Sunday Musings: Debt Disasters

Ulli Uncategorized Contact

MarketWatch featured an interesting story titled “Debt disaster fears rumble from Athens to London.” Here are a few highlights:

Rumors of a debt disaster are swirling around Europe, from Athens to Madrid and all the way to London.

Investors have rushed to sell Greek bonds since the newly elected government of George Papandreou made a startling revelation: the deficit will soar to over 12% of gross domestic product this year, well above previous official projections.

Greece’s predicament has escalated concerns about contagion in other European countries whose finances are in poor shape. Just this month, the ratings of Greece have been cut both by Fitch Ratings, and, late Wednesday, by Standard & Poor’s, and major agencies have warned Spain and Portugal of possible cuts.

The market reaction has been swift, and brutal. The euro has dropped below the key $1.50 level. Credit-default swaps on Greek government debt — essentially, bets that Greece will default — have ballooned.
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Irish and Spanish institutions also have seen extreme bouts of turbulence of late.

The most vulnerable countries like Greece and Spain indeed confront a mounting debt burden, which will likely lead to more ratings downgrades and more market sell-offs. The path to fiscal health will require painful, unpopular reforms.

But, most analysts agree that the European Union will, if necessary, bail out its members and never let a country’s fiscal situation deteriorate to the point of sovereign default. Those rescue expectations continue even as terms of euro entry explicitly forbids such moves.

Despite all good intentions of the EU to “assist” its members, the money has to come from somewhere. It’s not that alleged “strong” members of the Union are flush with cash and operating on the plus side of their balance sheets. Others are having their own financial issues as well with more money going out than coming in.

Even if financial support in some form is rendered, and I am sure it will be, it will nevertheless rattle world markets. That’s what I meant when I previously referred to an outside event that can at least temporally pull the markets off their highs.

If Greece or any other country defaults on their obligations, or at least the potential exists, the whipping boy of the past (the U.S dollar) all of a sudden becomes the darling of the world again that everyone wants to own. Recent events have supported that view as the bullish dollar chart (UUP) shows:



A bottom seems to have formed, but it will still take more upward momentum before the long-term trend line is crossed to the upside. Extreme bearishness on any asset will very often lead to opposite moves; and the dollar maybe no exception.

I currently have no positions in UUP but will consider it once the break of the trend line gives me the go ahead.

What Do You know About The ITCS Principle?

Ulli Uncategorized Contact

Forbes featured an interesting piece with the title “Brokers Behaving Badly.” Here are a few snips:

Brokers deserve to be compensated, but the ways they are compensated deserve very close scrutiny.
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There are two predominant methods of compensation. The first is commissions; the second is the so-called “fee based” account. In the old days, brokers charged commissions and advisers charged fees, but today, with the line between these two roles having been blurred, the matter is not so simple.

Commissions-based accounts are transaction-driven. Money is earned by the broker based on the size and quantity of investments sold to the client. Of course, the client will be more concerned with the quality of the investments, and that is where the client’s interest and the broker’s interest sometimes diverge.

Commissions can quickly add up to big money. Excessive trading of an account is called churning, and it is a fraudulent practice (see “Suitability Claims”). Usually, churning manifests itself in high turnover of the account’s assets, but, in fact, it’s the cost of the transactions, not the turnover that’s the evil. High costs diminish the likelihood that an investor will profit from investments being made.
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Commissions on securities transactions are sometimes referred to as “markups” on purchases or “markdowns” on sales. When it comes to stock transactions, the law requires brokers to disclose the amount of any markup or markdown. But sadly, that is not the case for bonds; the law does not require bond brokers to disclose these things, as incredible as that sounds.

The rule allowing bond brokers to hide their fees can lead to abuse. I have recently been involved in several cases where the markups and markdowns were greater than the interest the investor earned from the bonds. The investor had no way of knowing that, however, because the markups and markdowns were not disclosed. When a broker recommends selling one bond to buy another, the ITCS principle is often at work.
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Investment advisers, who are distinct from brokers, charge fees based on a percentage of the money in the account–the amount “under management.” An annual fee of 1% to 2% seems modest, but even that amount–paid year-in and year-out–is a drag on performance. Whether the management fee is a good deal depends on the quality of the services being provided. A manager whose responsibility is to watch and manage an account every day deserves compensation for sleepless nights. But it should not go unnoticed that the manager gets paid regardless of whether the account was profitable.

In the 1990s, the brokerage firms, under regulatory scrutiny for excessive commission-based sales, developed the so-called fee-based brokerage account. In a fee-based brokerage account, the broker earns a percentage of the money in the account, the same way an investment adviser is compensated. But a fee-based brokerage account, despite appearances, is not a managed account. If something goes wrong, the brokerage firm will not claim any responsibility for managing the account.

[My Emphasis]

While individual bonds may be the right investment for you, you can’t be sure what the markups are. As the article stated, sometimes they are higher than the interest earned. If you are holding a bond to maturity, it may not matter much to you, but if you suddenly need to liquidate a position, you may receive less than what you had anticipated.

The last paragraph emphasizes the difference between a fee-based brokerage account and a fee-only adviser managed account. I have talked to my share of investors in the past who did not know the difference.

To pay any kind of “management” fee to a broker, who puts your account in a canned asset allocation scheme with no exit strategy in case the markets head south, simply does not add value to justify that type of compensation. With no fiduciary relationship nor any responsibility, it does nothing but support the ITCS principle.

What is ITCS?

It’s The Commission, Stupid.

No Load Fund/ETF Tracker updated through 12/17/2009

Ulli Uncategorized Contact

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

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

More of the same from last week, with the major indexes not making any headway. The Nasdaq bucked the trend and gained 1%.

Our Trend Tracking Index (TTI) for domestic funds/ETFs has now crossed its trend line (red) to the upside by +6.61% 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 +8.89%. 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.

Fed Takes Starch Out Of Rally

Ulli Uncategorized Contact



A nice rally faded after the Fed announced that interest rates would be unchanged and remain at record low levels. The major indexes ended up barely changed.

Implied in the message was the hint that rates will move up, but not anytime soon. Furthermore, the Fed noted that that plans exist to end a host of programs designed to support the economy in the first half of 2010. Interpretation of the various statements pulled the indexes off their highs and pushed the dollar higher.

To me, it appears that the Fed will do anything to keep this fragile recovery going. Once stimulus plans come to an end, whenever that will be, that’s the moment of truth when rubber meets the road. In other words, does the economy have enough stamina on its own without trillions of dollars propping it up artificially?

Time will tell, but for right now the indexes are still stuck in a range and continue to bounce against overhead resistance. In the absence of a new impetus to create more upward momentum, we may be stuck in a trading range from which a breakout will eventually occur—we just won’t know yet if it will be to the upside or the downside.

The Final Frontier

Ulli Uncategorized Contact

The WSJ reports that ETFs are reaching the more remote corners of the world in “ETS Aim to Tame the Final Frontier:”

Exchange-traded funds are launching to focus on emerging-market nations, particularly the smaller ones that lack the allure of giants like India and China.

The freshest entry is Van Eck Global’s Market Vectors Poland ETF (trading symbol: PLND), which began trading on NYSE Arca on Nov. 25. The fund tracks the Market Vectors Poland Index and invests mostly in companies with market capitalizations of at least $150 million that are based or primarily listed in Poland or that generate at least 50% of revenue in the country.
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In the spirit of the Van Eck effort, Emerging Global Advisors offers ETFs that target emerging markets’ basic materials, consumer goods, consumer services, and metals and mining. In addition, Global X Management rolled out two sector-specific China ETFs, the Global X China Consumer ETF (CHIQ) and the Global X China Industrials ETF (CHII), on the New York Stock Exchange this week. The company also offers funds covering companies in Colombia and Scandinavia.
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Ensuring quality in a fund’s potential stocks always is a challenge. Van Eck’s new Poland ETF has strict requirements to vet member companies. Each stock must have a three-month average daily trading volume of at least $1 million and must have traded at least 250,000 shares a month over the last six months. As of Oct. 31, the Market Vectors Poland Index had 26 constituents, and its top sectors were financials, energy and industrials.

These frontier-country ETFs continue to do relatively well in terms of drawing assets, but because liquidity is limited, a danger exists that the funds could end up driving small markets, said Morningstar’s Mr. Burns.
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Demand for such ETFs is overshadowed by that for larger emerging nations, said Mr. Burns. These niche ETFs can’t compare to the iShares MSCI Brazil Index Fund (EWZ), which has $11.6 billion in assets, according to Morningstar.

Market Vectors Vietnam ETF (VNM) started in August and now has $79.5 million in assets, while Market Vectors Brazil Small-Cap ETF (BRF), which debuted in May, has $606.3 million, says Morningstar. In addition, Market Vectors Indonesia Index ETF (IDX), which was launched in January, has $184.9 million.

While it is too early to tell which of these new ETFs will survive, I consider them only appropriate for aggressive investors. Sticking with the more general indexes, which may include exposure to some of these countries, is a more conservative way to participate.

Some of these ETFs may very well move sharply and erratically as individual stocks do, which does not make them a good candidate for trend tracking. The reason that trend tracking works well with mutual funds and most ETFs is that some of the volatility has been removed due to broad diversification.

If you get involved in ETFs of relatively small emerging countries, you are adding lack of diversification back into the equation, which makes it more difficult to apply simple trend tracking rules. Just because these products are offered, does not make them a suitable addition to your portfolio.

Steady long-term growth is preferable in my book as opposed to introducing a casino like element that may add a questionable outcome.

I have no holdings in any of the ETFs mentioned in this article.

Trying To Figure Out The Future

Ulli Uncategorized Contact

Reader Pat had a follow up question regarding my recent post titled Head Fake.

Thanks for your response to my recent question about capitalizing on the inexorable rise in interest rates. HOWEVER, you did not really answer my question which was not to bemoan my loss in TBT but rather to determine how one can profit from the rise when it occurs.

That is, when the rates rise, the market as a whole – with few exceptions – will get clobbered, setting off sell orders. When I and others have to retreat to the sidelines, are there any ETFs that we can use to directly profit from the increased rates?

Short or buy puts on long term bond ETFs? Go long on SH? Anything else come to mind?

Thanks. It is wise to address the inevitable in advance.

While it is indeed wise to plan ahead, going too far out would be simply trying to predict the future which, when tracking trends, I don’t engage in. The fact that we are on the dark side of a burst real estate/credit bubble of never seen before dimensions is cause for great concern. Trying to make any early guesses as to how this scenario may play out, is gambling at best.

My mode of operation is to wait and see which areas of the market place will develop upward momentum once stocks have corrected. You can easily track these changes by using my weekly StatSheet.

Here’s how:

Simply focus on the column titled %M/A, which shows you how far below or above its own trend line a fund/ETF is currently positioned. You want to watch for transitions when a fund moves from below its trend line (a negative number) to above its trend line, which then will be represented by a positive number.

Since the trend line is the dividing line between bullish and bearish territory, I will predominantly focus on these changes, especially when a fund crosses to the upside.

Once that line has been crossed, I will wait a couple of trading days, before placing an order to buy. Since many ETFs represent short positions as well, you no longer have to specially sell short, if that’s what you want to do—just use the appropriate ETF.

Letting the trend come to you first before taking a position, rather then you trying to predict and force the issue, will enhance the odds of you being successful. Sure, we all like to have that crystal ball but, since we don’t, working with trends is the best way I know of to identify changes in momentum.

Should I ever find that crystal ball, I am sure that I will get an invitation to Omaha, Nebraska for lunch to meet with you know who.