The Big Picture for the Week of July 5, 2009

No video this week, the mountainside is crawling with in-laws and my routine this weekend is all cattywhompus. The most exciting part of my Friday was that Barron's was online a day early. I can only remember one other time it was out early in this sort of situation.

Of most interest so far (I haven't read the Malkiel interview yet) was the International Trader-Asia column. The focus was on Malaysia.

An ongoing thread on this site has been the need for foreign exposure and the extent to which it is becoming easier to access more and more foreign markets, stocks and so on. The Barron's article was a reminder that we still have a ways to go on this front.

One of the stocks mentioned is a name I have looked at before called Genting Berhad. It trades in Malaysia with ticker 3182, I believe the symbol for the ordinary share is GEBHF and there is an ADR for one of the Gentings (there are several) which has ticker GEBEY but I am not sure if this is the same Genting. The one that I know is symbol 3182 is involved in "plantations, develops and manages property, and is in the paper and oil-and-gas" businesses among other things. I found this company when I was writing this post about farms and plantations but did not mention it in that post for some reason.

The company is obviously involved with a lot of themes I've highlighted in the last couple of years but you know the one-liner about trading by appointment only--well this one appears to not even be taking appointments. The dollar volume in KL averages about $7 million per day, if I have the correct symbol for the ordinary shares on the pinks, well it hasn't traded since June 18th and if that is the correct symbol for the ADR it hasn't traded since June 4th.

It is too bad something like this isn't more easily traded for people so inclined. If you watch CNBC Asia then the Gentings are not particularly obscure and the businesses are not that difficult to understand but the numbers are probably hard to come by unless you have access to a Bloomberg terminal.

For the post linked to above I dug up a bunch of names and started the process of learning about them but the liquidity issues made it clear that buying one of these companies would be very difficult to do and selling could be even more difficult. Malaysia is an interesting country and the idea of owning one of the bigger (this is a relative term) plantations as a proxy is probably a good way to go as captured in the chart, hence the post linked above, but for now this remains elusive.

iShares Malaysia (EWM) allocates 5% to Genting Berhad but that fund has a 31% weighting in financial stocks and 28% split between the two consumer sectors so I doubt that Genting can move the needle much. We'll have to stay tuned.

The Tour de France starts today which should be exciting. The scenery is great, a lot of the action is intense and if Versus doesn't muck it up Phil and Paul can be very funny. As a tip, if you care about watching the tour Tivo the live showing which is all Phil and Paul (at least it has been in years past).

Oh, So Now There Are No Green Shoots?

By now you know the non-farm payrolls report came out and the job loss for June was worse than expected, fortunately the weekly jobless claims number stunk too (small humor attempt). And of course the stock market puked down yesterday.

The tenor of the comments on CNBC seemed to be that oh well, forget it about it now, this after the occasional berating of people who were not so bullish before the June data printed. This sort of manic tone that investors are exposed to from various parts of the media has the potential to be dangerous.

I write often about panic selling and panic buying, letting manic commentary in the media influence your thinking can precipitate panic trading. Think about the last few years from a very big picture. How bad is this really? And how much has changed in the last three months? This has been pretty bad, though not Armageddon, and not much has changed in three months. The stock market rallied a lot and that made some people feel better.

In late December I said I thought there would be a huge rally for no reason at all--it would just happen. I was obviously a couple of months early but it happened. This was not a prediction where I went out on a limb. After markets scare the hell out of people they have violent snapback rallies, this is just how it works.

For the last few weeks, maybe longer, I have been saying I thought there would be one more run down that would scare the hell out of people. I don't think a scare the hell out them decline would take out the old low but I don't know. This is not really a prediction where I am going out on the limb either because...say it with me...this is just how it works. The violent snap back rally, which I have also referred to as feel good rallies reassures people that things are ok and then the market tanks one more time bring it to what John Hussman has called the revulsion stage. Maybe it won't happen this time but the chances are good that it will.

There was no Armageddon or Great Depression 2.0 in the first week of March, we were not completely out of the woods in May, there will be no Armageddon or Great Depression 2.0 if we go down to SPX 700 this summer. I think this is shaping up to what I said months ago which was that the way out will be a stumble along the bottom.

Hopefully long time readers, and more importantly our firm's clients, will realize that my view has been steady as opposed to flip-flopping with each data point that comes along. Aside from probably being unhealthy, constant flip-flopping is more likely to be wrong.

Norway Is the Safest Sovereign Credit

This is probably not shocking if you've been reading this site for a while. The big picture view is that Norway is a surplus country that produces something that the world must have.

Norway is not riskless however due to future production estimates.

Specialization Evolves

Late in August I will be speaking about ETFs at an event called the Money Show in San Francisco. In addition to the two panels I am on I am writing an article for some sort of publication connected to the event (candidly I do not know the details of this). The article was requested to be 2500-3500 words which is much longer than anything I have ever written.

The article will focus on portfolio construction at the sector level using ETF. I have explored this sort of thing before but as more products come out the chance to create a mix that could only be done previously with individual stocks is starting to become reality. Except for Norway.

Basically I constructed a sample portfolio going sector by sector and the article consists of the rationale for each of the sector allocations. While I am not going to front run that article I can pick a sector and build it with different funds and still make the same point. A few days ago I touched on the industrial sector in a similar context to I'll stick with that one here.

The industrial sector currently has a 10% weight in the S&P 500. Usually it makes sense to underweight the sector when the cycle gets long in tooth and then overweight it after a big decline. You can decide for yourself whether overweighting or underweighting is the better position right now. However when you think it is time to underweight the sector you probably also would want to reduce the volatility of the holdings you are using to make up the sector. The process of transitioning to overweight from underweight would probably coincide with increasing the volatility of your exposure.

Consider the follow four ETFs that fall under the industrial sector (either entirely or mostly). For space sake I'll just use the symbols, you can look them up if you care and BTW I don't own any of these personally or for clients which speaks to the choice available.

XLI--megacap domestic exposure relatively low volatility
TAN--solar themed fund that is a wild ride in both directions
FLM--engineering companies that will design and build the world's infrastructure
PTRP--anything involved with greener transportation; volatility is between XLI and TAN

In hindsight it would have been better to have been underweight the sector, owning only XLI and then on March 9 sold out of XLI and gone to an overweight position using some combo of the specialized funds all of which have performed better than XLI off of that low. I would note that all four funds outperformed SPY off of the March low which should not be a shock based on the above comments about when to overweight the sector.

That last paragraph might seem silly but it isn't from the standpoint of the narrower themed funds lagging (even if just slightly) on the way down most of the time and leading on the way up and the sector (as measured by XLI) trailing behind SPY on the way down and outperforming on the way up. Being correct about when the market is going up or down is obviously the key variable and very difficult to get right so being 100% in XLI or 100% in a bunch of more volatile specialized funds is never the solution unless you are very aggressive.

While knowing what the market will do is elusive it is comforting to know that certain things, like the above, will stand up the vast majority of the time. If you believe in active management (even if you are your own manager) then at some point a decision needs to be made. Getting the timing right is not easy but knowing how to increase or decrease your volatility is easy. In a hyperbolic example you know that switching your industrial exposure from GE to First Solar is going to change the behavior of your portfolio a lot. It would be the same switching your industrial exposure from XLI to TAN. Changing the combo of the same four ETFs a little less dramatically would make the effect on the portfolio much less severe.

The Quarter Is Over

As a philosophical matter I think highly of the concept of living in the moment or focusing on the journey as opposed to the destination. Anyone believing in this sort of thing thinks it is a healthier way to navigate through life. With that in mind this post may seem like a bit of a contradiction.

First a little context for the second quarter and the first half of 2009. In the first quarter the S&P 500 was down 11.7%, in the second quarter it was up 15.3% and YTD it is up 1.7% plus a couple of dividends. Without getting into numbers which would be a no-no (as our firm understands it) you could expect a portfolio that has generally been defensively positioned all year to have gone down less in the first quarter, up less in the second quarter and be in the same neighborhood at the market YTD. Consistent with the goal of a smoother ride.

One way to describe the job of a portfolio manager it to set an expectation of some sort for clients and then try to meet or exceed the expectation. The expectation set would probably be centered around whatever the investment philosophy of the manager and prospective clients generally need to be of a like mind or it will be a bad fit.

Whether the ride has been smoother over the last six months or not, in my case might matter to our firm's clients now but the odds of anyone remembering their performance (whether they hire someone or do it themselves) of a given six month period in some random year is pretty low. Quick, how'd you do H2 2005?

What you do know is whether you've had a major setback because of this bear market or not. Major setback is probably a subjective term but then what was the expectation set for you or what expectation did you set for yourself?

While living in the moment is very important it is unlikely that a bad quarter or bad year ten or twenty years before you retire will have a truly detrimental effect on your long term financial plan. Of course this assumes proper asset allocation. When the tech bubble burst the ultimate low for the S&P 500 was about 50% below the high. It then made a new high five years later (late 2002-late 2007).

In the current bear the market again cut in half and just like last time very few people expect a new high to come in five years but of course it could. This is not a prediction but just as we learned some things in 2008 about fast declines we should have also learned (more correctly been reminded) of how fast the market can rally even if there is no fundamental justification.

Over long periods of time the market has had an average annual return of 9-10%. If that average is still in tact when you retire then the double bear of this decade will not have mattered a whole lot. In that light anyone who is young needs to focus on the long term and continue to sock it away (maybe a little more intelligently than domestic equity funds) and anyone who is older needs to have a proper asset allocation and not panic sell after a big decline.

You may be inclined to take the above as an argument passive indexing and for you that might be right but that is not what I am saying at all. If we circle back people causing themselves far more harm than a bad market (IE panic selling) then reducing the likelihood of being in a position to panic would have some appeal. It is reasonable to think more people would panic sell if their portfolio dropped 40% in a down 40% world than if it dropped 20% in a down 40% world.

Twofer Tuesday

IndexUniverse had an article up yesterday about the rebalancing at Russell Investments that occurs every June and was just implemented for 2009. IU seemed most interested in the increasing presence of Chinese stocks.

The five largest stocks in the Russell Global Index (I'm not familiar with this one) in order are;

Petrochina (PTR)
ExxonMobil (XOM)
Industrial & Commercial Bank of China (IDCBY)
China Mobile (CHL) a client holding
Walmart (WMT)

We are all much more aware of China as an investment destination than we were seven years ago. I seem to remember that the first Chinese stock on the NYSE was Sinopec Shanghai Petrochemical (SHI), but I may have that wrong, and then it seemed like most people knew about Petrochina early in this decade when Warren Buffet first piped up about having a position.

Fast forward a few years and US based investors can now access Chinese solar stocks, water stocks, technology companies and even shampoo companies. We clearly had a mania in Chinese stocks for a while there, then the market imploded and now things are whipping up again but the Shanghai market is still down more than half from its high, the Hang Seng down about 40% from its high and the Hang Seng H Shares, or enterprise index, is down 45% from its high.

I've disclosed my involvement with China many times before. I sold my only position in May 2007 (the other Sinopec with ticker SNP) and bought back in with China Mobile in the summer of 2008. I was a little early on both getting out and getting back in.

If IPOs like BaWang can do well, the shampoo company mentioned above, then that is reason to be concerned about overheating despite being so far below the old highs. The long term fundamental case for China has been made many times in many places but the decline is a good reminder that the stocks will be cyclical and volatile even if the big picture story remains in tact.

The best way to avoid getting badly hurt from another implosion is simply to not own too much. I currently target a 2% weight and I could see getting as high as 5%. That's 5% and I absolutely love the theme. I loved the theme during the 14 months I had no exposure. As great as something might be you can still get it wrong. Being wrong is not as bad as what the consequence of being wrong might be.

Speaking of themes I love there was an interesting segment on Squawk Australia on Tuesday morning (Aussie time) with Steve Johnson from a firm called Intelligent Investor. The end of the conversation was about his opinions on Australian Infrastructure funds/stocks. He said he currently likes four or five out of the 20 that he covers. Twenty? Macquarie and Babcock & Brown each have quite a few funds listed in Australia and there are a couple of others.

Infrastructure is just as important a theme as China (obviously there is overlap). The money is going to be spent on infrastructure and despite how much some of the stocks and funds went down the money was never not going to be spent. The US is not quite at the investment saturation point that Australia might be (the US may have 20 funds out there to pick from but the Australian market is a tiny fraction of the US market) but with all the new sector talk and other hype out there you avoid getting really hurt by something unforeseen by not making a big bet.

I get questioned a lot on the don't make a big bet mantra but think about how many themes there could be out there and how many you might have an opinion on. Just the other day I mentioned a half dozen just in the industrial sector. Five or six themes at 5% each on top of the more plain vanilla things you may hold and you probably have a full plate.

There Will Be Work

We have a fenced in pen off of our deck for the dogs to have a little bit of room to explore and play. A couple of weeks ago our two smallest dogs got out after something (maybe a squirrel?) dug a small hole in from the outside of the pen. The two dogs were only gone for a few minutes but it was very scary for a little bit. We had lined most of the pen with rocks of varying sizes but it was not perfect.

So Sunday morning Joellyn and I embarked on a masonry project where we made up some concrete, moved rocks and then reset the rocks in the concrete while trying to work the little bit of chicken wire that runs along the bottom of the fence into the concrete. What does this have to do with investing you may ask?

On Sunday a reader left a comment in response to my writing about owning foreign equities asking "doesn't it depend on what foreign equities you own?" Well yes it does.

The work in the pen required heavy lifting of many bags of concrete and adding more heavy rocks to the fencing. The idea of gravitating toward more foreign exposure more narrowly than just owning iShares MSCI EAFE Index Fund (EFA) requires a different type of heavy lifting. As a quick note EFA blends away a lot of attributes of the smaller, healthier countries, provides a lot of exposure to Japan and big Western Europe and tends to correlate much closer to the US market than many single country funds.

The concrete needed to be mixed, the rocks that were already there needed to be moved, more rocks, where needed, had to be hauled in from elsewhere on our property, everything needed to be set and then everything needed to be properly cleaned up; there were no short cuts.

If you believe your portfolio needs to become progressively more foreign then you need to learn the dynamics of many other foreign countries, figure the role that these countries can play in your portfolio, figure out how to access those countries and then follow those countries effectively; there can be no short cuts.

I realize there are time considerations, that people in general just may not want to devote this much energy to this and of course I may be wrong about the need for more foreign but this is how I see it. Of course there will be the hard core (or maybe not so hard core) passive investors who say this is just speculation and not investing.

I doubt I will change anyone's mind on this subject if I have not already done so but for a similar view from a different voice check out this week's Connie Mack show, specifically the segment with Andrew Lo from MIT and a half dozen other places. The simplistic takeaway from the interview is that things like buy and hold and using broad based index funds are not wrong but they need updating.

This may be a tie in with my views about markets and investing evolving. I have been writing about this as long as I have been writing. Over reliance on well it's always worked before is a bad idea. The status quo might be comfortable but are you willing to bet your future that it will be correct?

The picture is from the fence's earliest days.