The Liquidation of Markets

Every weekend I read Barry Ritholtz’s recommended reading and there are a lot of gems in there. Recently he posted this Credit Suisse graphic about markets at the turn of the 20th century by market share and compared it with 2014 on the topic of global equity investing.

In his article he mentioned the fallacy one might fall into as a UK equity investor in 1899… why bother investing in the USA when the UK market is so much larger? And then this line of thought ends up missing the huge growth in US market share over the next century.

However, the real issue here isn’t the relative change in market share by the different countries; it is the fact that almost all of these markets were entirely extinguished at one time or another by political, economic or military events that wiped out the investors.

The Rise of the Dollar

When I was growing up as a kid I remember they had TV commercials against Jimmy Carter explaining how the dollar declined vs. other currencies over the decades. In the late 1980’s the Japanese Yen soared in value until their market crashed in 1989. The Euro was originally near parity with the dollar, then fell to 70 cents on the dollar (I happened to be in Europe at the time, it was great), then rose to over $1.30 against the dollar.

In general if you keep your portfolio all in US assets you are essentially “100% long” against the dollar. A few years ago the dollar effectively fell almost 40% vs. many of the worlds’ major currencies – this is the time when the Canadian and Australian dollar almost reached parity with the US dollar. For US citizens who traveled frequently across the border into Canada, it seemed strange to think of the Loonie as being just the same as a US dollar, since for years it was worth substantially less. Thus if your portfolio was all in US dollar denominated assets, your value fell 40% that year vs. the worlds’s currencies, even though you couldn’t “feel” it unless you traveled abroad or tried to buy imported goods.

Recently, however, this has all turned around. The dollar is soaring vs. most of the world’s currencies, which is good news for travelers and makes imports cheaper. However, those who own foreign stocks are looking at losses regardless of how the underlying stock performs (often many of the underlying foreign businesses IMPROVE when the US dollar rises; for instance Indian outsourcing firms who are paid in US dollars find that this money stretches further when paying their Indian based staff in rupees), just because of the rising dollar.

It is controversial but many central banks are taking steps to effectively debase or reduce the value of their currency in order to keep their export economies competitive. This is essentially the strategy of Japan. On the other hand, some countries are faced with dire circumstances due to the fall in their currencies, which causes inflation locally and can crush banks and those who take out home loans and bank loans denominated in foreign currencies (a surprisingly common overseas practice, although the down side is clearly on display in countries like Russia where a 50% fall in the ruble means that your mortgage just doubled). Some countries like Venezuela and Argentina are in extreme shape and basic goods are not available on the shelves and local manufacturing has mostly seized up; this happens when you stop the flow of dollars outside the country and try to prop up your local currency regime (and lack credibility).

Finally, while everyone thinks the Fed is going to raise interest rates at some point, now we need to think of the impact on the dollar. All else being equal, raising interest rates is going to make the dollar even stronger against its peers, especially as those countries remain in a zero interest rate environment (ZIRP). Given the huge rise that the dollar has already seen, further increases will make exporters even less competitive on the world stage.

I am reading a few books on currency wars and I didn’t realize that the US and Saudi Arabia had an explicit deal where the US provided security as long as the Saudis invested their excess in US Treasury bonds and denominated the world price of oil in dollars and not any other currencies. This gave rise to the term “petro dollars”. While I had heard the term many times I did not realize that this was an explicit not implicit relationship. Even today oil is denominated in dollars, although Putin and the Chinese are working to change that over time with their own bi-lateral relationship (which is running into a rough patch with the fall in the ruble recently, but obviously has long term potential given Russia’s huge resource pool and China’s voracious demand for commodities).

Cross posted at Chicago Boyz

Performance Update for January, 2015

There has been a lot of activity in the markets.  I updated the google finance accounts where I track performance for the individual funds 1-6.  We set up stop losses and about half of them were triggered overall by the rout in the oil market and also the recent fall in Chinese stocks.  I created graphs of performance since last September (when I set up in google finance) marked against VTI which is a Vanguard ETF that mimics the US market performance and VEU which is a Vanguard ETF that mimics the non-US market performance.  Generally since our funds as a rule of thumb are about half US and half non US we’d be about in the middle.  But this is a rule of thumb and varies depending on the specific stocks and their unique performance in each portfolio.

Portfolio One

Portfolio Two

Portfolio Three

Portfolio Four

Portfolio Five

Portfolio Six

Investing – Basic Plan

If you want to invest on your own, there are some basic ways to approach it.  Here is a simple model that you might want to consider using.

The goals of this approach are as follows

• Build a simple, consistent approach that does not require a lot of re-balancing
• Minimize fees and expenses

The money you want to invest can be split into any grouping depending on your risk tolerance.  For the sake of this discussion, let’s assume that you want to split evenly before the 4 categories that are listed below.  If you were putting in $100,000, you might put $25,000 into each of the 4 categories below.

1. 2 year new issue brokerage CD’s (bought at par, or 100 cents / dollar, no gain loss)
2. 5 year new issue brokerage CD’s (bought at par, or 100 cents / dollar, no gain loss)
3. Vanguard ETF total US stock market (ticker VTI)
4. Vanguard ETF total world stock market except US (ticker VEU)

I wrote a lot of articles about buying CD’s from a brokerage.  Some highlights include 1) you get better rates than you get through your bank (for instance I saw 2 year CD’s at my bank at 0.7% and was able to get 1.2% through my brokerage) 2) the CD’s are guaranteed against loss – worst case you get your principal and accrued interest back (many of my CD’s were tied to banks that failed in 2008-9, so I tested this theory) 3) when you buy the CD’s up front through your brokerage account you pay no expenses except for any per-trade charge your brokerage like eTrade or Vanguard or Schwab might add to the trade (i.e. no annual fee).

What are the CD’s accomplishing?  They are your “safe money” in the portfolio.  You effectively can’t lose money if you hold them to maturity.  If you have to see early before they expire (i.e. you need the money to buy a house) your brokerage account can put them up for sale and you will have a small gain or loss depending on how interest rates have moved since the time you bought your CD.

There are other ways to do this (buying bonds, treasuries), but they are more complicated, and don’t offer significantly better returns than this.  On the other hand, you may note that some bond funds have had big gains, but these are mainly bets on interest rates and on the riskiness of portfolio items and this is fine but you need to know what you are getting into.  The CD’s should work fine for most investors.

Also note that many bond funds have fees in the 0.5% range (although some are more, and many are far less).  At this point, the fees will eat up your entire return!  We need to plan as if the low interest environment (ZIRP) that we are in will go out indefinitely, which means low returns and watching expenses is paramount unless you want to take on more risk in terms of your investments.

As far as the ETF’s, it is easy to buy them through your brokerage account, you just figure out how much you want to buy (say $25,000) and determine the current price (about $107 / share) which is 230 or so shares.  Put in an order, which might be free or might cost you up to $25 (depending on your brokerage), and voila – you are done.

Both VTI and VEU have rock bottom expense rates – VTI is at 0.05% / year (meaning $25,000 costs you $12.50 / year) and VEU is at 0.15% / year (meaning $25,000 costs you $37.50 / year).  Note that a typical financial advisor plus fees on ETF and mutual funds might cost 1.5% / year, which would mean $25,000 would cost you $375 / year.  Of course they also give you expert advice, so that is the flip side of that transaction.

How do you manage money using this model and re-balance?  Easy.  Likely semi-annually you will receive interest on your CD’s – this is about 1.5% on average between both of them – so you’d have 1.5% times $50,000 = $750 / year in interest.  That doesn’t sound like much, but that’s pretty much the best you can do nowadays.

For your stocks – you will receive the dividend yield every year as cash in your account – VEU yields about 3.5% and VTI yields 1.75%, so on average you’d probably get about 2.6% / year in dividends or $50,000 * 2.6% = $1300 in cash.

The interest income on CD’s is taxed at the highest marginal rate for you (likely 28% or higher) but the dividends will be taxed at a lower rate of about 15%.

Rebalancing?  You shouldn’t need to.  Just leave the assets where they are.  The 2 year CD’s will come due and you can buy new 2 year CD’s, and later the 5 year CD’s will come due.  Unless you need to buy a house or something I would just leave the ETF’s there forever – they are a bet on the stock markets in the US and around the world.

As your assets earn cash they will be deposited back in your cash brokerage account.  Take that cash, plus new cash you’ve saved up, and then pick one of the 4 categories depending on your risk tolerance, and invest more.

That’s it.  This is a super low cost plan that requires little re balancing and gives you a balanced portfolio.

Stop Orders Entered

After the recent analysis, the following stop orders have been entered.

Each of these stop loss orders is good until 2/20/15 (60 days from now).

Portfolio One

Sasol – SSL at 35 (now at $38.95) SOLD AT $35

Transalta – TAC at 8 (now at $9.18)

Portfolio Two

Anadarko – APC at $75 (now at $84.86) SOLD AT $74.97

Transalta – TAC at 8 (now at $9.18)

Portfolio Three

Anadarko – APC at $75 (now at $84.86) SOLD AT $74.97

Weibo – WB at $13 (at $15.78) SOLD AT $13.06

Portfolio Four

Coca Cola Femsa – KOF at $80 (now at $89.14)

Seaspan – SSW at $17 (now at $18.80)

Portfolio Five

Sasol – SSL at $35 (now at $38.95) SOLD AT $35

Seaspan – SSW at $17 (now at $18.80)

Portfolio Six

Coca Cola Femsa – KOF at $80 (now at $89.14)

Seaspan – SSW at $17 (now at $18.80)

Stocks to Review – December 2014

In order to decide what we should sell or keep, we need to review the stocks that have been hit across the six portfolios.  There are 12 stocks listed and grouped across the various industries and regions.

We will look by group to determine what we recommend to do next based on the specific circumstances of that stock and the factors that caused their valuation to change.  If it is a dividend related stock, we will also start to think if their dividend is “at risk”, because that would likely trigger another price drop.  Many of these stocks have rebounded off their lows, which makes this task easier.

Of the stocks reviewed, the ones we will watch closely will be Anadarko (APC), Sasol (SSL), TransAlta (TAC), Weibo (WB), Seaspan (SSW), and Coca-Cola Femsa (KOF).  We will consider stop losses on these stocks.

US Energy

• Exxon Mobil (XOM)
• Devon (DVN)
• Anadarko (APC)

Of the 3 US energy companies, Exxon Mobil is a long term keeper because it is so well and ruthlessly run.  They have a reasonable dividend of about 3% that doesn’t seem to be at risk.  XOM may even be a candidate for further purchases if it keeps declining in the short term.

Devon is much smaller than XOM.  Their dividend is not as good, under 2%, but that also means that they aren’t being forced to support an unmanageable dividend burden.  From what I’ve read they seem to have hedged against falling oil prices which should insulate them a bit in the short term.  Devon also could be an acquisition candidate at some point although their market cap is $24B so only a giant like XOM could take them out.

Anadarko (APC) (like XOM and DVN) hit a 52 week low, but bounced back recently.  Their dividend at 1.4% is low and doesn’t seem to be at risk.  The company also has financial flexibility.  We are on the edge with APC if the oil rout is extended this may not be a stock to hold.  For now we are holding on with the rebound in energy prices off their lows, but this is on watch.

Global Energy (ADR)

• Royal Dutch Shell (RDS.B)
• Sasol (SSL)
• Statoil (STO)

These global energy companies not only are hit by the drop in crude (see above), but also the decline in foreign currencies vs. the rising US dollar.

Statoil (STO) is denominated in Norwegian Kroner.  Over the last year the Kroner has declined 20% vs. the US dollar.  This means that our ADR has fallen 20% additional beyond the impact of other (negative) factors on the STO stock.  On the other hand, in the past the rising Kroner has boosted returns compared against US equivalent stocks, and provides diversification should the US dollar fall.  Statoil is likely going to defer some major deep water projects since those are not economical at the current oil price.  The dividend is now over 6% with the stock price decline; in general when dividends go much beyond 5% they often turn out to be unsustainable, or in any case should be watched closely.  The Norwegian government also holds a significant stake in this company, which allows them to impact behavior, but they seem to be a prudent steward (compared to partially public or state owned oil companies in Mexico or Brazil, for instance).

Shell (RDS.B) are denominated in UK pounds, which has fallen 5% this year vs. the US dollar.  Shell seems to be in relatively good shape, but the stock (like virtually all energy stocks) is near its 52 week low.  Their dividend is at almost 6% which seems sustainable for now but may not be in the long term.  They seem to be taking steps with their asset portfolio by country to sell components to optimize the company, which seems prudent.

Sasol (SSL) is denominated in South African Rand, which has fallen 11% vs. the US dollar.  SSL is a large energy company for Africa, but is much smaller than the other global majors.  The dividend is near 6%, a level to watch closely.  The stock at one point lost almost 50% of its value and may be a buy at this point or for consideration.  This stock seems more speculative than Statoil and Shell up above (which makes sense because each of the other companies are much larger) which means it is on watch (like APC, above).  On the other hand, since it is smaller, it has more room to grow on the high end in terms of stock price.

Canadian Energy (ADR)

• TransAlta (TAC) – TransAlta is a Canadian energy company primarily operating in the electricity business.  They also have substantial and growing interests in Australia.  The company has been hit with a big fall in electricity prices in its main provence, Alberta, which means it earns substantially less revenue on the power it generates (most of the company’s costs are fixed in the short and medium term, so this goes straight to the bottom line).  The long term bet on why power use is growing in Alberta, however, is the oil industry so this stock is significantly impacted by the same forces (low oil prices) as the other stocks listed above, in a medium or longer term horizon.  The stock has a large dividend, at 7%, which means it definitely is on watch.  If the company decided to cut the dividend (for whatever reason), it is likely that the price of the stock would fall.  Many investors likely own this stock for income purposes.  As an ADR, they also are driven by the fall in the Canadian dollar, which has dropped about 8% vs. the US dollar over the last year

Chinese Internet (ADR)

• Weibo (WB) – Weibo is a Chinese internet company, sometimes called their version of Twitter.  Alibaba, the giant of Chinese e-commerce (their Amazon), owns a 14% stake in WB, and in September the stock shot up because of speculation that Alibaba might buy the company or increase their ownership.  Chinese stocks are generally volatile and the tech industry is particularly so.  The stock has gone up recently, but is near a 52 week low.  This one is also on watch but seems to have a reasonable upside, especially if it was swallowed up.

US Technology

• Amazon (AMZN) – Amazon is, to (partially) quote Winston Churchill, “a riddle wrapped in an enigma”.  The company is a powerhouse, altering whole industries and taking a giant role in e-commerce.  The founder is famously frugal and uses old doors as desks for employees.  Also – the company doesn’t make profits or focus on short term profits.  They continue to invest and to move into new markets.  This company is probably the hardest company in the world to analyze as a result and I personally have had more arguments about Amazon than any other stock.  To be clear, we had it at $14, and I sold at over $100, taking almost an 8x gain, but then it marched all the way to $400 / share, and now has lost about 25% off its peak and is near $300 (we bought most recently at $337).  The market seems to generally believe in Amazon so this is a keeper, even though as an accountant I am often perplexed.

Chinese Shipping (ADR)

• Seaspan (SSW) – Seaspan is a smaller company that ships goods back and forth primarily to China.  They now have a very high dividend, near 7%, so that is something to watch.  If they ever cut this dividend I would expect that the stock price would be significantly impacted.  The stock price fell on SSW, but bounced back from its 52 week lows.  Even if China itself is slowing in terms of growth the demand for Chinese goods worldwide is still rapacious.  The company is also looking to upgrade their fleet continually to make it more fuel efficient in terms of scale.  On the other hand, shipping is a difficult business in a downturn, as shippers cut rates to near the marginal costs of running their fleet, just to keep afloat (bad pun).  If SSW has a more fuel efficient fleet than most, it should be able to withstand a downturn longer than competitors.  This is a stock on watch.

Casino / China

• Wynn (WYNN) – Wynn at one point lost almost half their value on concerns over Chinese cutbacks in gambling.  China has a huge gambling culture (wagers at Chinese casinos on average are much higher than in the USA) and there is only one place in China where you can gamble, and WYNN has a casino there.  Much of the Chinese gambling is also a method to move money out of the country, a much more complex topic than I could cover here, but it is safe to say that gambling in China is a much more serious business than it is in the USA.  The current Chinese leader is cracking down on “corruption” (I use parenthesis because the whole business culture is corrupt in a mega-sense, but he is talking about specific behavior elements like lavish behavior with official money) and this means gambling.  WYNN does have an attractive dividend and special dividend and in the long term (unless they open casinos on the mainland) they can recapture money as soon as the official glare goes away.

Mexico / Consumer Staples (ADR)

• Coca Cola FEMSA (KOF) – Like our other ADR’s, the Mexican Peso has been hit by a 10% drop in value vs. the US dollar, which weighs on this ADR.  It is off 52 week lows but has lost 1/3 of its value over the last 12 months.  The stock has a modest dividend so it is looked at as a long term growth play on the Latin American market.  The stock is on watch due to performance and low dividend but, like Chinese gambling, it is a hard market to walk away from since it is hot and bottled drinks of sugar and beer seem like a safer bet in the long term too.

Portfolio Six Quick Update December 2014

Portfolio six has Coca Cola Mexico, which was hit by the falling peso and general Mexican business conditions.  Exxon Mobil fell due to the oil price crash and Shell too, although Shell was also impacted by the rising dollar.  Finally this portfolio has Seaspan which has fallen due to a narrow earnings miss, the threat of slowdown in China, and currency changes.