Sunday Musings: A Sovereign Debt Crisis

Ulli Uncategorized Contact

Forbes featured an interesting story by Nouriel Roubini titled “The Coming Sovereign Debt Crisis.” Here are some highlights:

In 2009, downgrades and debt auction failures in countries like the UK, Greece, Ireland and Spain were a stark reminder that unless advanced economies begin to put their fiscal houses in order, investors and rating agencies will likely turn from friends to foes. The severe recession, combined with a financial crisis during 2008-09, worsened the fiscal positions of developed countries due to stimulus spending, lower tax revenues and support to the financial sector.

In 2008 and 2009, the decisions by these governments to do “whatever it takes” to backstop their financial systems and keep their economies afloat soothed investor concerns. But if countries remain biased toward continuing with loose fiscal and monetary policies to support growth, rather than focusing on fiscal consolidation, investors will become increasingly concerned about fiscal sustainability and gradually move out of debt markets they have long considered “safe havens.”

Most central banks will withdraw liquidity starting in 2010, but government financing needs will remain high thereafter. Monetization and increased debt issuances by governments in the developed world will raise inflation expectations. These governments will have to offer higher real yields or investors will move to more attractive emerging markets.

The UK, Spain, Greece and Ireland will face sovereign risk pressures, especially if their fiscal imbalances are not addressed immediately. Some eurozone members are quickly approaching their debt sustainability limits as deleveraging through devaluation is not an option for these countries. Countries like Germany—whose fiscal imbalances have deteriorated largely due to the economic and financial downturn—might have a greater capacity to stabilize their debt ratio. The U.S. and Japan might be among the last to face investor aversion—the dollar is the global reserve currency and the U.S. has the deepest and most liquid debt markets, while Japan is a net creditor and largely finances its debt domestically. But investors will turn increasingly cautious even about these countries if the necessary fiscal reforms are delayed.

Developed economies will therefore need to begin fiscal consolidation as soon as 2011-12 by generating primary surpluses, which can be accomplished through a combination of gradual tax hikes and spending cuts. However, an aging population, a sluggish economic recovery and higher unemployment will keep governments’ entitlement spending high and revenues subdued. These factors might also make tax hikes politically challenging. Fiscal consolidation efforts might not be strong until the bond vigilantes signal shifting to safer assets.

[Emphasis added]

You can probably add a few South American countries, such as Venezuela, to the list of those facing sovereign risk pressures. While I agree that loose fiscal policies need to come to an end, I just don’t see it happen anytime soon.

The more likely consequence will be a financial blow up someplace in the world, which may unravel the current stock market rally. This has been my recurring theme for a long time not for the reason of me being negative, but simply being realistic.

We are living in an interconnected, changing world were no major catastrophic financial event remains localized. Everybody is connected with everybody else, and we are all affected by each other’s actions to varying degrees.

My point in these discussions is always the same. Don’t become complacent with your investments. Know your exit strategy and follow through executing your trailing sell stops whenever they are triggered.

More On Actively Managed ETFs

Ulli Uncategorized Contact

I am reading “Actively managed ETFs pique interest of big fund companies:”

The actively managed exchange-traded-fund market is expected to explode as top mutual fund companies, including Putnam Investments, John Hancock Funds LLC, T. Rowe Price Group Inc. and Pacific Investment Management Co. LLC, consider entering the business or expand their lineups.

The number of actively managed ETFs is likely to rise from the current 15 to more than 40, while the number of providers offering such funds could go from seven to 15, according to Rob Ivanoff, an ETF analyst at Financial Research Corp.

“Every big fund company is looking at this,” said Cindy Zarker, director of research at Cerulli Associates Inc.

Many asset managers have held off launching actively managed ETFs because of concerns about the effect that daily disclosure of their holdings would have on the shareholders of mutual funds that the ETFs mimicked. Other asset managers, while now unsure of demand for actively managed ETFs, want to hedge their bets in case mutual fund 12(b)-1 fees are abolished and brokers are more willing to try the new product.

For the most part, advisers have taken a wait-and-see attitude toward actively managed ETFs, intending to hold off until the products can post at least a one-year or three-year track record. But some say that reluctance may be ebbing.

Many investment management companies are discussing getting around the track record hurdle by converting their mutual funds to ETFs, said William M. Thomas, chief executive of Grail Advisors LLC, which has five actively managed ETFs.

“We are working with several mutual fund companies that are contemplating converting mutual funds to ETFs because they have solid, strong performance and are in a crowded marketplace where they are one of 250 large-cap-growth stock funds,” he said.

Pimco, which launched its first two actively managed ETFs last year, has registered to launch three more this year: the Pimco Government Limited Maturity Strategy Fund, the Pimco Prime Limited Maturity Strategy Fund and the Pimco Short Term Municipal Bond Strategy Fund.

The company also has had discussions about launching an ETF version of its giant Total Return Fund, said Don Suskind, a vice president and head of the ETF product management team.

[Emphasis added]

It’s an interesting concept that some mutual funds may convert to ETFs. That confirms my long-held belief that if mutual fund companies don’t come off their high horse and offer lower fees along with less restrictive trading policies, their days may be numbered.

If actively managed ETFs can attract enough followers over time, and offer a wide variety of low cost products, which they will, there would be no reason to ever buy a mutual fund again.

I am following these developments closely, but will not add any of these types of ETFs to my data base until I see at least 9 months of price history along with acceptable average daily trading volume. To me, that number has to be at least $4 million before I even consider modest exposure—assuming, of course, that the trends support such a move.

Overall, these are positive developments for the individual investor and for trend tracking in general. Of course, I can hear the new battle cry, which no longer will be whether mutual funds are better than ETFs, but whether managed ETFs are better than indexed ETFs.

As always, these comparisons are downright silly because the author usually has an axe to grind. I have found in the past that at times mutual funds will outperform ETFs and vice versa.

It’s more important to use the most appropriate instrument when making an investment. Momentum figures, such as I publish in the weekly StatSheet, may make it easier for you to make that decision.

No Load Fund/ETF Tracker updated through 1/14/2010

Ulli Uncategorized Contact

My latest No Load Fund/ETF Tracker has been posted at:

http://www.successful-investment.com/newsletter-archive.php

Disappointment over JP Morgan’s earnings pulled the major indexes into negative territory for the week.

Our Trend Tracking Index (TTI) for domestic funds/ETFs has now crossed its trend line (red) to the upside by +6.11% keeping the current buy signal intact. The effective date was June 3, 2009.



The international index has now broken above its long-term trend line by +9.28%. A Buy signal was triggered effective May 11, 2009. We are holding our positions subject to a trailing stop loss.

[Click on charts to enlarge]
For more details, and the latest market commentary, as well as the updated No load Fund/ETF StatSheet, please see the above link.

Don’t Get Stuck In A Range

Ulli Uncategorized Contact

Recently, I had an email exchange with a reader, who misunderstood the exact recommended sell stop figures and used 7.5% for broadly diversified equity mutual funds/ETFs and a range of 10-12% for sector and country ETFs.

There is nothing wrong with using a sell stop percentage that you are comfortable with, such as 7.5%. I know of advisory firms that use 8% straight across the board. All of these different percentages will do the intended job for you, which is to limit losses or to lock in profits once the trend comes to an end.

However, I want to caution against using a range, such as this reader did when applying his 10-12% rule. The reason is that it can lead to wishy-washy decision making.

Here’s what I mean. Say, an ETF has come off its high by -10%, so you decide to hang on and watch it a while longer. It then drops to -11% and you continue holding on; subsequently it slides to -12.5% and you decide to wait a little longer since this number is still fairly close to your maximum of -12%.

You can see where I am going with this. It’s very easy at this point to let emotions control your decision making process and, all of a sudden, you’re down to -14% and still have not sold.

Use a fixed number to determine your exit point, and not a range, which will help you avoid getting stuck with this kind of slippage.

Again, I give myself a little leeway once a sell stop has been triggered. For example, if my intended exit point was set at -7%, and my position closes at -7.15% or so, I will wait a day (sometimes two) to see if the market rebounds before pulling the trigger.

On the other hand, if market activity pushes my holding straight to -8% at the close, I will the sell the next day—no questions asked.

Again, this is not an exact science, but I believe that sticking to a firm number as discussed, will make it easier for you to execute any exit strategy as opposed to being stuck in a range.

Thoughts On Utility Funds

Ulli Uncategorized Contact

Many investors prefer utility funds/ETFs when it comes to the generation of income but, as the past years have shown, they are anything but the perceived place of safety where money can be parked without worry.

The WSJ featured an article on the subject titled “A Classic Dividend Play.” Let’s listen in:

Utility stocks didn’t fully participate in last year’s market rebound and may remain laggards for some time, given the likelihood of an anemic economic recovery and higher interest rates. Considering that, the biggest appeal of utility-stock mutual funds and exchange-traded funds may continue to be what has been the sector’s main drawing point historically: high dividend yields over the long haul.

Last year, utility funds were the weakest performers among 21 U.S.-stock categories tracked by Morningstar Inc., returning 18% (including price change and dividends) in a year when the Standard & Poor’s 500-stock index returned over 26%. The only utility funds that greatly outperformed the sector average benefited from nontraditional holdings.

Of course, utility stocks have never been considered that exciting. Deregulation and the shooting star of energy-trading utilities such as Enron Corp. added some spice to the sector.

And utilities funds had some appeal as defensive positions in the market debacle of 2008, posting an average return of negative 34%, better than many other types of stock funds and the S&P; 500, which plunged 38%, according to Morningstar. But in general, utility stocks remain most attractive to conservative investors seeking a reliable income stream from high dividend yields.

As of late December, the median yield of the 26 utilities funds followed by Morningstar was 2.9%, outpacing the 1.2% yield for large-company “blend” funds and the 2.3% yield of the S&P; 500.

Investing in regulated utilities, however, isn’t without risk. Some analysts say the potential for higher interest rates and the looming prospect of cap-and-trade legislation aimed at curbing greenhouse-gas emissions may hurt the sector over the next few years.

“We’re a little concerned” about utilities funds’ exposure to the factors holding down regulated electrical utilities, says Tom Roseen, a research manager at Lipper Inc., which says U.S. electric utilities account for about 30% of the average U.S. utilities-fund portfolio.

Higher interest rates are of particular concern, says Don Linzer, managing director of Schneider Downs Wealth Management Advisors. Utilities tend to have a lot of debt because of construction requirements, so a rise in interest rates would increase those borrowing costs. And if bond yields rise, that increases the appeal to investors of bonds versus utilities stocks.

[Emphasis added]

I must be missing the point, because I am not sure how utilities can be considered a “defensive position.” Is it maybe because they lost “only” 34% in 2008 vs. the S&P;’s loss of 38%? Sure, that would make an investor feel much better…

All kidding aside, while utilities can be a great place to park your money in order to generate a consistent dividend, you still need to pay attention to the direction of the trend. One look at the chart of XLU makes this abundantly clear:



Even supposedly safe investments such as utilities took a steep dive in 2008, and for those who participated, it will take quite some time to make up the losses despite the 2009 gains.

Actually, from a trend tracking point of view, utility funds/ETFs are well suited since they tend to move in less erratic fashion compared to other sectors. If this type of investment appeals to you, pick your entry point once the long term trend line has been crossed to the upside.

Then work with a trailing sell stop so that will never participate in a disaster year like 2008. All the data you need are easily accessible in my weekly StatSheet.

You Don’t Need A New High

Ulli Uncategorized Contact

Reader Bill was looking for clarification with setting his sell stops as we moved into the New Year. Here’s what he said:

I have all the formulas (for my sell stops) on my spreadsheet so the NOW part updates itself everyday giving me a new GET OUT @ number.

My question and I think I already know the answer is:

Each year should I start the HIGH and LOW’s anew? Or should I just keep them running?

I would think just to keep them running.

Let me make it clear again. Just because we enter a new year does not mean you have to adjust the high points for your sell stops.

The only high price of any importance is the one your fund/ETF has made since you purchased it. While this may coincide with a yearly high, it does not have to.

For example, say you bought an ETF at 10.00. Since that purchase, the price may have gone to 11.00 before slipping back to, say 10.70. The yearly high may have been at 11.75, which does not matter to you at all. In this case, 11.00 becomes the price from which you calculate your trailing sell stop until that price is being taken out.

On a side note, tracking low points has no value when it comes to the use of a stop loss strategy.