The Big Picture for the Week of November 14, 2010

By now you've probably seen at least some of the Jeremy Grantham interview on CNBC. Credit Writedowns posted the entire video and it is worth watching. Here is the written transcript as well. There are a couple of things I wanted to hone in on and explore.

About 2/3 of the way through he says;

So, if someone put a gun to my head and said, "I've got to buy stocks. What should I buy?" I'd say, "Buy two units of the Coca-Colas. They're the cheapest group in— in the equity world. Buttress it with a fairly large dose of emerging markets. They're a little overpriced. But, they've got potential. And— a lot more cash than normal for opportunities should the bubble blow up.

He says he isn't specifically recommending Coca Cola (or Johnson & Johnson which is a client holding and a name he has mentioned elsewhere) but he likes this sort of blue chip dividend stock. His comments on emerging markets are a little contradictory in that he lays out a case for the move to continue for a while and he makes the comment above as well but he also notes that they have already started to sell and are now at a modest underweight. The reason for this is that the stocks are no longer cheap and GMO is a strict value shop.

If you stick with a strict value strategy of some sort then you need to always stick with it but you can do this and still believe a theme has legs even if it is not "cheap." If one wanted to take Grantham's advice literally there are of course ways to do it with individual stocks, ETFs or a combo of both.

In thinking about blue chips in the context he means he obviously named KO and in past posts he's mentioned JNJ. To that we could probably add some other staples stocks like tobacco companies and consumer product makers as individual stocks. Finding a half dozen names like this, mature, low beta dividend payers to build one (out of three per Grantham) tranche of the portfolio would not be difficult.

Of course instead of a handful of names like the above this portion could possibly go into something like the SPDR S&P Dividend ETF (SDY) or the iShares DJ Select Dividend Fund (DVY) which a couple of clients own. The trailing yields are 3.26% and 3.73% respectively. An important point of understanding is that these funds have gone through some serious upheaval as a result of the financial crisis. DVY used to be more than 40% financials and now is just 12% in that sector and while I am not certain how much of SDY used to be in financials (I've never held that one for clients) I believe the number was similar and now that fund has 10.5% in financials. Both funds now are heaviest in utilities followed by staples. Where there was upheaval in the past, there could be in the future.

As I think about picking between a handful of blue chips and one of the dividend funds while being true to Grantham's idea I believe I'd rather pick a few stocks. In the context I think we are working under it seems like five or six stocks would result in fewer moving parts than the variables that might impact a dividend ETF. Again the idea is staying true to what Grantham appears to be talking about.

Grantham refers frequently to the other tranche as emerging markets which is a term I think has lost meaning. In picking countries I think the euro should be avoided (one exception would be Finland) along with Japan with a minimal weighting (if any) to the UK. From there countries need to be selected by merit with an understanding of the volatility characteristics of any countries selected.

For this tranche I think picking ETFs is much easier to do in terms of capturing the effect that Grantham is talking about. This can be done with country funds, thematic funds (which includes sector funds) or a combo of the two. There are now dozens of country and regional funds, plenty of theme funds with the desired country exposure and of course sector funds for Brazil and China and we should expect more specialized funds to come out of the pipeline.

While the funds certainly make for easy access I do not think they allow for shortcuts in the analytical process. Anyone buying the iShares South Africa ETF (EZA), for example, needs to understand the dynamics of the country, both past and current, and should have at least an inkling of what is going on at MTN Group which weighs in at 11% of the fund and Sasol (SSL) at 9.5% of the fund.

If you agree with my belief that proper study includes at least a little time spent on the largest holdings then you might be willing to consider individual stocks instead of just ETFs. The chart captures an index in blue versus a component of that index in red. Over a long period of time the stock has outperformed but you can tell from the chart that over shorter periods both the index and the equity track closely together without a whole lot of volatility except during the meltdown.

I stumbled across the stock in some random article, then saw it is a midsize component in the ETF for its country. It is a real company with an English website and annual report with a long track record of profitability. Three percent allocated to this stock may or may not work out as a good hold but it won't wipe anyone out--the key being proper allocation, a favorable disposition toward the country, belief in the company's numbers, at least a decent understanding of what goes on day to day at the company and a reasonable basis to expect that the company will continue to execute.

If you spend the time I promise you that you will find interesting companies, that serve as fine proxies for their country with a better yield than you would get buying the country fund.

The third tranche of Grantham's answer was holding cash for future opportunities. The gripe that people have with cash is the low yield. Yes yields are low but if you can train yourself to think of cash as a tool at your disposal then the low yields should be less of a mental obstacle.

As a much shorter point, early in the interview Grantham makes the case for top down management essentially saying that once you get things like countries and themes correct, the stock chosen should be far less important of a decision. Far less important, yes, but not totally unimportant. In buying a big Canadian bank or a big Australian bank, for example, the vast majority of the time it probably doesn't matter which one you choose. The correlation is usually very tight and they all seem to take turns being the "best."

However in going broader and saying you just want one country where maybe the choices are more limited, then the work picking a stock can be more difficult--there are fewer stocks for Hungary than Canada for example-- and so here the argument for a stock becomes far less compelling.