New Years Eve Mish Mash

Long time reader Stephen Drone pointed us to an article from Tim Middleton dated yesterday in which he plans to use double long ETFs because he expects a big move up in stocks. I don't think I have ever been a regular reader of his stuff and if I ever was I haven't been for ages.

Per the article he is putting 10% in the double long S&P 500 (SSO), 6.2% in the double long mid cap (MVV) and 6.2% in the double long small cap (SAA). His logic is "...That makes both stock and bond prices compelling right now. Ergo, I want to own a ton of both. And thanks to leveraged ETFs, I can." He mentions that sometimes these funds "misbehave" but that they would have done the trick over some period of time.

He may be right about the market or not in terms of direction but owning the double long funds may not work even if he is right. In 2007, which was an up year, SSO lagged the S&P 500 SPDR (SPY). The combination of up and down days will determine how a levered fund does over time and obviously there is no way to know ahead of time. That he makes the misbehave comment at all would seem to imply he knows that they may not capture the effect over a longer period of time yet he is buying them anyway.

I have picked on him a couple of time before (but it haven't mentioned him since May, 2006) for a couple of different things. Everyone gets some calls wrong so I won't rehash those but there have been a couple of instances where he made what seemed like huge sector bets with his ETF portfolio. Big sector bets are not a bad thing in and of themselves but I'm not positive he realizes he is making them. Here is a post of mine from September, 2005 about his Q3 2005 result in which I address this. I may have this all wrong about Middleton but it seems to me that if you are going to make a big sector bet in a portfolio you're writing about you might want to explain why. People often get hurt more from not knowing they have made a big bet than the big bet itself.

I need some reader help. The week after next I am speaking at an ETF conference put on by IndexUniverse in Boca Raton, FL. The picture above is where we are staying, the Boca Raton Resort (swanky, huh?). Joellyn is coming along and aside from Barney Fife and Thelma Lou go to Raleigh jokes we are wondering if there is anything to do in or near Boca Raton besides shopping and dining. Any help would be appreciated.

The second picture is from the Roady's Humanitarian Bowl played yesterday in Boise, ID. I don't know about you but I can't get enough blue turf football.

I was on CNBC yesterday afternoon. If you care, you can watch it here.

Lastly I'd like to wish everyone a Happy New Year. 2008 has been a rough one, very rough, for many people so hopefully 2009 can be better. On the topic of rough years I will recap 2008 for the portfolio in this weekend's video. If you have been with me for a while you probably have some sense of how things have gone (I've been quite lucky) but I'll try to dissect as best as can be done in ten minutes (the YouTube limit).
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Municipal Debt

Doug Kass wrote up his list of 20 surprises in 2009 for theStreet.com. Included in the list is the following;

11. State and municipal imbalances and deficits mushroom. The municipal bond market seizes up in the face of poor fiscal management, revenue shortfalls and rising budgets at state and local levels. Municipal bond yields spike higher. A new Municipal TARP totaling $2 trillion is introduced in the year's second half.

I don't know about any muni Tarp but I have written a couple of posts expressing concern about going into this area. Many people in print and on TV are extolling the space for the yields available. I take the yields as a warning of something coming. There is some stat out there, I think I saw it on Barry's site a while back, about 31 states either having a deficit or soon to have a deficit.

One could argue that treasury yields are so low because of the crisis/deleveraging/flight to safety trade which is of course true but we need to watch out for justifying abnormalities. An anomaly that lasts for months isn't an anomaly it is something else--IMO it is a warning.

As opposed to trying to quantify what it all means I'd rather just heed the warning not have a meaningful commitment to the space. This is what I wrote about and did in the portfolio with financial stocks when the yield curve inverted. Just lightening up into an early warning is enough to reduce pain. Look at many of the famous value mutual funds that held on to (and probably still own) financial stocks too long.

One of these times someone will outsmart one of these indicators but it doesn't have to be you and it won't be me.

One last item; I'm scheduled to appear on Closing Bell on CNBC at about 15 or 20 minutes after the close of the market, I hope you can check it out.
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The NZ Perspective

Liam Dann: Keep calm, all things must pass - Best of business analysis - NZ Herald News:

Money Funny quote.

There will be a downturn. It will fall somewhere between Mad Max and 'a bit bumpy' in severity.

On a related note I wrote about New Zealand port stocks for greenfaucet today. I hope you can check it out.
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The Weekend That Wall Street Died - WSJ.com

The Weekend That Wall Street Died - WSJ.com

Read this.
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Latins Quiet About Madoff Losses

Latins Quiet About Madoff Losses - WSJ.com

It is curious that so many banks and other institutional investors (including the feeder funds) were duped by the Madoff scam. It shows that as do-it-yourselfers try to learn and do a better job managing their portfolios mistakes and laziness occurs at the highest levels of finance. Obviously greed is an ingredient in there somewhere too.
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Sunday Morning Coffee

I mentioned our weather in yesterday's video. All of the roads on the mountain get treacherous beyond reasonable expectation when there is snow. I've heard several explanations as to why the roads get so dangerous here (dirt and paved), I don't know if any of them are right or not I just know that the only way to drive safely is to put it four wheel drive low and not exceed 5 mph going down any hill (we don't even try to drive our pick up, just our 4-runner). People get stuck and or have accidents all the time because they are going 10 mph. But again the right vehicle, in the right gear at 4 mph is no problem.

So I don't know why the road gets so dangerous but I do know what the risk factors are (snow and cold weather), heed the warning and act appropriately. Knowing why the roads are dangerous is not as important as just knowing that they are dangerous. The solution is simple, don't go out but if you need to then drive very very slowly in a low gear.

No doubt you can see the where I am going with the repetitive nature of those two paragraphs in applying the idea to managing your portfolio. Any sort of long term moving average indicator warned of trouble long before we got to down a lot. No long term moving average indicator told how bad it would be or what would cause it. If you heeded such an indicator and are down 20 or 25% instead of 40% does it matter what the cause was?

In yesterday's comment thread (thanks for all the comments) there were some attempts to get into some real minutia about various aspect of portfolio management which is fine but hopefully in getting into the small picture no one loses sight of the big picture. The big picture for all of this talk of defensive action is to try to avoid a big chunk of down a lot--simple as that. Why do I prefer this or that? This or that doesn't really matter. If you are one who does not want to ride a bear market all the way down then anything you do that allows you to miss a meaningful chunk is productive and successful.

My logic is that simple; I want to try to not go down a lot when the market goes down a lot. If you believe buy and hold no matter what is superior then you should not try this. If you look at studies on this subject and conclude this is inferior then you should not try this. The goal is so simplistic that it should be easy to sort out whether some sort of defensive action in the context I discuss fits in with the way you think or not.

In the picture, Roscoe is making a snow angel on one of our hikes. As of now the NFL will not be fining him $10,000.
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The Big Picture for the Week of December 28, 2008

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Why Is The Market Open Today?

A reader asked if I had read The Only Guide to Alternative Investments You'll Ever Need by Larry Swedroe and Jared Kizer and then proceeded to leave the entire book (slight hyperbole) in the comments which you can read here. The reader wanted to know if I had an opinion on the conclusions drawn in the book. I have not read the book so going by what the reader left....

The first part of the question focused on the long term diversification benefits of REITs. First let me say that I am quite certain REITs refers to REITs listed and traded on the public exchanges. I wrote pretty extensively about REITs last February and I've been out of the segment since December 2007.

I can't refute any of the arguments in any of the studies about REITs' impact on portfolios but I am not convinced they offer a whole lot of diversification benefit. They certainly did not on this go around which prompted my exploration of farmland stocks. I've not really done anything meaningful with farmland stocks and I am not saying I won't go back into REITs but in terms of being great diverisifiers, I'm not sold. The post above from February that I linked to focuses on why David Swenen's notion of 20% in REITs (does he still think this?) is not right for me.

Apparently Swedroe and Kizer think highly of TIPS. Most clients own TIP and WIP and I disclosed buying the PowerShares Agriculture ETF (DBA) because I expect inflation to pick up in the next couple of years. I would say I'm on board with that one.

There is also a focus in the book about expensive, complicated investment products being bad for several reasons. I agree. The way I view the world if I can buy it online in my brokerage account it is not a complex product--the strategy (underlying a fund) might be but the product is not. A few months ago I remarked about a particular mutual fund being complicated because there are a lot of trades within the fund and the manager appeared to not know the sector positioning when he was on CNBC; complex strategy simple wrapper.

Where possible I prefer simple (I realize this can be a relative term) both in portfolio construction and in life.
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Holiday Randoms

WisdomTree announced its dividends and by and large they look pretty robust. They have had an issue with new assets coming in during the year and creating more shares to spread the dividends around to.

In a down 40% year it makes sense that as the year ends there are not a lot of newly created shares in existence to collect the dividend. As a result the dividends of the funds are now in line with the indicated yields of the indexes that underlie the funds.

Other news from WisdomTree is that going forward a lot of their funds that had been paying annually will be paying quarterly. This stands to reduce the impact of the effect of share creations mentioned above but it should be understood that many foreign companies pay dividends once or twice a year as opposed to the four times that most US companies observe. The net effect could be a higher yield but I do not expect each of the four dividends to be the same.

I think this is great and fundholder friendly news, now we need WisdomTree to get cracking on some of those currency ETFs in the hopper.

Like many folks the Madoff incident is teaching me about the difference between feeder funds and funds of funds. Forgetting the Ponzi scheme for a moment the idea of collecting $1 billion to feed into a fund that someone else manages and still collect a percent or two on the billion sounds like a pretty sweet gig. Does a feeder person have to make any decisions at all? I'm being sarcastic, I have never understood the value of these sorts of middlemen.

I did a small trade yesterday for many clients. I added the PowerShares Agriculture Commodity ETF (DBA) for most clients. DBA plus GLD now takes most clients to a mid single digit weighting in commodities from low single digits. Quite simply the actions underway to fix the crisis are inflationary. For now asset prices have deflated (or maybe more correct to say are still deflating) but I believe that when the deflation ends we will see higher consumer prices, they have already increased the money supply and the path to higher prices is easy to see.

Mid single digits is hardly betting the farm but it made sense to me to increase the commodity exposure now before prices start to go up and while DBA is so far off of its high.

Roger McNamee was on Street Signs yesterday and he was given the chance to make some interesting comments but there was one in particular that struck a cord with me. He shared his belief about the infrastructure spending eventually improving people's quality of life by cutting commuting time. I realize not everyone can work from home but I am incredibly thankful for not having a daily commute.

Sticking with the network I was asked to appear on Closing Bell yesterday for a segment about investing in 2009. We are snowed in so I couldn't make it. The segment that I think it was became a discussion about dividends. One of the participants said he is a dividend investor and the other guest was not very focused on dividends.

I love dividends, they are important most of the time. The one time they are less important is when the market goes up a lot, like 1934 up a lot. After an historic decline the odds of a big move up (bear market rally or new bull market) increase. If you buy into that it might make sense to focus less on dividends for now. The last two equities I've added don't really pay any kind of meaningful dividend.

Have a great holiday!
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The Bailing Out Of Homeowners Will Be Unfair

The above is important context for this post. No matter what the final combo of acronymed facilities, stimulus programs and the like it will not be fair to everyone.

First, a slightly more serious point. There has been chatter about refinancing mortgages to 4.5% but then the chatter moved to talk of 3%. This would create a lot of problems, well maybe not the borrower. Lending a bunch of money for 30 years at 3% exposes lenders to interest rate risk. What happens when rates go back to normal? Any bank loaded down with a bunch of 3% debt that is unlikely to refinance away will face a whole new set of writedowns when rates go back to 6 or 7%--or higher. It would seem to me there would be all sorts of problems for banks and other lenders putting out that much money at 3%.

I don't know if securitization is now supposed to now be dead but assuming not how eager are you to collect 3% for ten years, oh wait no I mean 30 years? 3% would seem to be a problem at many stops along the food chain and so I doubt it will happen.

Now for my not so serious idea, scrap all of the acronyms and stimulus plans now in motion or on the drawing board. According to this there are 44 million mortgages out there. Why not structure a program that earmarks every mortgage be reduced by $100,000 and then refinance every mortgage based on the new principal amount at the same interest rate already in place for the specific mortgage?

If you have a $400,000 balance at 7% after implementation of this plan you would have a $300,000 balance at 7%. The borrower would have a payment that was smaller by $665, the bank would have another $100k to strengthen its capital ratios and a loan with an interest rate that is still marketable.

You might be wondering why not give everyone the same percentage of their mortgage, like 20%. You certainly could but that would be as unfair.

The only, ahem, problem is that the cost is off by one decimal place. If I counted zeros correctly, the cost would be $44 trillion. If it worked out to $4.4 trillion it would be in the ball park of what will be spent. Oh well back to the drawing board.
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WWSD?

The S of course is for Mr. Spock who was known for being coldly analytical about everything, well maybe everything except the green women. Or was that James Tiberius Kirk?

Anywhoo can you be coldly analytical about the stock market? Can anyone? We are in the middle of a nasty market these days. The S&P 500 is down 43% from its peak from 14 months ago. Many stocks are down 50-70% from their respective peaks.

During bear markets many stocks go down a lot more than market for no true fundamental reason. There are plenty of stocks, domestic and foreign, that are down more than their fundamentals justify and that will not go out of business in this cycle (or any cycle in the foreseeable future).

The reason people are scared to buy stocks now is the fear that the stocks they choose go down a lot more from here and it is a reasonable fear but not the best way to make investment decisions. Quite a few market pros think the S&P 500 could go to 600 before this bear is over (I do not). SPX 600 is an unknown, it may happen it may not. What is known is that many stocks are now at much lower prices than they were a year ago or at similar prices to what they were five and ten years ago. Again this is easily knowable by looking at a chart. Not only are many of these names at lower prices some of them are also much cheaper (lower prices as potentially nominal and cheaper in terms of common valuation metrics).

If you know a stock has a much lower price today, has a cheaper valuation today, is unlikely to go out of business and you have some cash it probably makes sense to buy a little now. I'm not saying a bottom is in and I'm not saying get 100% invested right now but if you raised cash, have not bought anything while the S&P 500 has had a 7, 8 or 9 handle and you have not sworn off stocks you'll probably get a price you'll be happy with a few years from now.

But what about the S&P 500 going to 600? From Friday's close 600 would be a 32% drop. Yes that could happen but the probability of a 32% drop after a 43% drop is quite low. The focus here is what is known now versus what is feared for in the future.
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The Big Picture for the Week of December 21, 2008

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Friday Randoms

This article about the fishing industry in Iceland made its way into many newspapers yesterday. Apparently there is a boom in fishing, the Icelanders have not over-fished their waters and the weak ISK helps when they sell the fish abroad.

Iceland will recover at some point although it may look different that it did. If you read anything about the ascendancy of Iceland that occurred you will invariably find a comment about Range Rovers driving through the streets of Reykjavik and having been there for a few days a couple of years ago I can tell you it is true; Range Rovers and BMWs aplenty. Or it was true anyway.

While I don't know how they should do this I think they need to really push to draw in more things like data centers and certain types of manufacturing that would benefit from the geothermal energy. The cost efficiencies are obvious and the location (five hours from NYC and three hours from the European continent would seem to be ideal for many multinational businesses.

While the move up in foreign currencies and gold has been pronounced and I think it is the right direction for a while it will not be a straight shot up. If you are interested in these parts of the market (they are now all easily accessed) for a longer term hold you should remember that nothing can be a one way trade but the bigger macro is that rates in the US are at zero and going to stay there for a long time. Gold at $1500 is a bigger move than I would expect but a move that ends up looking pretty good seems reasonable even if the next $50 is down.

Speaking of which, sort of, the crew over at Bespoke noticed that gold and platinum are trading at about the same level which is a rare thing. A long/short pair trade involving gold and platinum (there are several ETPs to access platinum) is popular with some folks. Someone left a question about what absolute products I use and while a pairing of gold and platinum is not in my wheelhouse that is one that does work for some folks. Anyone just starting learn about absolute strategies and who has a knack for commodities might want to do some learning about that one.
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The Dark Side With Nat X

Yesterday I encountered a bit of the dark side of the investing world (I know, there are many dark sides).

I had been planning to add a little, I do mean a little, corporate bond exposure for most clients and yesterday turned out to be the day. After a bit of you're done, no you're not, yes you are with Schwab I was able to get the order done and it was paper I wanted but I spent some time looking for what to buy and this reminded me of a few things.

I had a particular focus in terms of what sectors I was open to and the ones I was not, rating, cash flow of the company, debt to equity and a couple of other things as I perceive the position as a chicken's way in which I think is right for now.

There were a few, just a few, issues in Schwab's inventory that fit the bill but I had trouble finding enough size, I really did not buy that much, to get the order done. So liquidity was an issue, which reminded me that if you come in to but $10,000 or $20,000 worth it is likely that you will get a lousy offer (or bid if you are a seller). It is pretty much the same story (too big difficult to find quantity, too small maybe a bad price) in the muni market when that market is functioning normally.

Access issues also pertain to foreign stocks. I have mentioned a couple of times that I have been following a particular Chinese stock as a potential second name to own and have enquired with Schwab about how easy, or not, it would be to buy and they set a very low expectation and keep in mind it is an ADR, it trades on the pinks but still it is an ADR.

It would be easy for an individual to buy the stock, much easier than for a portfolio manager buying for clients (unless Schwab is truly awful at executing orders), but it would be more difficult for an individual to get bond business done. This is a dark side. It is important to understand these obstacles, any type of product will have some drawbacks and we all need to get over this fact.

A while back I wrote about Norwegian fishery stocks. On some level the notion is interesting but I have no plans to buy any of the names. But any US based investor so motivated would have a tough time buying any of them. A couple of them don't have five letter designators (ie ticker symbols) for US trading and the one that appears to trade the most dollar volume (actually krone volume), Cermaq (CEQ in Oslo and CRMQF on the pinks), has not traded in the US since October 6, according to both Yahoo Finance and PinkSheets.com.

This would be a tough one to get done but if someone really was motivated to own the name they would figure it out, realize they might have to give something up (like a few cents on the price) and it could get done. Same thing with difficult to trade bonds. Of course the other thing that could be given up on is the entire idea in which case a US listed fishery (if there is one) or a bond fund could be purchased instead. There would be a give up here too. Whatever made Cermaq or Cumberland County, Vermont bonds attractive would not be accessed.

If portfolio construction and management will require more ingenuity and resourcefulness in the future, and I believe that it will, these issues might matter to you, they matter to me and while not every holding will require pulling teeth to get in to or out of some will and you may want to start to sort this dark side out now before circumstance forces you to.
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Thoughts Over Early Morning Cocoa

This will be difficult to articulate but I'll do my best. The Fed news yesterday caused panicked reactions in just about every market; stocks up, yield down, commodities up and the greenback down. There is a path laid for some sort of something down the road with regard to inflation, interest rate shocks and higher input (think resource) prices. Unless of course the Fed does a good job being proactive in moving rates back up and shutting down of the various facilities put into place during the crisis, ahem.

That being said my plan is to increase exposure to a couple of things in the next couple of weeks including equities, corporates and one or two other things. Earlier this week I added another absolute return fund for many clients bringing most clients to two, totaling a mid-single digit weight. I'll stress that I'm talking about a slight increase and then when I am done I would still have a generally defensive position, just less so.

From the big picture standpoint we are 14 months and 40 or so percent from the peak. The way these things tend to work is that really big declines and time fixes a lot of problems and of course people tend not to believe a bottom can be in until long past the actual bottom. I still believe in the idea of a stumble along the bottom without going meaningfully lower than we have already been. If this turns out to be correct then there is much less risk in adding exposure here. That is not to say they have to rally and then stay up, just that there is less risk after a 40% drop.

I've been on this jag for a while, done a couple of things along the way and plan to add a little more. My concerns about inflation and higher rates will influence the actions taken as I do believe these will become bigger obstacles over the next year or two.

In the picture (taken yesterday) Tater is about to catch a snowball.
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What Are We Switzerland?

A range of 0% to 0.25%?

I guess stocks like the news and the statement but the statement sounded awful. Holy schnikies!

Kudos for continuing to be creative, I guess, but I don't trust the reaction in equities. The debt and currency reactions seem more reliable.

Side note; we are in the middle of the biggest December storm here I can remember. It has been snowing non-stop since 3pm yesterday. We are over a foot here and still snowing.
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Unfrozen Caveman Lawyer

I found this article from InvestmentNews (via IndexUniverse) that was about portfolio construction evolution (I've been writing about this in one way or another since 2004).

The focus was on multi-asset class OEFs including the new Pimco Global Multi Asset Growth Fund (PGAIX) which I wrote about a few weeks ago.

The case against these funds (in the article) was that they are expensive and that a lot of them are down a lot. The case for was a little weak but the funds are "more sophisticated" but not much more was said than that.

There were a couple of funds mentioned that I had not heard of before. One was the MFS Diversified Target Return Fund (DVRAX) which is down 38% YTD. DVRAX shoots for a 5% real return by combining stock picks from UBS and currency strategies.

Another fund mentioned was Schroders Multi Asset Growth Fund (SALAX) which is down 37% YTD. Aside from the usual stocks and bonds it invests in in real estate, commodities, currencies, and private equity, and investments in absolute return strategies.

Ouch on both of them.

If you've been reading the blog for a while you know I am a big believer in the concept of alternative strategies when used in moderation. Based on the results of the above funds and the couple of funds I was lucky enough to stumble across there is a wide range of possibilities in terms of results. Allocate 3% into a fund like this that doesn't work out like the ones above and you will have learned a lesson. Allocate 15% to such a fund and you may have dug yourself an unnecessarily big (on a relative basis) hole to get out of.

There are plenty of things that could fit into this segment of the market including any of the funds I've written about before, farmland stocks, Norwegian fisheries, the new carbon futures ETP (exchange traded product), hydro electric or anything else you can find. I write about these sorts of things because it is important to learn about them, figure out how they might behave during certain periods of market stress and explore how to use them.

For now I still think going small is the right way to go but for one person farmland stocks might be the answer or for someone else a carbon credit ETF or maybe nothing at all but I am convinced it is important to study these things as I believe it will evolve into an asset class as everyday as REITs which used to not get much consideration as an asset class. If you are on this now then I think you might be ahead of the game.
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Occam's Heater

We heat the main part of our cabin with a propane floor heater (when we don't light a fire) that is original to the house. When we were out of town the pilot light went out. We had our dog sitter just turn it off and we would fix it when we got home.

So we got home and re-lit the pilot but it kept going out. A friend told us to replace the thermostat before taking anything apart in the floor. If the thermostat (which was 40 years old) was bad then there would be no spark to run the heater which somehow caused the pilot to go out. The thermostat unscrewed from the wall and had only two wires, red and white. A new thermostat cost $17 at Home Depot (we went cheap simple) and told us where to connect the existing red and white wires with R for red and W for white labeled right on the new thermostat. The entire thing took six minutes and yes the heater still works.

Seeking out a solution in the actual unit would have required taking things (what's a thermocouple?) apart in a tiny crawl space in the dirt which would have taken more than six minutes and in this case not fixed the problem.

I think there are several ways to apply this (this being simple and cheap) to investing in terms of strategy, products chosen, method of analysis and anything else you can come up with. Just keep it simple relative to the time you want to put in and stick to cheap, easy to understand products. Like many things, investing doesn't have to be that difficult.

I found this image on a post from Prieur du Plessis. Hopefully we won't end up needing two or three of these to go to the grocery store.
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Sunday Morning Coffee

Barron's had an article about reallocating retirement portfolios that have been derailed by the current bear market. There were comments from people citing statistics that have favored certain asset classes before and presumably these folks were relying on these statistics again. For example there was a quote about buying REITs when they yield more than ten year treasuries and that currently (per the article) REITs yield three times that of treasuries. The obvious question not addressed was whether the folks quoted bought REITs when the yield first surpassed the yield on treasuries. That would seem to be the implication and so as that was wrong how do we know that now it would be right?

A case was made for various segments of the fixed income market. It probably makes some sense to commit a little more to fixed income but the more I read about people suggesting the muni market the more I think something bad will happen there. A little bit of exposure to municipal paper is probably not a big deal but I am certain there are people pouring way too much in as they chase after yield. When has chasing yield ever been a bad thing (that is a sarcastic comment)?

As I mentioned the other day I think the yields in munis versus treasuries is warning of something bad and I do not want too much there in case that sentiment turns out to be correct.

There was one comment that was totally out of context that I wish they would have devoted more ink to which was someone's suggestion of having 20% in alternative assets which to the planner meant real estate, commodities and hedging strategies (ie absolute return). I don't know about 20% but I have been saying for ages that people need to learn more about this than they already know, being willing to commit a modest amount capital but I would say to avoid the private equity ETFs (I've written about these ETFs for TSCM and been down on them right out of the chute).

One subject that I think was left out, unless it was too subtle for me to realize, was investor behavior. Maybe more correctly called saver behavior. One consequence of the naughties (or if you prefer the oughts) may very well be that it will be more difficult for people of normal means to have successful retirements. There are several ways to mitigate this threat including saving more, spending less and working longer. No matter who you are your financial plan will benefit by doing those things (I realize not everyone can work longer). I'm not saying to necessarily stay at a job you dread, life is too short for that, but instead figure it out for yourself such than you can strike a balance with helping your finances, doing something you like and continuing to have purpose.

I get preachy about these things but quality of life is more important than money. It makes sense to sort these issues out before you're forced to do something in a hurried or desperate fashion.
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The Big Picture For The Week Of December 14, 2008

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El Bailout Es Morte!

I've got to head out the door to Phoenix in a minute so just a short one here and I'm not taking the time to check the spelling of morte.

There were some concerned comments left overnight about the bailout flushing. Certainly I am surprised the bailout did not pass and I am not sure whether TARP money will somehow be allocated or not but the day appears like it will be ghastly.

Someone asked about whether to go to cash. So is it a good idea to panic along with everyone else? Is that ever a good idea? If you have not raised any cash months ago then I'm not sure what to say. The news is bad but for now this is consistent with a stumble along the bottom. The news now is the bailout but it could have been something else.

We'll see how it reverberates, whether it takes it outside the range to the down side at some point but when is an emotional response within your portfolio a good idea?
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XLF WTF?

The chart compares the Financial Sector SPDR (XLF) versus the S&P 500 going back to about the time XLF peaked.

What prompted this post was noticing yesterday's more than 7% drop. At $11.90 it is up 37% from its low of $8.67. As you can see it is close to down 70% from its all time peak. That is in the same neighborhood as the tech sector decline at the start of the decade.

That two sectors could implode like this in one decade is truly astonishing. Here we are all these years after the peak in tech and really the sector has not come anywhere close to recovering. Is the financial sector facing the same fate, years without making it back?

I'm not sure there is any fundamental case for the sector now and there may not be one for a long time. There was no fundamental case a few weeks ago when XLF was printing in the eights yet it did have a 37% move. I would expect the occasional big move up for no reason. If the broad market has some sort of meaningful feel good rally then XLF could easily pop another 30 or 40%, it did it once it can do again.

In trying to figure out to build financial exposure with at least a little fundamental support there are foreign banks with far fewer moving parts (meaning less leverage, less risky business models, maybe little to no investment banking), the public exchanges' business model doesn't expose them to the problems the banks are having, credit card processors (the transaction companies) would seem to be immune and there are other segments too.

Generally these stocks are down a ton, they have not been spared price-wise. But if the businesses of these types of companies are different than that of Citigroup, Bank of America, Wachovia, Goldman Sachs and so on (ultimately whether they are different is for you to decide) then these companies would stand a better chance of recovering with the market than the more troubled institutions.

Just as Apple (AAPL) and Research In Motion (RIMM) managed to do well when most of tech faltered there will be pockets of the financial sector that do come back. It is unlikely that this effect can be captured with XLF or any of the other domestic sector ETFs.
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WSJ on Bill Miller

The WSJ had an article about Bill Miller's fall (a nod to IndexUniverse). You probably know most of the story. He had excellent, SPX beating returns for a very long time by buying when others were afraid. He also made concentrated bets on certain stocks like Amazon.com (AMZN) and quite a few financial stocks that either failed or came close to failing.

In the article were also some interesting tidbits that I think are more useful than the bigger story. First is a comment from Chris Davis who recounted telling Miller that "one of my (Davis') goals is to just be right more than I'm wrong." Miller told Davis "that's really stupid, what matters is how much you make when you're right. If you're wrong nine times out of 10 and your stocks go to zero -- but the tenth one goes up 20 times -- you'll be just fine. Davis said he could not live that way and neither could I.

The article also talks about his buying more and more of all the financial names, like Bear Stearns, as they went down. It seems pretty clear that he really believes (maybe now it would be believed) in buying more as they went down. This was a contributing factor to his success, and make no mistake he was wildly successful for a long time, and also a contributing factor in his..what should we say..fall from grace or whatever.

Miller's approach is 180 degrees, I think, from what I do and what I've been writing about. Davis' just be right more than I'm wrong is something I believe in and have mentioned on the blog probably 100 times. There is obviously an element of philosophy embedded in this. I don't ever want to try to have to explain to someone why he's down 58% in a down 38% world as the WSJ says Miller is and more important than that I don't ever want to come anywhere close to derailing anyone's financial situation in that manner (obviously my role is different than that of a fund managers so this might be apples to oranges).

A building block; if you buy an index fund and hold it for 30 years chances are you'll be somewhere near 10% annualized. If it actually worked out that way then the 10% annualized would include all the bulls, bears, booms and busts. So all the TV coverage, all the bytes on the internet and all the worry and you could just own an index fund for 30 years (assumes proper asset allocation) and probably make out ok if you saved enough. Of course you'd be down 40% right now which is why I am not a fan of indexing.

With that as a backdrop I think it makes sense to seek out simple ways to add long term value. This includes a defensive strategy when appropriate and overweighting dividends for most of the cycle. Chances are you have your own ideas about all of this but investing can be simple. While I would say that simple is not the same as easy there are things that can make it easier like not making big bets in terms of stocks selected (if you use individual stocks), countries, sectors or cap sizes. If you use funds and you are unsure then you need to look under the hood of the funds you own.

From what I can tell Miller was extremely overweight financials at the wrong time. I wrote about underweighting the sector because of the yield curve and I guess Miller did not do this. Obviously he knows about the theory (inverted curve bad for financial stocks) and ignored it. I believe that the inverted curve is a pretty reliable indicator (because it impedes access to capital which would seem to be very important for a bank). Heeding reliable things that you find might make investing a little easier for you.

Personally I think Miller's saga is a great learning tool.
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Bonds

A reader asked if I thought the treasury market was in a bubble. He was probably prompted by this news about bill rates going to zero.

The word bubble is a tad overused doesn't really bring much to the table in terms of figuring things out. If you think it is a bubble fine, if not that's fine too.

Clearly the action in the bond market is bizarre and might be telegraphing a problem coming, a big problem. I am probably not the one to tell you ahead of time what the dominoes will be so much as point out a couple of watchout situations.

Clearly there has been a buying panic in treasuries of all maturities. The ten year is under 3%, the 30 year is close to 3% and the shortest bills are at zero with some wondering if yields will go negative. Municipal paper is yielding a lot more than treasuries with like maturities. Corporate paper is doing odd things as well--spread wise.

This all strikes me a a warning. The muni over treasury yield is not a blip for a day or two but has been going on long enough to reasonably be called persistent. Some have said the bond market might be worse off than the equity market and I think that is pretty close to right.

Treasury rates are essentially at all time lows. At some point when something (the yield) can't lower then it will go higher. Yield up means price down. The money being printed for all these bailouts creates a path for price inflation (larger money supply is the definition of inflation) once the asset deflation ends if not sooner. This threat could cause anyone buying our debt to demand higher yields for the various risks they are assuming. This is also an argument for a weaker dollar.

There is nothing that says this has to be the outcome, although it is what I believe, and obviously it is ok to look at this and draw a different conclusion but if you manage your own portfolio you should know some of the particulars and have an opinion.

If you use fixed income as a means of evening out the equity portion of your portfolio then I would say this is not a great time to be overly aggressive.
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Eye Of The Beholder

A couple of comments came in about the utility of the 200 DMA as a trigger point for defensive action. There was a question about how much research I've done and a mention (though no link) of a study that concluded it did not work in the 1990s. So a few things here to go over.

I wrote a post (you can look for it if you are so inclined) comparing it to straight buy and hold from the early 1980's forward is it was better than buy and hold by a noticeable amount. As far as how much research, there is no way to answer that. First of all I am not a white-paper guy. If I could quantify how much, some would think that was sufficient and others not (some folks always want more data no matter how much they already have).

The intended focus is not "hey use the thing I use" it is "hey you might want to use something." The something you might want to use should make sense to you based on whatever it is that matters to you. I've never claimed the 200 DMA was perfect but it is simple. Look at it over whatever time period that makes sense to you and decide for yourself. then look at other concepts in the same light and see if any of it makes sense. For me it does.

As far as it not working during the 1990s I guess it depends on what "not working" means. It has fake outs every so often, it did earlier in this decade and it did during the 1990s too. There were several instances where it got people out and then back in a little later at about the same level, in those instances it smoothed out the ride but did not add any financial value.

My goal from the beginning with this is simply to go down less when the market goes down a lot. Your goal might be different. Avoiding a chunk of down a lot potentially does a couple of things. One it can smooth out the ride and it can add to the overall return during the entire stock market cycle, at least that is my hope. You can look for yourself at the charts and make your own decision.

One housekeeping item, I appreciate all the comments left on the blog. This is going to be a crazy week and so I might not be able to answer as much as normal.

A totally unrelated note; I put 3/4 of a tank of gas into our Toyota 4-runner and it only cost $16.45. Woo-hoo!
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Right On Queue

After yesterday's look at an article on supposedly failed diversification from the NYT I found another one from Reuters. The Reuters post was very similar to the NYT article.

One thing that I did not mention is that 2008 (and for however long it lasts beyond 2008) has been the year that is the outlier for everything. It has been the outcome that would be the least probable scenario in any sort of financial planning process.

With that sentiment I am not commenting on whether it should have happened, whose fault it is, the fixes gone bad, what I think will happen next or anything else just the simple idea that down 40%, 30-40% below the 200 DMA for broad market indexes, the implosion in oil, the possibility that the fixed income market is worse off than equities, that commodities have also imploded and anything I am forgetting have created a cocktail of 100 year floods in every asset class (including the bizarre rally in treasuries; TYX as at 3.11!).

2008 was the year no asset allocation model would ever realistically account for. The odds that a diversified portfolio that took no defensive action would stand up to this onslaught were close to nil.

Some of my recent posts have explored ways to possibly construct a different type of portfolio that would mean a different type of market participation and a different type of result. The reason anyone would consider this is if they simply find they cannot stomach normal stock market behavior. However the assumption that the capital markets and the sorts of inter-assets relationships that have existed for decades are now permanently defunct is a bad bet.

This is a disruption of normal market function, without getting into how long it might last for now, that is what it is. I still think normal stock market participation, with some sort of defensive strategy, is the best way to go. I can envision a scenario where a lot of people one way or another give up on stocks, then maybe we end up having a decent cyclical bull market and many of the folks who gave come back in just in time for the next cyclical bear.

The explorations of different portfolio methods is interesting and can be a learning tool as I think it stretches out the mind a little bit but above all I would urge (repeat theme here) keeping it simple with a normal-ish portfolio. Defensive action in the manner I've described before is simple. There is no need to even worry about magnitude--indeed I was wrong about the bear market's magnitude (down 50% twice in one decade? really?) but that has not mattered.

To reiterate a point made many times over, it doesn't matter if every fund or stock you have is down 40%, what matters is not being fully invested in a bunch of funds and stocks that are down 40%.
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Sunday Morning Coffee

There are a handful of world class investors whom I will go out of my way to see, hear or read. One of these heavyweights is of course Oscar Rogers. I have not seen anything from him in a while, this link is from late October and I believe is his latest public commentary.

In that clip he gives an impassioned plea for them to fix it.

I think Oscar might be on the verge of throwing in the towel despite this article from the NY Times saying that diversification does still work and that investors should not give up on it.

The idea was simply that in a short term, panicked flight to safety yes everything goes down but the proper mix did go down less. The article never mentioned any sort of defensive strategy like the things I write about. It is no shock that an MSM article would omit such an idea but as mentioned in this week's video hopefully you did something along these lines in the current bear market or have learned to for the next bear market.

I still believe in diversification. The notion of how to construct a diversified portfolio is evolving however by necessity and thanks to new investment products (not all new products are bad even if a lot of them are flawed). A few of my recent articles for TheStreet.com and a couple of posts on the blog have tried seek out different ways to structure portfolios to have much less risk and reward which of course means the need for a much higher savings rate.

The inspiration is that this decade will cause people to want to give up on the stock market. Well anyone wanting to give up still needs to save and get some sort of return on their savings even if a "normal" 70/30 allocation is not how they will do it.

One idea I'm trying to pull together for an article is along the lines of picking six or seven asset classes (including cash), picking one or two broad based funds for each one and from more of a bottom up tactical strategy entirely sell out of a fund (asset class) that goes below its 200 DMA, or any other defensive concept, and go back in when it goes above. While you are out you are out, not chasing into something else. I imagine this concept would have gone into cash asset class by asset class over the last however many months and now be 100% cash or close to it.

The asset classes might be;

• Domestic Equities
• Foreign Equities
• Commodities
• Domestic Bonds
• Foreign Bonds
• Inflation Protected
  
• Absolute Return
• Anything else you can think of

The reason not to use a target date fund or asset allocation fund is that most of the time diversification will work and breaking out the asset classes give a better chance to capture the zigs and zags as they occur.

For domestic equities, for example, this strategy could use the Russell 3000 Index Fund (IWV). It went below its 200 DMA last December. So the idea is to have sold when that happened and then just wait until it goes back above. Obviously it sill has not gone back above so that part of the allocation would be in cash. Obviously most of the different segments would have gone to cash a while ago.

This is obviously not that original on several levels but for someone on the verge of giving up there is not that much work. Pick one or two broad based, index-like funds for each segment, set up something to alert you when each holding breaches its 200 DMA and check your email. The funds used would ideally just be a proxy not an attempt to add value versus a proxy. IWV is the US market, something like iShares Aggregate Bond (AGG) is the bond market and so on.

One issue, and there are many, is that IWV is about 40% below its 200 DMA which is a lot of potential gain to give up. While that is a drawback the 200 DMA is headed lower and in another couple of months or so the slope down for it will steepen dramatically and so a crossover could occur long before a 40% rally, or not.

As a reminder this concept would be aimed at people that want to give up but know they can't and I assume that if you take the time to read a stock market blog people that want to give up does not include you. So while there are flaws galore it is better than nothing.
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The Big Picture for the Week of December 7, 2008

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Prediction?

You might recall what Clubber said when he was asked for a prediction and coincidentally his prediction back then would have been correct in 2008.

A great discussion broke out in the comments on yesterday's post about stock market predictions with long time reader BillB stating his belief that, essentially, there is no predicting only guessing.

Another reader mentioned John Hussman's seeming knack for market calls.

The notion of predicting where the market will be at a certain time is difficult, absurd and obviously most people get it very wrong. The consensus prediction in BusinessWeek (they have stopped doing this survey) was wrong just about every year. Of course I ah, um, er have tried to make predictions along these lines too. The important thing is not letting the predictions take you too far from your exit and re-entry strategies. If you thought a given year would be up but appropriately took defensive action when your trigger point hit and spared yourself some downside then who cares about the prediction? This is what I do; have an opinion but stay disciplined.

My bigger picture thoughts have some similarities to Hussman although they developed before I started reading his commentaries. Where I think Hussman and I are similar is with the risk at a given period of time being in one direction or the other. I think I come to these conclusions with more macro factors based on what the market is doing. In my simple way of thinking a breach of the 200 DMA signals unhealthy demand for equities. Regardless of what I think the reason might be if demand becomes unhealthy there is then greater risk to the downside.

Now that we have fallen forty whatever percent I think there is more risk of a massive rally (even if it would just be a bear market rally). This notion of course could be wrong and we could take another massive step down from here however the way things usually work fast, big declines are usually followed by fast big rallies. From there it gets tougher to get a feel for what would be next. The details of this bear market might be different but the emotions of fear and greed are not different.

I think it is fair to say there is an element of contrarian thinking in some of this; there is more risk of decline when no one is afraid and less risk of decline when everyone is afraid.

Another difference between Hussman and me is that he places a lot of emphasis on valuations and I do not. While it is not the only thing he looks at, I don't think PE ratios reliably predict anything. Of course the biggest difference with Hussman's approach and mine is he is much better at this sort of thing then I am.
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Thursday Tidbits

A couple of bullish calls noted in the FT. First you probably heard Bill Miller, the manager of the Legg Mason Value Trust Fund (LMTVX) thinks a bottom is in.

You probably also heard him get derided in a couple of places for already calling a bottom in the spring and for being down almost 60%.

One thing is certain the real bottom will be met with much disbelief and then some hindsight bias will no doubt point to some obvious things that most people will not see in real time.

Also in the FT is a call from UBS that the S&P 500 will close 2009 at 1300. That is an interesting number. In mid November I had a quick post about some sort of massive snap back met by another run down in the end and the number I tossed out was 1300. While 1300 was not really a prediction a logical point is that if you look back in market history there have been massive moves up, 30, 40, 50% during very bad times. To say one of those is coming when the selling really ends (even if the fundamentals are forever broken and the country is financially ruined--which is not what I think) is far from a bold prediction. Of course whether it would fit neatly into a calendar year is the wrong focus.

The Harvard Endowment is making news for a swift drop in a very short period of time. I've been writing about the way endowment fund invest for quite a while. There is a fascination with these funds (I too am fascinated) but I think a line needs to be drawn between learning from them and trying to emulate them. The first post I can find on not emulating them is a post I wrote in October 2007. The guys running these funds are smarter than we are but no one is 100% correct all of the time.

Lastly a couple of more new ETFs from ProShares;

Double Long Gold (UGL)
Double Short Gold (GLL)
Double Long Silver (AGQ)
Double Short Silver (ZSL)
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An Interesting Number Actually

Dennis Kneale (I know, I know) just gave out an interesting number.

Since 1950 there have been 68 days where the Dow Jones 30 was up or down 4%. 28 of the 68 have come in the last three months.

Now I'll say that doesn't seem quite right, more the 68 than the 28, but assuming my skepticism is unfounded are we having a volatility bubble? Does that question even make sense? Does a truck catching air in the African desert make any sense?

I might be a tad cloudy today, in bed at 3 am (landed at 2:05) up at 7 am to drive home.
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Making Our Way Back

We flew back to Phoenix last night and are driving home to Walker this morning. Regular blogging to resume tomorrow.

In the mean time how about a reader inspired debate?

Is the US treasury market a bubble (or anyone word that describes excess)?

The picture of Trixie, Pee Wee and Cappi was from before we left.
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Perfect Example

I often mention not worrying about things beyond our control. We are in Honolulu facing a serious delay, 90 minute late departure at best.

There is some maintenance issue that will be fixed when it is fixed. I could be all pissed off but would not make it better would it?

Apply this line of thought to your portfolio.

Aloha.
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The Country That Was A Hedge Fund

A good read on what happened in Iceland from Fortune.
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First item is this article from the WSJ. Apparently the Pennsylvania employee pension has run into some trouble with a portable alpha strategy sold to it.

I would think the legacy of Robert Citron would have taught all municipal pools of money to beware investment banks selling sophisticated strategies.

As a theme of the last couple of days; there is nothing wrong with simplicity. To that point I wanted to touch on something that I don't think I have specifically focused on enough.

One of the goals of taking defensive action after heeding a warning of some sort from the market is to simply have smaller ups and downs within the portfolio. I've spelled out the actions I have taken numerous times and so having a lot of cash raised means you go down less on down days and up less on up days. If the market seems like it is going to head lower for a while doesn't it make sense to simply reduce exposure?

If the average stock in the market is down 40% (made that number up, it is just an example) it stands to reason that the average stock in your portfolio will be down 40%. What seems easier to you, picking the stocks that will somehow only go down 20% or owning fewer stocks after taking heed of something like a breach of the 200 DMA or the 50 DMA crossing below the 200 DMA or the market getting 5% below the 200 DMA?

I'm sure that at the beginning of the year there was an analyst somewhere who made a compelling fundamental case for why DuPont (DD) would hold up in the face of a slow down. Still the stock is down 57% from its high. Now that analysis, if it exists, could have been completely correct but still the name is down a lot more than the market.

I do believe sector decisions and country decisions can help smooth out the ride but those decisions are nowhere near as important or as easy as simply having less exposure when it counts.

On an unrelated note a reader left the following comment on yesterday's post about Plaxico Burress; I hope you appreciate the fabulous life you have. Well I have specifically built the life I wanted to have which took time and planning. I had a couple hardships early on in my life, one of which that was quite serious, which gave me an appreciation for life such that I don't grow old in a cubicle plodding through rush hour traffic wishing the week away to get to Friday. I was in the log cabin before I had this phase of my career (meaning I took a risk to start into the current phase). So yes I fully appreciate the life I have worked hard to build and when I talk about bootstraps and the like I have a couple life experiences to back it up.
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Bad Things Happen In Nightclubs

Giants wide receiver Plaxico Burress will face weapons charges after shooting himself in the leg at a nightclub Friday night. Burress is one in a long list of professional athletes making news in the last few years that contained the words nightclub and gun. These situations happen so frequently that it must almost be statistically significant.

If these guys removed their gun from the equation I suspect there would be less shooting. If they did not go to the nightclub then the odds of gun trouble would diminish greatly. But for some reason they want to go to nightclubs and when they go they want to take a gun, maybe they can't help themselves?

Market participants do things in their portfolios that are the equivalent of going to a nightclub with a gun. This can include intentional lopsided bets, panicking out at the bottom, panicking in at the top, getting talked into doing something by reading an article or listening to someone on TV. Everyone goes to a nightclub now and then but if you don't go often and you don't take your gun with you you're probably going to have fewer problems in your portfolio...hopefully that wasn't too confusing.

The picture is from an hour long hike (each way) through the jungle to quiet little spot near by.
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