Thoughts on Portfolio One

These portfolios started out as a long run risk taking vehicle that (hopefully) would grow and show the importance of investing. The average person has a net worth of zero (after you take into account debt on cars and mortgages) and has little cash in the bank. With these stock portfolios at least everyone has some core body of savings that they can use for investing or to purchase key capital goods (an initial house, a wedding ring). Now, for some of the participants, the portfolios have moved away from a long term risk vehicle to more of a generalized investment portfolio that should logically be slanted towards equities and higher risk since the participants are young but also has to take into account the possibility of a correction that could reduce equity values 25% – 50% for some extended period of time (years) like it did in 2008. You do not want to be in a position where you sell at a downturn and don’t stay in the market because you have to liquidate remaining stocks to cover necessary investments.

For some of the participants we needed to move out of individual stocks and into ETF’s because their professions make owning individual stocks more complicated. ETF’s, however, share the same mix of risk and return as underlying stocks and during the transition we’ve also shifted some of the money out of equity ETF’s and into CD’s and gold as a hedge and partial hedge.

Our current goal for portfolio one is to take some level of risk out of the portfolio and replace it with a combination of CD (get a return of about 1.5%), gold (generally holds more during a crash), or cash (if you need it in the next few months). Depending on the short term interest rate the brokerage account gives in the cash fund we may just choose to leave it in cash instead of CD’s.

Portfolio One is worth about $45k. We could take out $15k or so which would leave $30k in stocks. This is still a pretty high percent of stock for the market (about 70% equity).

Continue reading “Thoughts on Portfolio One”

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.

US_stocks

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.
Continue reading “The Liquidation of Markets”

Currency Returns Since the Crash

It is important to realize the impacts of currencies on the stocks that you select, and your portfolio in total. If you are a US citizen (as are most readers of this blog), then your portfolio of stocks, bonds and cash is essentially “denominated” in US dollars).

The fact that the Australian dollar is up 50% from the 2009 market nadir (against its’ own performance) is compounded by the fact that the US dollar dropped during the last 5 years, for a “net” impact of over 70%. While this is a simplified example, if you just held Australian dollars (plus their implied governmental interest rates), and then transferred them (plus interest) into US dollars at the end of that period, you’d be up 70% on your money (US dollars).

This is important because we have Australian, European, Japanese and ETF’s from other nations in our portfolio.  The fact that the dollar has overall been declining during this period means that stocks held in other currencies have seen their returns boosted in comparison to US dollar investments (like stocks on the NYSE or NASDAQ or US Treasuries).

While there are many reasons why the US dollar has been a poor performer, past performance is not a good indicator of the future, and currency fluctuations are very difficult to predict.  Many people (myself included) have been mystified by the continued strength of the Euro, but the historical returns are undeniable.

When you are selecting stocks, particularly ADR’s which represent stocks traded on foreign exchanges, currency returns may be just as important as stock returns.  When you view the performance of the stock in US Dollars, both the currency returns and the underlying stock performance are “one” number, since the price of the currency is part of the ADR stock price.  To see the impact of the currency, you need to look at underlying performance in the “native” stock market and view this against the price of the ADR in the US market.

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In this case we’ve graphed WBC (the Westpac Banking Corp stock on the Australian Exchange) against the equivalent US ADR (WBK) that trades on the New York Stock Exchange.  You can see how the two stocks mirror each other, with an additional “kicker” on the US ADR because of the decline of the US dollar against the Australian dollar.  If the Australian dollar underperformed vs. the US dollar, these trends would be reversed.  Note that there are many other additional factors to consider including dividends received (WBK is a heavy dividend payer).  With free graphing and analysis tools available at Yahoo and Google and many other sites, it is much easier to do these sorts of analyses and to spot the impact of currencies on your investments.

Stock Market Performance and Our Stocks in the News

Over the 11+ years that we’ve been setting up these trust funds, tools for monitoring stock performance have improved greatly.  Today I use Google Finance to keep portfolios online for each of the six trust funds, and I update them for buys and sells and available cash.  When we first started these portfolios, it was the dawn of the Internet age (remember those commercials for e-trade), and we usually waited to receive our paper statements.

On the other hand, you don’t want to move into a mode of constant reshuffling of the portfolios.  Watching frequently is strongly correlated with frequent trading – you see and react to short term market movements, and you “kick yourself” when you don’t act on short term hunches.

For these portfolios there is a secondary consideration that I want the portfolio beneficiaries, who will ultimately receive 100% of the value of these stocks, to be as large a part of the decision making process on purchases and sales as possible.  This is a key purpose of these trust funds – to teach the beneficiaries about money and to show the real and substantial long term gains that can occur from systematic investing in a thoughtful way over a long period of time.  For purchases we are able to accomplish this by making it an annual process, tied with the annual back-to-school ritual.  For sales, I am attempting to make this more of a joint decision making process by setting “stop loss” levels up front and communicating these levels rather than selling when I think something is 1) overvalued 2) headed for a big loss.  I still have to move unilaterally on an occasional sale when I want to move relatively quickly, however, but I try to minimize those activities.

With all this said, I do watch the markets relatively closely (usually for a few minutes each night I scan the google finance portfolios for the six trust funds and see if alerts pop up for any of the stocks).

While it is easy to say that “the market has rallied this year and gone up by x%” and then to compare this return vs. your stocks, in reality every stock has its own story based on nationality (about 1/2 of our stocks are non-US), its industry, and then finally there is the large “joint” component of economic moves by the Federal Reserve starting with ZIRP and then moving into “Quantitative Easing”.  These events greatly influence all stock pricing, which can be seen clearly when the entire portfolio moves up and down in unison based on news (or perceived consensus on behavior) from the Feds.

Another entire path is how the international markets are faring – the Chinese economy is built on capital expansion, both in real estate and in manufacturing, and they have their own version of high leverage in various trust products and local debt and banking relationships that are starting to flash major warning signals.  When you listen to the news on economics 90% of it is about the US and our policies, when we represent maybe 20% of the world wide economy and we are heavily influenced by what happens elsewhere.  Of high interest to stock investors is the fact that Chinese markets have been in a slump for years, as they anticipated high growth before the growth became reality and then Chinese investors have since moved on to the (perceived) “easier gains” of local real estate.

Thus with all of this background behind us, here are some of the stories that I’m watching…

Australian banks seem to be the most expensive in the world, and are booming due to a real estate and highly valued currency.  We own Westpac, and this is something to watch.  Note also that when evaluating a high dividend stock (they currently yield almost 6%), it is important to look beyond just the stock value to see the total return.

Yahoo! is a 2013 pick and has done very well recently, up over 40% since we selected it in late Q3 2013.  The new CEO (Marissa Mayer) recently fired her hand-picked head of advertising who had a $60M pay package and their advertising revenue isn’t growing.  However, this doesn’t matter much since almost all of the value of this stock is in its China (Alibaba) stake and Japan stake – the US operations are mostly irrelevant (or a possible upside) to the stocks’ total valuation, per this article.

Shell (we own the “B” shares because they are out of the UK and don’t have the dividend withholding that we would have if we owned the “A” shares out of the Netherlands) recently issued earnings guidance that was touted as “Shell shock” about bad quarterly results.  The stock went down and now we are watching to see what happens next.

Beyond Shell we have a large exposure to the oil industry, including Statoil (Norway), SASOL (South Africa), CNOOC in China (we sold CEO recently when it hit our stop loss), Exxon, and also Anadarko (natural gas).  Thus we need to monitor these companies, to some extent, but we mainly buy and hold them because this is an essential part of the world economy and they pay strong dividends (mostly).

We continue to monitor these stocks and will close down our stop-losses pretty soon and create new stop-losses going out into 2014 for a few months.  We want to keep some down side coverage going both for stocks that have had a great run but also for stocks that might be headed for a fall.  Our stop loss strategy is summarized in this post.

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.

Market Timing on Debt

The historical “rule of thumb” is that markets are rational. This is likely true over some period of time, but not in the short run.

A recent article in the WSJ (more like a blurb, on the back page) called “The Big Number” described the current situation with junk bonds.

Yield hungry investors are making the bond market a welcoming place for even the lowest rated borrowers. The average yield paid by new triple-C rated issuers (i.e. “junk”) of corporate bonds in the third quarter hit a record low.

The current yield on new CCC bonds is 9.05%, down from 10.65% in the second quarter of last year. This is a decline of 18% in about a year, which is a giant decrease for a company considering re-financing.

In addition to being able to sell debt at the lowest rates in years, these highly leveraged firms are also able to find buyers for their debt (i.e. the market is liquid).

When the market freezes up, as it did in 2008, there are two main impacts – 1) the rates that everyone pays for financing in the short term move up sharply 2) there is little financing available for those that don’t have the strongest credit. In practical terms, #2 means that if you need money, it will cost you very dearly such as when Goldman Sachs had to borrow from Warren Buffet at a 10% preferred stock issuance.

While it is very difficult to determine the right time to buy and sell, there is no doubt that “market timing” is of incredible importance. If you have a highly leveraged company, these low rates and many yield hungry buyers willing to lend to you means that you can retire very high cost debt, load up on lower cost debt, and roll out maturities for many years, buying your company valuable time in case there is a recession or business downturn.

Today is literally the opposite point of time in terms of market timing from when Goldman Sachs was forced to pay 10% rates to Buffett; today even the lousiest company (in terms of credit ratings) can get funding cheaper than that (9.05%, per this article). This doesn’t mean that rates won’t still fall – if I could predict that I’d be on an island somewhere – but it does show the amazing difference in market conditions that just a few years made, without the economy itself changing in any substantive manner.

Who is buying all of this? Right now your bank account and CD’s effectively pay almost zero, and US government debt 10 years out is 1.6%. Thus for someone who wants income, an investment that pays 9.05% LOOKS a lot better than under 2%.

The flip side of loaning to the most highly leveraged, lowest rated companies, is risk. Risk can be business risk or their continued ability to find low rate financing (liquidity).

On a market timing basis, this is the best time for these sorts of companies.

Cross posted at Chicago Boyz

Buy And Hold Works… Sometimes

For these trust funds we work to link stock selections with long-term thinking. These portfolios start when the beneficiary is 11 or so years old so they have a long time horizon.

With that, there are times that it is wise to sell. If you believe that a stock has been part of a huge run-up and gains are not sustainable, you should sell. We sold a number of stocks in 2007 when valuations were insanely high (such as China Mobile (CHL), which peaked near $100 in 2007-8 and now is settled back in around $50 / share) and many of them have not recovered back to those levels. Unfortunately, we re-invested the proceeds into new stocks which promptly went down with the rest of the market but it still was the right thing to do.

On the other hand, some stocks seem to get permanently impaired or on a downward spiral from which they never recovered. We bought Nokia (NOK) and then sold at a loss – and the stock has kept dropping since, damaged by their dismal position in the smart phone market. We also did the same with Cemex (CX) which also had a high near $40 in the 2007-8 time frame but has settled to around $10 / share.

It is hard to know when to capitulate, and when to hold on to wait for the rebound. Urban Outfitters (URBN) was selected because it had low debt and seemed well run – until they had a bad earnings report and the stock tanked. We held onto it for over a year after it had lost about a third of its value, and then a lot of their top management resigned. Yet recently it came back and is now above its original purchase price. Other stocks that we waited on until they came back include Comcast (CMSCA) and Ebay (EBAY). On the other hand, we are still waiting for recovery on Canon (CAJ), Riverbed (RVBD), WYNN, Exelon (EXC), and Alcoa (AA). I am bullish EXC in the long term as well as RVBD; I think there is hope for CAJ because they are well run; and watching WYNN and AA.