Thursday, October 2, 2008

Model Portfolio

One of my very few readers, and very good friend JW, asked me to post what to do next, in this kind of "fooled by randomness" environment...

I have to confess that I simply don't know...

I do however remain fairly happy with the decisions that I have begun to make in 1999, when the stock market began to peak, post-Asian crisis (yet another random event). In fact, if you share my then acquired fixed-income philosophy, there are unique opportunities in this credit market.

First things first however.

My model portfolio:

Individual Muni Bonds 50%

Individual I-Bonds or TIPS: 10%

Individual GSE Bonds (now backed by the Treasury) Bonds: 5%

Individual Corporate Bonds: 5%

Individual Preferred Stocks: 5%

Equity (Stock and Equity Income Funds): 5%

Cash (CDs, Money Market, Currency, Stable Value): 20%

I continue to like the construction of this portfolio. The US stock market almost quadrupled between 1994 and 1999, the event that led me to the then increasingly attractive fixed income rates. It is impossible to know if and when the stock market will surpass its prior highs and so I prefer the guaranteed returns of fixed income even if I reserve the right to change my mind one of these days. I will let you know if I do...

In the meantime, the rates I like the most in this environment are from individual munis. A 20-year AAA paying a net 5.5% is nothing to sneeze at, and I can't see inflation going any higher, as we enter what may be more than a mild recession.

See you soon...

Monday, August 11, 2008

Muni Bonds

As most of my (VERY FEW) readers know, I like individual muni bonds. I do believe that well-chosen individual bonds can provide for diversification, credit quality and a stream of income that will ultimtely be required for retirement. Some however raise the issue of the credit quality of individual municipalities, and so I follow an approach that attempts to mitigate that risk by:

Diversification: GOs, Airports, Mass Transit, Universities, Utilities and States

Maturity: A range of maturities but tending towards 20 years to maximize income

Call Protection: Issuer call option at least 5, but ideally 10 years away

Underlying Credit: At least BBB+ but most in the A+ to AAA range

Insurance: I will take it, but don't count on it


AUSTIN TEX CMNTY CO 5%30REV DUE 08/01/30DIST PUB FAC CUSIP: 052405AW7, a AA- underlying in the properous Texas State capital

BROWARD CNTY FLA 5.25%27REV DUE 04/01/27EDL OID SUBJ CUSIP: 115015DA4, a BBB+ but I believe that Nova University will continue to do well as the largest private university in the country

CONROE TEX INDP 5.125%30GO UTX DUE 02/15/30SCH DIST CUSIP: 208418AZ6, A Texas School which is guaranteed by the AAA State Permanent School Fund from the State

DALLAS TEX AREA RAP 5%32REV DUE 12/01/32TRAN SALES T CUSIP: 235241FB7, another AA- for the rapid transit system in Dallas

FLORIDA HSG FIN COR 5%35REV DUE 07/20/35REV CUSIP: 34073N5F3, a AAA, GNMA-backed even if many tend to stay away from housing

NEW JERSEY ST EDL 5%33REV DUE 07/01/33FACS AUTH RE CUSIP: 646065JA1, our very own AAA-rated Princeton university

NEW JERSEY WASTEWAT 7%11GO DUE 07/01/11TREATMENT TR CUSIP: 64614MBR5, does anyone seriously believe that the wastewater business in NJ will suffer?

PENNSYLVANIA ST TPK 5%23REV DUE 12/01/23COMMN OIL CUSIP: 709221PR0, if you have been there you know the toll revenues aren't going anywhere... not with that kind of traffic

PUERTO RICO COMW 5.25%30REV DUE 07/01/30HWY & TRANSN CUSIP: 745190ZM3, tax free in all fifty states even if it carries a BBB+ undelying

You may correctly point that these don't tend to provide for capital growth but zero-coupon munis, which do, will be the subject of another post. In the meantime, I like the site

See you soon

Saturday, July 12, 2008

Dollar prophecies

Many of my friends have asked me to prophecise about the direction of the U.S. Dollar. Since I can't prophecise without data, I went and look for the dollar as a percentage of world reserve currencies, the movement against the DM and, to finalize, which nations constituted large percentages of world GDP throughout history.

I found that:

The current 63.3% dollar composition of foreign reserves is very much in line with historical standards. The Yen has actually lost some ground, while the Euro inherited most of its reserve status from the Deutsche Mark.

The Dollar predicatbly almost doubled its value relative to the DM after WW2 and stayed at a stable (and artificially high) level until the end of Brenton Woods in 1971. After Brenton Woods, the DM regained value with a vengeance reflecting the renewed strength of the German economy. Since 1980 however the USD has fluctuated in a relatively narrow range between 1.4 and 1.9 and I don't see reasons for a dramatic change

The most interesting finding was in the table below, showing the Chinese as the prominent global economy until 1820, representing as much as 30% of world GDP. After the industrial revolution lifted the western economies, the Chinese economy began a steady relative decline and by 1973 represented only 4.6%.

We all know what has been happening with the Chinese economy, which today already represents about 10% of the world GDB (PPP, IMF). The Yuan however remained stable until July, 2005 at a pegged 8.2, and only recently began to gain in value to about 6.9.

My unsurprising prophecy, from the lessons of history and the DM, is that the Yuan will continue to appreciate even if it may be difficult to find perfect investment vehicles to play the Chinese currency. I am currently researching the following article, suggested by my dear friend and reader TJ.

See you soon


Thursday, July 10, 2008

Dear MS, I liked your post so much that I took the liberty and published it, along with (very) few clarifications to my original post

Dear Blogger

although i tend to agree with most of your thoughts, i also have to play the devil's advocate,

1) Financials may be finding an artificial floor, but keep in mind that this floor is being set, or sponsored by, as you mentioned, the Fed. Effectively, that means the Fed will be printing money to cover up losses from irresponsible lending practices - which is directly converted into inflation. Inflation means the dollar in your pocket has less purchasing power. Therefore, YOU, and me, and all of the tax payers and USD holders are buying BSC, and eventually LEH, MER, C(?), etc. Well, if you are already buying, indirectly, the financial sector, by simply holding your USD, why do you want to increase your exposure? you ARE already long Financials - so if banks recover, USD recover, and you make $$. Don't double the trades that are losing, but the ones that are winning.. that s one of my first trading rules.

2) Munis: I also like the munies, and although you have been looking into project bonds - which may not be directly affected by the Real Estate burst, municipalities are, by nature, highly correlated to the Real Estate market. So, when buying munies, aside from the tax incentives, you have to have a clear oppinion that the Real Estate prices will not decline more. Sure that, if MTM is not an issue (as you plan to hold it to maturity), then the risk becomes more binary (will they be solvent and pay at the end, or not). Also, if you don't make mark to market of the positions, the pain and suffering from mark losses decreases a lot. The downside is that you may decide to reconsider it when it might be too late!

Because I agreee with the comment, I should have clarified that I tend to have diversified positions in high-quality revenue bonds. Some examples include Princeton University, NJ Wastewater and the Robert Wood Johnson hospital in Hamilton. I would also never invest in a Bond Fund, which does have to mark to market, potentially producing fluctuations that I have no interest in following. I do however try to somewhat mitigate the inherent inflation risk with somewhat of a ladder, even if I do not like sacrificing too much yield.

3) Hybrids: falls into the same category of 1), and i do have the same thoughts. Altough the Fed intervention makes debt much safer then equity - as we've seen with BSC. However, you may have the coupons cancelled for a while - if they decide not to pay dividends.

4) SP: agree. But also agree that "past performances are no guarantee of future returns". Since i am not traditionally an equities investor, i can't add any valuable thoughts here..

by the way, love the comments on the Bubbles. i guess that summarize really what i think - and how i am invested right now (as i think we are through an economic - not sector - bubble burst). My main concern right now is not to find nice returns, but to maintain wealth.

To finalize, here is a good quiz:

What was the only asset that didn't lose value during the WW2?
a) Real Estate/Land
b) Gold
c) Oil
d) Wine well, let's just say that we tried few of the best examples of the answer the last weekend...

On this very wise quiz, here is a fascinating link featuring Jim Cramer and Gary Vainerchuck... Time to buy Ports?

Have a good one!MS

Tuesday, July 8, 2008

Long awaited update

The markets remained fairly stable through most of 2007 and so this blog simply watched the unfolding events.

You will however wisely note that "the times, they are changing", and I feel obliged to provide my very few readers with some tidbits of commentary.

I may recall that I wrote my very first prophecy, on November 11, 2006, when the S&P was trading at 1,380:

"Without regard to political views or macro-economic factors (e.g., fiscal deficit), I suggest that the S&P will see a reversal back to 1,200 during 2007. This correction will be triggered by the opposite factors that brought the 2003 rally - higher rates and JGTTRA sunset. Moreover, I suggest that the concomitant stock and housing market corrections will be catalyst to a mild recession, one which will last through the 2008 election"

Well, little did we know... the S&P is now hovering at 1,250, from the correction that started in October, 2007, even if JGTTRA is now set to expire in 2010 (JGTTRA by the way is also commonly known as the "Bush tax cuts").

The question that many of my friends have asked is what am I doing next?

I suggest these new prophecies, absent an unforeseen macro event:

- The U.S. credit crunch may not have necessarily hit bottom, but a floor seems to have been established by the FED actions in rescuing Bear Sterns and in providing emergency loans. Do I then buy Financials? I tend to avoid specific names, but am considering Vanguard's Financial Sector ETF, VFH, which is trading at 36.40, down from a 52-week high of 65.37, and paying a dividend yield of 3.11%.

- Municipal bonds are offering compelling historical valuations with a 10-year tax-exempt bond yielding about the same as a taxable Treasury. Some would counter with the risk from the monoline bond-insurers, but I have long ago given-up trying to perfectly time the markets, and so am fairly happy with the current 20-year rate of about 5%, even if I tend to only buy individual, high-quality (underlying as opposed to insured rate) bonds to full maturity. I could also argue that if the current favorable taxation of dividends at 15% were to expire with JGTTRA, then muni-bonds may see very significant appreciation.

- Hybrids: see "my preferred investment" post. Hybrids have lost about 20% in value and some are now paying over 8% in a dividend yield that is (still) taxed at 15%. This 20% loss is far better than the decline in the Financials ETF, and perhaps better than the overall S&P, when factoring the dividend yield. I also find an 8% dividend very attractive, even if I very carefully check special conditions that may trigger payment stops as I continue to actively manage my positions.

- S&P: so, let's get to the bottom of it, the place where significant percentages of portfolios are typically invested. Further declines, back to my predicted 1,200, or perhaps even lower, are acutely possible. My S&P investments are however for the long-term (at least 15 years), and thus I find that the current valuation levels may prove to be a decent entry point. I do find solace in knowing that we have seen declines that have lasted over 10 years in the past but never a decline lasting over 20+ years. Furthermore, even if past performances are no guarantee of future returns, I also look at our nine recessions since 1953, and the declines in equity markets from peak to bottom was an average 25.6% with a best case of 13.9% and a worst case of48.2%. Moreover, the number of trading days for stocks to hit bottom was an average 108 days, with a best case of 30 and a worst case of 261. In comparison, the current decline started last October when the S&P traded at 1,576.

- Bubbles: my daughters truly love making them... I tend to stay away... Internet in the late 90s, housing in the early 2000s, and now commodities and certain emerging markets... They may be a great way to make outlandish profits but who am I to guess the bubble of the moment, as well as, the right entry and exit points... I am just a prophecist, not a financial markets whiz...

See you soon...