Portfolio Two Updated July 2013

Portfolio Two is our second longest lived portfolio. We started this portfolio almost ten years ago. The beneficiary contributed $5000 and the trustee contributed $10,000 for a total of $15,000. The portfolio is worth $18,991 for a gain of $3991 which is 26%, or about 4% over the life of the fund (adjusted for the timing of cash flows). You can see the detail here or on the links on the right side of this page.

Currently the portfolio is doing well. We have only one stock underwater in terms of “total return” (price appreciation plus dividends) and that is WYNN, and it has come up substantially from earlier lows. Two technology stocks, SPLUNK and FACEBOOK, also have performed well recently (we bought FB near the nadir post IPO and it is getting near its IPO price of $38).

Siemens (SI) is a German engineering company that has missed earnings many times recently and they are looking to replace the CEO. That effort usually provides a good short-term catalyst for the stock and we will watch to see how it performs going forward. NIDEC (NJ) is a Japanese manufacturer that has gone down over recent years and cut its dividend; Japan has tried to rejuvenate their economy by reducing the value of their currency; in our US dollar terms gains in the stock price are often wiped out by depreciation after it is translated back into US dollars (done automatically by the ADR). Both of these stocks are now on watch.

While looking at stocks we’ve sold over the years, two have come back from substantial lows. Home Depot (HD) was sold back during the dark days falling out of 2009-10 but the stock has roughly doubled since then. USANA (the sales company) has also doubled since we sold them. A typical investment advisor wouldn’t bring up past sales that have gone against us but this is a portfolio not for profit just for our benefits and learning so we need to watch what happened. However, we have net done pretty well from the stocks we’ve sold, all things considered.


US Markets vs. The Rest of the World

Although the US stock market has pulled back a bit as of late, we are up over 10% in the year to date. The rest of the world with the exception of the US, however, is actually down about 1% or so. The Vanguard ETF VEU is a decent, simple proxy for the rest of the non-US market (although any single measure is flawed). I started using an average of the US markets and the VUE to compare against the trust funds documented in this blog (see funds 1-5 plus newly started 6 in links to the right) because it is a more applicable mix since 30-50% of the assets are in non US stocks (ADR’s).

There are two main components for the foreign markets right now

1) their currency against the US dollar
2) their market index performance

The US dollar has strengthened against many of the foreign currencies, which means that US assets are worth more and foreign assets are worth correspondingly less. We recently looked at the impact of this on the Japanese markets, where strong growth in local currency (the Yen) didn’t translate to increases in value of stocks to US citizens (unless you bought from an ETF or mutual fund that hedged the dollar / yen exposure to stay neutral, which most of them do not).

Many of the foreign indexes have declined, and European stocks in general have not recovered from the 2007-8 crash to the same extent as the US market did. A simple rule is that anything (in the US) bought in 2006-7 near the peak was way overpriced and anyone who bought during the trough in 2008 when the markets were in their nadir did very well. This rule generally applied overseas as well but some markets didn’t come back as strongly.

Every country is unique as is their impact on the markets. There have been riots and other acts of instability in emerging markets. However, it seems that the moves of the US to perhaps reduce “quantitative easing” by the Fed (QE1-3…) that are spooking the foreign markets, since a rise in the value of the US dollar and interest rates is thought to have a major impact on the relative attractiveness of these foreign markets. Today the world benefits from low interest rates and it is anticipated that at some point these low interest rates will rise and it will have various (mostly negative) impacts on countries and currencies around the world.

Investing is very complex and this blog highly recommends that you do your own research. The point of this post is that in order to judge performance you need some applicable benchmarks and if over 30% of your portfolio is in non-US assets you can’t judge against a US benchmark. You also need to understand not only the performance of the overseas markets but also the performance of their currency vs. the US dollar.

Currency Rates and Japan

Japanese Market and Currency Swings

The Japanese stock market has been rallying, although recent losses have been in the headlines. Lets use this rally to provide us a stark example of the impact of currency rates on your portfolio.

As part of a policy from the Japanese government to spur growth, their currency has been allowed to depreciate 25% over the last 6 months. If you go to any typical financial site on the web you can see the ratio of the US Dollar to the Japanese Yen or follow the ticker “JPY” which is the ratio of the Yen / Dollar. The Japanese Yen was .013 per USD in October, 2012 and is now at a ratio of .0098 per USD as of May, 2013.

Now let’s look at the gain in stock prices. The Japanese Nikkei 225 index, which peaked at 38,916 in January of 1990, was around 10,000 in January 2011. The index reached 14,000 recently, for a gain of approximately 40% in local currency terms.

Anyone would want to participate in a 40% stock market rally, right?

Well, results can vary. EWJ, an iShares ETF covering the Japanese market, is “unhedged”. Thus if you invest you get the local market appreciation (the 40% gain) but this is offset by any currency moves, which means that you lose 25% when you put it back into US dollars. Let’s do a (very simplified) math problem here:

– $100 worth of US investment gains 40% in local currency terms = $140
– Take that $140 and multiply it by 75% (to reflect the 25% loss in currency) and you now get $105 USD
– Thus your gain in USD terms, after the currency change is 5% ($105-$100 / $100)

Due to a number of factors the math doesn’t work that simply so let’s show some real world examples.

Performance of Unhedged (EWF) and Hedged (DXJ) ETF’s

EWF is the “unhedged” ETF for the Japanese market, and DXJ is the “hedged” ETF for the Japanese market (meaning that they buy enough USD derivative offsets to adjust performance against currency moves in the US dollar).

Over the last year the DXJ returned around 50% while EWJ returned 20%. This article describes the battle for market share between the two funds, which DXJ (the hedged one) seems to be winning in the near term.

For many years the Japanese Yen APPRECIATED against the US dollar, so this is a reversal of long term trends. If you’d have used the hedged ETF all those years ago you would have had the opposite results. Hedging is great when the US dollar is appreciating, but goes the opposite when the dollar is falling. Note too that in the long term hedging an ETF is more costly than leaving it in an unhedged state, although this premium is not that large.

Simpler Example – A Single Stock

Let’s look at a simpler story – Nidec, a Japanese manufacturer, has been a stock we selected for Portfolio Two and held it for several years. The ADR for this stock is NJ, and its “underlying” stock on the Tokyo Stock Exchange has the symbol 6594. The two stocks should trade very close to lock step, and the only significant difference in value should be caused by currency swings. Over the last six months

– 6594 on the Japanese exchange (denominated in Yen) has had a positive return of 29%
– NJ, an ADR on NYSE (denominated in dollars) has had a positive return of 10%

Portfolio Two Updated November 2012

Portfolio Two is our second longest lived portfolio, at 9 years. $5000 has been contributed by the beneficiary and $10,000 by the trustee for a total of $15,000. The fund is now worth $16,481, for a gain of $1481, or 10% on the total invested, at a rate of about 1.7% / year over the life of the fund. Go to the right to see a spreadsheet with details or here.

Portfolio Two recently invested in Metro PCS which received a buy out offer and we sold immediately for a gain of $220. WYNN has started to come back from a 30% losing position and is now down about 22%. Urban outfitters also came back from a big loss and is up 7% on the original investment.

On the other hand, the Japanese company Nidec (NJ) has suffered a serious decline, along with the rest of the Japanese market. Portfolio One recently sold Canon (CAJ) and I am thinking strongly of selling NJ, too. The Japanese market is suffering from slow to no growth and a very strong Yen (currency) is hurting exports.

This portfolio also shows the importance of dividends. The portfolio has received $1148 in dividends over its lifetime, which is equal to its gain above investment.

Japanese Stocks

The recent events in Japan have impacts on stock portfolios around the world, including the trust funds that I manage and discuss on this site. There are really four general areas to discuss:

1) Japanese companies which have been directly hit hard by the events as the Japanese market dived (the EWJ ETF which represents the broad market is down about 11% in the last 30 days, vs. 5% decline in the S&P 500)
2) The impact on the Japanese currency, which is up about 3% vs. the US dollar in the last 30 days (after an intervention by the Bank of Japan which tried to stem the gain)
3) The impact on other firms because of the supply chain in Japan (for example GM is shutting down some plants in the US due to a lack of spare parts)
4) The impact on companies that sell to the Japanese people (for example Japan is the largest luxury market in the world for Tiffany)

While I watched with dismay as some of the stocks in my portfolio were part of this decline, notably Canon (CAJ) and Toyota (TM), and Nidec (NJ). The popular wisdom is that the hedge funds bailed out of the Tokyo market, accelerating the decline, much of which has subsequently been recovered. I can’t verify if that is true or not.

In our portfolios, we tend to sit tight and hold unless there is a compelling reason to sell. I think that these three companies are still good companies and if anything, at their current values, they are more of a “buy” than ever. I am not averse to selling when I think that a company is poorly managed or stuck in a dead end industry, but this is not the case with these stocks.

Some of the losses (in local currency terms) were pared by the fact that the currency appreciated vs. the dollar, which shielded some of the blow. This is part of a long term trend of the USD weakening vs. the Yen, as you can see below.

While I make my own choices I do like to go to multiple sources for research. I appreciated the directness of Barron’s approach in their most recent issue, which makes no bones about their recommendation.

Buy Japan

The earthquake, tsunami and subsequent nuclear events also raise the value of diversification. While you can’t prepare for these sorts of events in your portfolio directly, by spreading your bets across countries, industries, currencies and asset classes you can diminish the blow (and also limit your upside).

For now I am happy with my decision to sit tight on the Japanese stocks, which has been partially vindicated by the recent rally as well as the increase in currency values (which has other long term negative impacts as well).

Tax Update

When Dan and I were first invited to join Chicago Boyz Jonathan mentioned my high quality posts on energy and taxation.  Recently I have not been writing too often about taxation because the news from the US perspective has been almost universally negative.

Two core principles of taxation are:
1) the tax should be effective, meaning that if it intends to raise a certain amount of revenue that it should be designed to achieve that end
2) the tax should minimize negative impacts on overall economic behavior

Japan Considers Lowering Its Corporate Tax Rate

There was an old joke that Arkansas’ motto was “thank god for Mississippi” because else Arkansas would have been #50 in the rankings by state on various metrics.  In that same vein, when ever I talk corporate taxes and about how the United States is the least competitive corporate tax environment in the world, they would say that in fact, Japan was worse.

Now even Japan has woken up to the fact that high corporate tax rates push investment overseas (since companies can choose where to invest in new plants, subsidiaries and businesses) and are a relatively poor way to raise incremental tax revenues.  According to this Wall Street Journal article titled “Kan Seeks Cuts in Japan’s 40% Corporate Tax Rate” the newly installed Japanese government is considering reducing this punitive rate, which would take away our “Mississippi” per the analogy above.
Continue reading “Tax Update”

Realism Required On Stock Returns


Gail Marks Jarvis is a columnist for the Chicago Tribune on financial matters. The Tribune recently combined their personal finance and real estate sections into one section, which seems to make sense.

Ms Marks Jarvis provides financial advice. In a column titled “Options About for IRA investors” she wrote the following:

Financial planners have not strayed from their usual advice for people in their 20s, 30s and 40s, despite the more than 50 percent decline in stocks and the subsequent 70 percent upturn.

If you have years to go before you retire, you are likely to make more money in stock funds than in CDs, said financial planner Gary Bowyer. On average, bonds gain 5.5 percent a year, while stocks return 9.4 percent. Although some years are awful, Bowyer said, gains close to the average are likely over 20 or 30 years.

The first and most crucial mis-characterization comes in the first paragraph; she mentions that stocks declined 50% with a subsequent 70% upturn. While this may technically be true, it will lead many people astray; it would SEEM that if you went down 50% and then up 70% you’d be “net” up 20% (70% – 50%) if you weren’t very good at math or didn’t pay attention to the subtleties of the market. However, it isn’t like that at all; if you have $100 and then it goes down 50% it goes to $50; a subsequent 70% rise means that now it is at $85, so you are still DOWN $15 (or 15% on your investment, ignoring the fact that you lost a year towards retirement that you can’t make up, which means that it is an even bigger loss than it appears).

I would agree that most “financial planners”, who make their living selling financial products, would tell you to keep on investing in stocks (mutual funds) and other types of products that earn them money; but it isn’t true that this is the advice that you will find out there at large nowadays (just keep putting money in stocks and it will be all right).

As far as stocks returning 9.4%, that is completely fanciful. Stocks have been DOWN for the last decade, and for it to return 9.4% you’d have to make up all that lost time plus the time value of money. Many planners are urging a much more conservative rate assumption than that. About the only people that use such high rates as assumptions are pension plans that are trying to avoid future cash infusions and yet pay out high payments to retirees.

There are many instances where the stocks aren’t regaining their past highs; look at the NASDAQ index which peaked at above 5,000 (5,132) but is now near 2400. The Japanese stock index (NIKKEI) peaked at 38,916 but is now near 10,800.

This is not to say that you shouldn’t invest in the stock market; but nowadays very few people would view it as sensible to assume such a high rate of return on stocks unless you discount the last decade or so plus the experiences of NASDAQ and the NIKKEI, among others. I also think that the 50% / 70% comparison is misleading to most investors.

Cross posted at LITGM