big macros out there right now. One is that there is a global slowdown occurring in many places that we can perhaps attribute to excesses galore and escalating inflation. The other macro is the commodity boom and whatever that will ultimately turn out to be. Sorting those out might mean some countries do poorly and some do well or maybe all countries buckle under the weight of inflation in certain prices and asset (house) deflation.

For purposes of this post I am not trying quantify or give an opinion on what these things will mean. These are some of the issues that world markets have to confront. While market always confront risks, foreign has been a one way trade that has offered fantastic outperformance. In that light a set back seems reasonable. That is not a call for US equities to do better than foreign but that save for several in their own world destinations, don't let global equity price declines catch you off guard.

Demand for stocks is unhealthy now and most people understand that. In this environment, while the risks for foreign are greater than the were the more important thing, in my opinion, is one way or another having taken some sort of defensive action in the portfolio be it more cash than normal, inverse ETFs, puts, whatever.

There are times to go along for the ride up (most of the time) and times where defense makes more sense. Defense has been the key for quite a few months now and could be for a while longer.
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Sunday Morning Coffee

Due to a medical call that kept me out until 2:30 and of course the need to tell Joellyn what happened that kept me up until 2:45 there will be no post this morning.

I'll just say that if you do an activity that generally calls for a helmet, wear a helmet (I've mentioned that one before). I'll also add that if you do an activity that generally calls for a helmet and is safer to do during the daylight hours, do it during daylight hours.
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The Big Picture For The Week Of June 22, 2008

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Mid Morning

I have spent several hours this morning doing some charting and its not pretty.
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Financials

It is is possible that "is now the time to buy financials" has been asked on TV everyday (literally) for over a year now and for anyone who views themselves as an investor (as opposed to a trader) the right answer has been no every time.

Throughout all of this I have done very little analysis. I warned about problems long before they manifested themselves in equity prices because of distortions in the yield curve, which did matter, underweighted the sector and have continued to say that not enough time has passed to make any sort of fundamental case for taking on an equalweight position.

This is easily repeated by anyone in the future. "Hey the yield curve is inverted, that's gonna be some kind of problem for financials." That seem complex? Of course not.

With each week (or maybe each day) we get news of another set of writedowns, capital raisings and dividend cuts. This past week the market has begun to pay more attention to the regional banks as measured by the Regional Bank ETF (KRE). KRE held up better in the first few months of the year but has done worse over the last two months and diverged lower again in the last few days.

The shift in focus from the money centers to the regionals (if that statement is even accurate) would seem to represent a domino effect. Are there only two dominoes? It would seem unlikely. It makes sense to think the impact on the regionals (fundamentally) will get worse. There have been smaller banks that have failed as a result of all of this, perhaps those were the more aggressive ones, but the crisis will touch even the conservative small banks in one way or another.

The word delevering has popped lately, "we're going to see the banks delever." Delevering is an unwinding. It has started but it is not complete. I do not know what the full impact of that will be and fortunately I don't need to know. Correctly quantifying what happens next is far less important than what your weighting in financials is. If you agreed that this cycle's yield curve inversion would not be different and you underweighted the sector you already did the work you need to do.

For now the right thing is to wait.

I would not want to be zero weight, that is also a big bet. Just because it has been correct doesn't make it less of a big bet. One thing is right, most of the stock price decline has already happened. The Financial Sector SPDR (XLF) is down about 42% from the all time high. The full decline from the top will not exceed 84%. I doubt it will exceed 60% for XLF but obviously certain individual stocks are and will be a different story.

Not sure if I am the only one watching the College Baseball World Series or not but is there anyone who likes that Hootie and the Blowfish sounding OAR group that ESPN is bludgeoning us over the head with? Sweet mercy.
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They Blew It All To Hell

Over the last couple of years I have had a knack for finding exciting markets that have been up a lot, go up a bit further and then implode.

Iceland and Vietnam as the poster children for this.

Today ISK is at 81.41 which is lower than I have ever seen. Vietnam's stock market has cratered and inflation is around 25%.

That these markets have blown up is not the thing because that has happened before, is obviously happening now and more importantly will happen again.

If you invest in narrow themes this sort of thing will happen, I said as much in any of the posts on these places over the years.

What is important is the realization going in what the potential in either direct is. Both exposures were always small (and only for a few clients with high tolerances for volatility) which is a way to manage risk and action, although different with each one, was taken.

I'm not sure whether either one is accurately called a mistake or a bad trade as each one has positive and negative attributes but to be clear each market has blown up.

There has never been any shaking my long term conviction in both destinations but the key take away is that no matter how enamored you are with some narrow theme do not go too heavy. Depending on the overall market environment an implosion in a 2% position may not even be detectable to your bottom line.
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New Term?

I stumbled across a story on MarketWatch about "encore" careers which, as the name implies, are post career careers. Apparently there are between 6 million and 9.5 million American between the ages of 44 and 70 currently working in encore careers (as young as 44? really?).

There are obviously two primary benefits; making money and having purpose--the implication being that having purpose would make for healthier aging.

I think this sort of thing is vitally important. From a financial aspect anything that you can do that relieves some of the burden off the portfolio is a huge plus. It allows for a bigger margin for error, better weathering of the next decade-long round trip to nowhere, allows for more choice with how much risk the portfolio takes and when that risk is taken and having more money left in case life gets more expensive later on due to health reasons.

Is it crazy to think that using 2008 dollars a couple could fund a modest lifestyle on $4000-$5000 per month and one way or another generate $1500 from a part time yet purposeful encore career(s)?

From a healthy aging I have several role models including my father and several people here in Walker and can attest, anecdotally, that having something that gives you purpose (and if it pays, all the better) does make for healthier aging.

I think finding something that is both purposeful and paying would probably take years but that needn't be a hardship as the things that would give you a sense of purpose have probably been important to you for a while and figuring out how realistically it could be monetized would not be that difficult.

As a matter of philosophy I would encourage anyone who feels no sense of purpose in their work to figure a way to change their circumstance. It may take several years to bring about, which in itself creates purpose, but life is too short to wish away every week hoping to get to Friday night. This may mean less income which allows me to tie in living below your means which hopefully everyone does but of course we know that is not the case.
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Mid Morning

The Celtics won the NBA Championship last night in what seems like one of the weirder NBA finals I can remember.

From Doc Rivers' point of view the most important aspect was defense. The Celts d'd up the Lakers and just took away what the Lakers wanted to do.

By playing menacing defense they mitigated any potential periods of poor shooting.

This works in portfolio management too. By now you know about this RBS call by Bob Janjuah in the Telegraph calling for SPX 1050 by September.

There was a reader email waiting for me when I woke up asking whether the Janjuah call was cause for concern. For me it is not the least bit concerning or worrying.

Certain things are in our control and certain things are not. As a matter of life (as opposed to just market) philosophy it does not make sense to worry about things beyond our control.

Clearly whatever the stock market does this summer is beyond our control. What is within our control is the recognition that demand for equities has been unhealthy by several measures for many months now. Demand became unhealthy in late 2007 in the neighborhood of SPX 1500.

If demand is unhealthy for equities how aggressive should you be with equities? Heeding the warning that demand is unhealthy provides the opportunity to be spared the full brunt of down a lot which if done successfully can be more important than other parts of the stock market cycle that call for more offense.

Again, recognition that demand is unhealthy is within your control.

Alphaville has some more coverage of the RBS call.

A couple of comments came in about the Celtics, including a link to the Globe's front page, so thank you to those folks. Irregardless, ahem, this has been a helluva decade for Boston sports fans.
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Big Slow Changes

That is a panamax vessel headed on out to deliver stuff to some place that needs it.

If you have ever entertained owning one of the shipping stocks, well that's what it looks like.

It is not so easy to turn one of those around which is analogy for the US economy made by Abby Joseph Cohen a few years back (if I'm wrong in attributing it to AJC please let me know).

The slow turning tanker description can also apply to other things as well in the context of certain themes taking a very long time to play out.

Two points, then, that might tie in to the same theme that have been unfolding for a while.

Stephen Roach said that no country has ever devalued it's way to prosperity. The dollar has dropped a ton over the last few years. At the moment the dollar is either on the mend or this is just a counter trend move that will peter out and the dollar will head back down (I think the latter but that any future moves down would be slower than they have been).

While the dollar has been devaluing something else has happened, a lot of emerging markets have gone from being debtor nations to being creditor nations as the US has gone further in debt, a point made recently by Mohamed El-Erian and recapped here.

Both of these have been playing out for several years, could continue to play out for several more (that is the dollar continues to weaken and certain emerging markets get stronger) and all the while US equities, as measured by the S&P 500, are about 10% below where they were about eight years ago.

The stock market performance has been pitiful yet we have endured.

People get very worried about all of the negatives out there (and don't get me wrong they are out there and they are bad) for fear that we will have some sort of repeat of the 1970's. Based on stock market returns, it sort of is the 1970s, isn't it? If it is the 1970's all over again ok, on January 1, 1980 the S&P 500 stood at 107.94. On January 1 1990 it was at 353.40.

If the market ends up being a three and half bagger plus dividends in the ten years following whatever this is now we would all be thrilled. Actually I suspect that most folks would be thrilled with a 150% gain in ten years.

Obviously there is no way to know what will happen between 2010 and 2020 and so it makes sense to follow the money thematically. Forgetting about bad six month or twelve month periods that will come along and instead thinking big picture, where is the money going? What countries will prosper? What countries will ascend? What countries become more globally relevant?

If you are close enough to investing to read a stock market blog you already have opinions about which countries fit in to the above paragraph. Hopefully you are accessing these countries one way or another, that way you don't have to rely on a 250% rally in the next decade.
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Mid Morning-Special ETFs halted edition!

A reader commented that iShares Brazil (EWZ) was halted, I called iShares and was told iShares Taiwan and (EWT) and iShares Mexico (EWW) are also halted and iShares does not know why.

News pending is the normal reason to halt a stock but I've never heard of this for an ETF.

That three of them (will there be more?) are halted implies a computer glitch somewhere but if iShares doesn't know why then who else would?

Maybe it is the smoke monster from Lost causing problems?

UPDATE UPDATE UPDATE

It was not iShares Mexico that is halted but iShares Malaysia which has ticker EWM so I think the rep I spoke to just mixed up the symbols.

Malaysia makes a lot more sense because it is closer to the island.
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More BuyWrite

PowerShares launched the NASDAQ 100 Buy Write ETF (PQBW).

The top chart is from the PowerShares site and shows how the index has fared versus the NASDAQ 100 since 1999. The second chart is shorter and covers as far back as big charts can go for the BXN index that underlies PQBW.

I have never traded QQQQ personally or for clients. I think of the NASDAQ 100 as being a proxy for tech, it is about 65% tech, and in that light I don't think it is the best proxy for tech.

Typically tech is a place where people seek to add outsized returns to their portfolio as opposed to something like utilities (utilities get their occasional day in the sun but but there are more "sexy" stories in tech than utilities).

Buywrite exposure is usually thought of for reducing portfolio volatility and maybe adding some yield.

The (hopefully) outsized returns combined with (hopefully) lower volatility would seem to be at cross purposes-- at least that how it seems to me.

In sorting through products that come, to the extent you even do that, it makes sense to think about where volatility should be allocated to and where it should not. No one buys Brazil or Taiwan for low octane just as no one buys a preferred stock for the juice.

That is not to say that within a sector like tech you wouldn't want to have a little less volatility at times or a little more. The way to have less might be with a non-specialized ETF and the way to have more might be to build out that part of the portfolio with smaller nichier stocks.

The obvious question would be why not use PQBW when you really want to reduce tech sector volatility? Well you could but I don't think that is too appealing. You would think that the reason to underweight volatility in a sector would be because you think it won't do well but also embedded in that underweight needs to be the understanding that you would likely mis-time a big turn up, I would miss it too.

By owning something that by design can't keep up with up a lot you compound being underweight/missing the big turn when it comes. But you may view PQBW differently.
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May Face A Crisis?

I found this article in the Telegraph warning of a possible meltdown in emerging markets caused by what looks like looming inflation problems.

The accompanying chart captures the Sensex in India and the Shanghai Composite for the last six months.

Looks to me like the crisis might already be here. There is no way to know at this point how big of an impact the points cited in the Telegraph article will have from here forward. Clearly declines like what you see on the chart are the attempt to price in something. A few months ago when the threat of inflation got less attention than it is getting now it seemed like there was not much concern about what was at the time a small dip.

Now that the dips have become more like meltdowns there is much more attention focused on the inflation issue. In this light it becomes reasonable to believe that the markets began to price in inflation problems last fall; may not be right but it is reasonable.

When things can't get any better, that means they cannot get better. We have been there a few times with emerging markets and also various segments of the materials and energy sectors and when things are going so well for something it might make sense to shave it down some.

This was the case with Statoil when I peeled off a little bit back in May. Not every sale can occur under this circumstance because not every holding will go parabolic, actually very few go parabolic. But this is something to be cognizant of for things that do go parabolic.

The other day I wrote a post saying that I think the time to buy China (in moderation) is very close and while my thoughts will either be right or wrong it is a safe bet that the Shanghai Composite, and anything else that is down a lot, will begin to discount the positives before the fundamentals show the positives.

We are at a point with these emerging markets where the fear about near term prospects (like the next couple of years) have escalated meaningfully. Adding a 2% weight in that circumstance is not the worst thing you can do and at 2% the consequence for being dead wrong is far from ruinous.

To be clear I have not done anything yet with China but if I do I will let you know. The point of this post is to point out some of the characteristics that are often present at big turning points.
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Sunday Morning Den Of Rattlesnakes

No easy investment theme to tie in (at least I couldn't think of one) so I'll just post the picture.

I have a few others from this pit to work in for later posts, maybe.

Supposedly this was taken by a friend of a friend.

Either way the picture was taken near Oracle, AZ.
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Abu Dhabi Investment Authority

From BusinessWeek; Apparently the ADIA wants to simplify its portfolio by having less hedge fund exposure and more index fund exposure with the following allocation.

These sorts of things are always useful and interesting. They allocate more to equities than Mohamed El-Erian did in his recent Barron's interview.

ADIA is indexing a lot of their portfolio after a consultant studied the portfolio and pointed out that most of their active managers were lagging their respective benchmarks.

This was a catalyst for ADIA to index 60% of the portfolio to come more in line with some of the better known US endowment funds (60% was the number in the B-week article, I'm not sure if that is how much any of the endowments actually commit to indexing).

El-Erian allocated 42% to regular equities versus a range for ADIA between 54% and 71% and it is also not clear how much of ADIA's equity exposure would go to the US versus El-Erian's 15%.

Accessing the equities and bonds are obviously easy to do (talking access not necessarily quality of selection). The alternative category is sort of wide open. It seems that most of the products that are targeted to this segment have times where correlation is low and other periods where it is high. There are a couple of things out there though seem to have done a good job more often than not that shouldn't be that difficult to find for anyone interested.

The real estate segment is one that for me that might be evolving into one of the farm stocks perhaps combined with a more traditional REIT or other type of real estate stock. The catalyst for this, well actually two catalysts, are the concern that REITs correlation to financials went up at the worst possible time and the big macro theme (which I think will have legs for the long term) of food becoming progressively more important.

Private equity is always tricky. There are a lot private equity things that aren't really private equity and for the things that are really PE exposure the market can always do funky things via fear and greed that would be beyond the holder's control that could distort the effect.

Infrastructure as a distinct allocation, as discussed previously, sort of depends on what is selected. Buy Foster Wheeler (FWLT), are you really capturing a separate asset class or just a stock you think will do well? I would say the former. If you buy Malaysian toll road company Plus Expressways (5052.KL or PEXWF.PK) are you really capturing a separate asset class or just a stock you think will do well? I think the latter but an argument could be made the other way.

The ADIA allocation seems like it would be easier to implement both practically and psychologically. A key difference is that by only allocating 42% to equities I wonder if El-Erian is questioning whether equities might stop working altogether. If so I would disagree with that notion and just mention again that even if US equities average smaller returns other destination will offer "normal" returns.

The ADIA allocation seems to be just their spin on how to build a diversified portfolio. Obviously commodities are missing, perhaps captured elsewhere in their total portfolio (remember the above just represents a portion) and I would say a little bit in foreign currency might be right for some folks too.

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The Big Picture For The Week Of June 15, 2008

I misspoke in the video. I mean EFA.
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Mid Morning

Well I am probably the last to know but the S&P 500 Total Return Index (so regular SPX plus dividends) can be charted on BigCharts.com with ticker SPYZ. Seems useful to me.

The Shanghai Composite has gone on another run down and closed today at 2868 down 53% from the peak last fall and down 45% YTD.

I've disclosed being out for a while now with the intention of going back in and I think the time for me to go back in is quite soon. From 15,000 feet China will not go out of business and it has more than cut in half.

There are three stocks that I am willing to buy but have not decided exactly how to move back in with these names. In most instances I weight a stock at 2 or 3% of the portfolio. I will not have 9% (three stocks at 3% each) in China and I doubt I would have 6% but I think I could go with two stocks each weighted at 2% but, in the interest of talking about process, that is where I am for now.

My preference is for individual stocks as opposed to ETFs because I am not thrilled with the composition of the ETFs. FXI and GXC are heavy in financials and PGJ seems to change it's weighting often enough that I don't think you can get a real good handle on what you will own a few months from now.

Obviously I have no expectation of timing a bottom with this but it is very likely that the bottom comes after a big decline at a time when far fewer people are interested and those who are interested would be very cautious about going in.
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Real Estate Price ETFs

Macro Shares filed for two ETFs that allow for gaming real estate prices as measured by the S&P Case-Shiller Composite 10 Home Price Index.

The 10 in the name refers to the ten cities in the index which are Boston, Chicago, Denver, Las Vegas, Los Angeles, Miami, New York, San Diego, San Francisco, and Washington D.C.

One fund will go double long the index with ticker UMM and the other will go double short the index with ticker DMM.

You can read more about these from IndexUniverse and 24/7 Wallstreet.

We all know that real estate prices have been going down. One report a couple of weeks ago, via Bloomberg, had the Case-Shiller 20 Index (so a bigger sampling) declining by 14.4% versus the previous year.

For now there seems to be no consensus of how long before the house decline bottoms and turns around. Speculation on when the turn occurs could make both ETF very popular when they list, assuming the funds do list quickly.

Both oil macro shares garnered a lot of attention for the unintended consequence of trading very far their respective NAVs. One explanation I heard for this a long time ago, but it may not be correct, was that the oil macros had to price in the reality of contango and backwardation that exists in the oil market. I do not know if the new home price macros will have some other unintended consequence like maybe stemming from how Case-Shiller indexes don't price cash indexes only futures markets. At least I could not find cash indexes on Yahoo Finance, BigCharts or StockCharts.com.

Assuming no unintended consequence and once the market does bottom it is possible that this becomes a one-way trade for a long time. The history of housing cycles seem to have far fewer downturns than with equities. Keep in mind this is just an initial reaction/hunch that could be several years away from even having a shot of being correct.

Forgetting the specifics of the of these products, UMM and DMM stand to be the first of what I believe will be many more products that offer access to equity-like returns that don't really involve exposure to capital markets--things like GDP, carbon credits and some of the other ideas that have come up before in this site like maybe timberland in New Zealand and so on.

I am convinced that the alternative asset space is going to grow, asset allocations will as a matter of routine include alternative assets along with stocks, bonds and so on and products like these will be part of the mix.

It is still very early (UMM and DMM haven't even listed yet after all) and we all have more to learn but it will happen.
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Mid Morning

A couple of great questions came in on the Seeking Alpha version of this morning's post about run-of-the-mill bear markets and I thought it would be useful to post the questions here and how I answered them.

Why do you think we won't have a decline similar to what we had in '00-'03, which was a lot more than 30%?

Markets cut in half every so often; the great depression, the mid 1970's; the start of this decade and I also know there was a depression in the 1870's but do not know what the market did then, there was also a bank panic in 1907 that lead to a 37% decline that year. If you notice you see the gaps in time ranging from 22 years on up.

I believe the reason for this is that the market "can't" cut in half so soon after doing so as a matter of perception/sentiment. You get a reasonable bit of generational turnover after 20 years or so. I put can't in quotation marks because certainly anything is theoretically possible.

The one thing that does make this bear different from previous is the derivatives situation...gives the current situation the potential to be worse than the average bear.

I debated Michael Panzner in a point counter point type of thing on derivatives two or three years ago in the WSJ Online. The thing for me that makes a derivatives-led meltdown unlikely is that they are not all derivatives of the same instrument. They are derivatives of hundreds or maybe thousands of different underlying instruments.

An ABX derivative probably has very little to do with some sort of currency swap to hedge an Uridashi bond.
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It's Still A Bear Market

I have been referring to the market action of the last six months or so as a normal bear market.

In the months leading up to the bear I wrote repeatedly about why I thought a bear was coming and most of that opinion was based on a very simple premise which was this time will not be different.

Normal, based on history, would be about a 30% decline from the peak over a period of time of nine to 18 months.

The length of the bull, the excesses that built up, the distortions in the yield curve and the slow-ish rolling over last fall that was denied by most folks were all classic signs of a bear market--one I still think will be a run of the mill bear market.

It is a good bet that someone will leave a comment here or one of the other sites where my posts get re-run noting concerns with some aspects of the current bear and why those aspects make this one different.

There is a tendency to expect the worst from the current set of current events. This has repeated many times over throughout history and this is no different. There is no getting through to the person so motivated by current circumstance that they leave a comment telling the world why I am an idiot for not realizing why this is different.

Assuming you're not that guy, think about what is on the world's plate at the moment. In no particular order we have very high oil prices with a big debate over why (FWIW I think time spent wondering why is not very productive--what's the prize for being right?), well this is not the first time for that. Something is not right in the housing market (you can fill in your own adjective and magnitude) which has happened before. People are worried about the greenback and various deficits-surely no one thinks that is unprecedented. The banks are in trouble, Paulson says that happens every few years.

There are mores flash points than that but there is nothing new about the big macro for any of them. The details of each one might be a little different but as these sorts of worries have popped up in the past they have each engendered genuine fear only to all do the same thing; cycle through for a short while with much less actual impact than expected. The poster child for this effect (and I have mentioned it before) was from the summer of 2002 when CEOs were going to have to sign off on their earnings. Many of you may not even remember this but it created real panic and was a non-event for the market.

None of this is to say you should do nothing. I've written at length about how I try to avoid down a lot, disclosed most of the steps I have taken along the way in belief of taking action when demand for equities becomes unhealthy. The context today is not to freak out and become emotionally unglued. People fear the unfamiliar and assume the worst but markets have a way of working and so far this bear market is going exactly by the book.
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Mid Morning

Oil is up over $6 today as I write this. The daily swings have become much bigger in the last week or two than what is normal. This may signify something meaningful.

Forgetting what you think of the supply and demand aspect of oil for a moment, bigger swings than normal after a huge run that draws out many predictions of much higher prices very soon would seem to cry out for a meaningful drop before doing anything else. This sort of pattern is pretty reliable like when gold went above $1000 for a couple of days.

I buy into the long term supply and demand issues, I have been writing about them for as long as I have been writing, but whatever the exact reality of demand growth versus supply is, it is difficult to argue that the YTD move in crude is justified by the fundamentals alone.

WTI could fall to $110 (not a prediction) and still be up a lot for the year.

If you want to talk about long term supply and demand I am right there with you but such relatively violent moves should not be ignored as a short term tell.
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Academic Theory...

...from the hallowed halls...

Quite a few times I have mentioned my opinion that normal equity returns will continue to exist but we may have to look harder to find them.

Yesterday's post on Vietnam, which ties in with looking harder, got me to thinking about something that theoretically takes on relevance if looking harder turns out to be correct.

If we allow that normal means a 10% annualized average return then in a simplistic world $100,000 invested on June 11, 2007 would be worth $235,794.76 on June 11, 2017.

What if, instead of putting $100,000 into a diversified portfolio one year ago you put it all into Potash Corp of Saskatchewan (POT)? Your 1368 shares would have been worth $301,726.08 based on yesterday's closing price which is almost $70,000 more than you would have hoped to have nine years from now.

In this obviously extreme example an argument could be made for selling the stock (paying the gain if held in a taxable account) and putting it in short term money or otherwise taking no risk for the next nine years. Selling the POT after a year and a day, paying the 15% and then averaging 3% per year would leave the original $100,000 at $343,886.48 in June 2017 when last June your target for that time was originally $235,794.

Before anyone adds 1+1 and gets eleven let me explain where I am going with this by way of yesterday's example with VOF.L. To recap, bought at $2.48, sold half in a few months at $4.73 and still have the other half now priced below $2.00.

If you accept the notion that finding normal equity returns will come about by looking in places that are less familiar to us then you can conclude that less familiar must include some countries/groups/themes/asset classes that are more volatile than buying a combo of SPY/EFA/IWM for your equity exposure.

Relative to less familiar there is nothing out of the ordinary with the sort of move VOF.L had. A diversified portfolio that includes these sorts of things could easily have a couple of things that go up 50-100% in what seems like a short period of time. I'm gonna say if you own something that goes up 100% in three or four months you need to at least consider selling some or all of it.

The psychology of taking a short term gain like this is you just got a few year's worth of return in a few months, you were lucky, take the gain. The reality of this sort of thing is that often big moves often go the other way when the momentum runs out of steam.

In hindsight, based on price, clearly, selling all of VOF.L would have been better. Too much sitting on things that go up 100% and then cut in half without any action prevents you from getting to where you need to be.

The point of this is that if normal returns are going to be more difficult to come by and you are willing to look for them in new (to you) places you will probably need to reorient your thinking about holding on to things. Go ahead and buy with the intention of holding if your so inclined to think that way (and I am) but be willing to take a large gain when the market gives it to you. A 2% weight in something that doubles in a few months adds 200 basis points for the year which is a lot if you are targeting a "normal" equity return.

To tie in the POT example if you can add 200 basis points in the manner above you are a little bit ahead and do not need to rush back in to something else.

It is unlikely that a portfolio will be chock full of VOF.Ls but future success may require having a few of them. If so, then the thinking will need to expand/evolve.

The picture (not mine) is of Hepner Hall at San Diego State University. In my four years there I only had one class in that building.
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