Archive for January, 2010

Classifying your assets

There are many ways to classify your assets. If you look at the 2009 annual review charts, you will notice that we have a 5 step classification system which is designed to help us understand where the money is flowing in the international financial system.

Level 1, Extremely Nervous: Money Markets, Short Term Government Bonds
When return of capital is more important than return on capital.

Level 2, Moderately Bearish: Longer term Government Bonds plus High Quality Corporate Bonds
Investors are not very positive on economic growth and not worried about inflation as a result.

Level 3, Neutral and Looking for Yield: Utilities, REITs, High Yield Bonds and Convertible Bonds
Investors are willing to take risk but don’t see strong growth in GDP or corporate earnings. Commodities also fall in this category.

Level 4, Moderately Bullish: Developed Markets, Large Cap and Liquid Equities
Investors see growth in GDP and corporate earnings but are concerned about risks to that growth in the future.

Level 5, Aggressively Bullish: Emerging Markets, Sector and Theme Funds
Investors are actively seeking more speculative markets and feel that the risks to growth are remote.

The key difference between our ranking system and a more traditional system is that we are looking to rank for where investors are putting their money. The point of the IRP System is to make use of the professional managers at the funds but to take control of the asset allocation. The difference between Core Value and Core Growth is interesting but irrelevant when investors are running for the exits. In a less dramatic sense, the IRP System will also keep you in funds for as long as they are outperforming their peers and cash. This helps avoid the temptation to take profits on winners too early.

How will 2010 turn out? We still predict that the markets will be choppy as we approach decision time on how Central Banks will exit the market and how much the developed countries will raise taxes. For actual investment ideas, watch the IRP System for the latest signals.

The IRP System is still telling us to look at Emerging Markets, Metals (Copper, Gold and Silver) and selected currencies.

In the US Sectors Portfolio, it is still Gold on top (although Silver still rates higher in the ETF Long portfolio) with Health Care making a strong move into the top 3.

On a Global Basis, the ETF portfolios are still positive on the emerging markets and metals, much like the Taiwan based portfolio.

In several of the portfolios, Technology funds and Real Estate have remained at the top of the list.

For Commodities, sugar, natural gas and copper top the list.

Central Banks and Exit Strategies

Your local Central Bank is preparing an “Exit Strategy”, should you?

Last year was the Year of Government Intervention. In many countries around the world, that meant a significant shift of debt burden from the private sector to the public sector.

This year, developed country governments are looking at budget deficits for many years to come.

The “bond vigilantes” have not been able to wield much influence in the face of quantitative easing (QE) programs. They are wise not to bet against an adversary who can create high powered money with a few keystrokes on the computer.

The FED believes it is avoiding the mistake of 1937 by continuing its loose monetary policy. However, it is less clear that other big economies have the stomach to keep expanding their monetary base and government deficits. In Europe, Sovereign Debt levels are rising to unsustainable levels in several EU countries. Germany is trying to indicate that it will not bail out Greece but the fate of the Euro may hang on just such a bailout.

All the speculation is interesting but the action will take place behind closed doors. For the average investor, what is one to do?

This year, like last year, the key will be to watch the IRP System. 2010 is likely to be a volatile year. Big investors like the FED, Sovereign Wealth Funds, Hedge Funds and others are unlikely to give clear signals of their intentions because they will only hurt the value of the assets they are trying to sell into the market. We are entering a period where traditional analytical techniques (which depend largely on extrapolating past trends into the future) will be of even less value than normal because the change in money flows will be largely government (politically) directed rather than a business response to changes in the economic outlook.

So, you do not necessarily have to prepare an “Exit Strategy” but you should be watching the various asset classes in your investment universe to make sure you money is well positioned.

So, what is the IRP System telling us this week?

From a global perspective, the top asset classes have shifted positions a bit but remain unchanged. Emerging markets and Metals are still the preferred asset classes. In the US, the Gold ETF outpaces all the other sectors (although in our Global ETF Portfolio, Silver is the better bet). Consumer Discretionary and Technology are slightly ahead of Energy but the trends are not particularly strong.

For Commodities, Sugar and Natural Gas are leading with Base Metals in a weakened third place position. Silver is again looking better than Gold.

As for currencies, the system suggests going long the Korean Won and short the Euro and Japanese Yen. The NZ dollar is running a bit stronger than the pack and the British Pound is running weaker with the other currencies in a trading range.

To sum it up, more risky equity assets, commodities and select currencies are still worth holding. The technology sector is still strong and Pharmaceuticals are improving (discounting a possible failure of ObamaCare?). There is no need to rush for the exit this week but a number of our positive indicators are less robust than they were only a month or two ago. Be prepared to make adjustments to your portfolios in the next few months.

Preparing to Sell

What a strange title after such a pleasant beginning to 2010. Don’t worry…no need to sell today. But, be prepared to make big changes in your portfolio as the year unfolds.

Emerging markets are on top because they have the ingredients that investors are looking for: Growth, Natural Resources (in many cases), High Savings Rates, Strong Work Ethics, and Products You Can Drop on your Feet.

Two items in the news this week should strike most investors as interesting milestones: China outexported Germany in 2009 to become the world’s top exporter and Chile was invited to join the OECD. I do not remember reading those predictions in the year 2000 (or even 2007).

But those achievements (and investment returns) are now historical and we need to look forward. Will the emerging markets theme continue? For now, the answer is yes. The System is still recommending emerging markets in those portfolios that have them in their universe. Will the emerging markets theme falter and will we need to switch into other asset classes at some point in the future? The answer is: probably.

But will we be ready to make the switch when the signal comes? Let’s consider three examples:

  1. You buy some packaged vegetables from the grocery store. When you pull them out of the refrigerator later, they have gone bad. What do you do? You throw them away rather than risking your health by eating them.
  2. You buy a car. Very quickly, it develops mechanical trouble. You make several trips to the mechanic but nothing seems to get the car working correctly. You have a lemon. It is time to sell or you might end up on the side of the road.
  3. You make an investment in a mutual fund or a stock. The investment starts to lose money. When you open your monthly statements, you notice that it is falling while other investments are rising. Do you sell it?

While the first two cases are straight forward, in case three, the answer is not so clear cut for many of us.

Selling the investment will be painful emotionally and financially. However, it is not immediately clear that holding onto the investment is as damaging as eating rotten food or driving an unreliable car.

Perhaps the investment will regain previous levels. If that were to happen, then perhaps the initial investment wasn’t a mistake after all.

So now we have uncovered the emotional comfort of “Buy and Hold”: One need not recognize a mistake.

To think about it another way, “Buy and Hold” equals “an obsession with being right.”

But since no one is right all the time, will that help you reach your financial goals?

Probably not. That’s why we advocate the unemotional IRP system to signal when to change your asset allocation.

In each of the charts here and on our website, we hope to show you how the system outperforms a simple Buy and Hold of the underlying assets while still retaining the benefits of diversification in your portfolio.

Let the IRP System take the emotion out of your asset allocation so that you can reach your investment goals.

HSBC Direct – 2009 Results

Our second review for 2009 involves our HSBC Direct Portfolio which is available online in Taiwan.

The main lesson of this portfolio is that one can start from a 100% cash position in the dark days of the first quarter and still make 56.3% for the year. The System did well to protect on the downside (by staying in cash in the beginning) and by jumping into the market when the financial system stabilized.

1Q – Global Financial Crisis

The System was only willing to budge from 100% cash to 40% in bonds.

2Q – The turnaround

This turned out to be the busiest quarter for the portfolio. The stance changed from very conservative to aggressive with a high weighting in emerging markets.

3Q/4Q – A few changes

The second half of the year saw a few adjustments but mostly the portfolio maintained a fairly bullish stance with a sizable weighting in emerging markets as well as bets on mining and gold.