BUY iShares Dow Jones US Technology ETF (IYW)

OK, we are going against the macros here but we plead temporary insanity.

The USA economy still has the Debt of Damocles—created by our profligate spending and indebtedness—hanging over it. While we have flooded the world with fiat currency liquidity to avert a deflationary spiral, almost nothing has been done to place limits on the use of leverage by financial institutions, nor even to increase visibility with respect to the trading of the financial WMDs—mortgage-backed securities, credit default swaps, collateralized debt obligations, and the like—that zoomed us into trouble faster than we realized. Meanwhile, most of the “toxic assets” created during our binge remain on the books of institutions deemed “too big to fail.” The residential real estate market, despite being goosed with the $8,000 tax credit—akin to pouring gasoline on a fire when we should be trying to deleverage—has failed to deal with the inventory of foreclosed homes, with many more on the way. The commercial real estate market faces a potentially calamitous wave of refinancing of projects that are no longer worth enough to cover the debt. Unemployment continues to rise and the average credit card debt per household was $8329 as of the end of 2008.

We’re in a deep hole, but the government keeps digging. Support for the zombie banks that was initiated by the Bush administration has continued apace with the Obama administration (even to the point of being run by the same guys). Interest rates are artificially low, and the secular decline of the dollar has accelerated, or at least spurted ahead. The government not only has stepped up current spending with the so-called stimulus package, but shows no inclination to rein in ruinous projected future spending on entitlements—indeed the main debate now is over how big an additional commitment of future tax payer dollars to make to support “health care reform.” Policymakers are so far out of touch with reality that they enacted a program encouraging consumers to take on additional debt (“cash-for-clunkers”).

All this will not end well. So…why is the NASDAQ up 35% on the year, and up 68% since the 9 Mar 09 low? Well, we could say that the velocity of job losses—the rate at which the rate of unemployment is growing—has slowed. We could say that 2Q09 results were surprisingly good, in terms of profitability, although revenue generally was flat to down. We could say that housing prices appear to have plateaued here (no long declining). We could say that China’s stimulus package worked a lot better than ours, putting money directly into the hands of consumers and encouraging them to spend without creating any additional debt, and consequently economic growth in China got a boost. (Of course, that manuever is a lot easier when your government cash flow numbers are positive.) We could say that confidence is up, as evidenced by the rise in the stock market…oh, wait a minute…that’s the effect we are trying to explain in the first place…never mind.

The honest answer is we don’t know why the market is up so sharply. The torrent of liquidity the central banks unleashed averted what would have been in our view a salutary cleansing crash putting a lot of ne’er-do-wells out of business, but the collective wisdom of the market is evidently that this is a good thing. Who knows; maybe postponing the battle will enable the ne’er-do-wells to transform into heros and ultimately prevail. Yeah, right.

OK, so it may be insane, but it is happening…so, let’s examine the case for the bulls. While we don’t believe it holds water, if it does, then

1. The economy has ceased to contract and will start expanding now
2. The consumer will continue spending money at a gradually expanding rate
3. Emerging markets will continue growing faster; demand for commodities will rise again
4. Most countries will continue to gain more from free trade than they lose
5. Inflation will resurface sooner rather than later

These are all conditions that favor the high tech sector. On the business side, productivity is at a premium in an expanding market where labor is tighter and—in an environment with a bias in favor of free trade—global competition militates efficiency. On the consumer side, an ever-expanding global middle class will stoke increasing demand for the latest and greatest entertainment and personal productivity products.

Accordingly, we are going with the iShares Dow Jones US Technology EFT (IYW) here. All things being equal, we would prefer an international fund, but the only one that has done better this year than IYW (+42% to +26%) is the SPDR S&P International Technology Sector ETF (IPK) and it is way too small and too thinly traded ($0.011B in assets trading 5000 shares per day). Also it is not a genuine international fund as it excludes USA technical companies. No problem, high tech is international in terms of customers anyway.

We would have gone with a NASDAQ index fund but the PowerShares QQQ (QQQQ) unaccountably trails the underlying index  this year (+23% to +35%), and the First Trust NASDAQ-100-Tech Index ETF (QTEC) is +33% but again too small and thinly traded ($0.028B in assets and 35,000 shares per day).

So the IYW it is. This ETF “seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the largest public companies in the technology sector of the U.S. market, as represented by the Dow Jones U.S. Technology Index.” Microsoft, Apple, IBM, Cisco, Google, Intel, and Qualcom are all among their top ten holdings. They have over a billion in assets and trading volume is north of 400,000 shares/day. The P/E is running around 26 and the yield is about half-a-percent. For more information, check out iShares’ website.

We are taking this position to avoid being inundated in the rising tide of optimism; we want to participate in this ebullient upside. However, because we do expect this tide to turn—and, of course, it’s quite possible it already has!—we will tolerate no more than a ten percent loss here.

BUY MSCI Brazil Index (EWZ—yet again)

Again, it makes sense to be long Brazil strategically, as we stated back in 2006. We have moved out of our position here twice due to the risk that the odds in favor of a sharp world-wide decline that will take Brazilian equities with it had waxed. But here and now, the risk is in not being long; under these conditions a position here is di rigeur.

The instrument of our investment in Brazil is the iShares MSCI Brazil Index (EWZ). This exchange-traded fund is heavily weighted towards commodities (27%), energy (27%) and financials (19%), as befits a fund for a rapidly developing country with a maturing economy. There is also significant representation for utilities (8%), consumer staples (7%), telecom (4%), and consumer discretionary, industrials, and information technologies (2% each). The P/E ratio is running around 13 and the yield is 4%. EWZ is very heavily traded (21 MM shares/day).

Previous EWZ-related posts:

• BUY MCSI Brazil Index (EWZ) (2 Jan 07)
• SELL MCSI Brazil Index (EWZ) (10 Sep 08)
• BUY MCSI Brazil Index (EWZ—again) (6 May 09)
• SELL MCSI Brazil Index (EWZ—again) (13 May 09)

BUY MSCI Malaysia Index (EWM…again)

As those who were with us when we launched this portfolio back at the end of 2006 may recall, Malaysia is one of our favorite places to invest outside of the USA, and the iShares MSCI Malaysia Index ETF was one of our original 11 positions. But in March 2008, we liquidated the position at a profit (ROI of 29% and CAGR of 24%), as we moved to a more defensive position.

Now that we are lightening up on our shorts, we are looking to increase our long exposure and EWM looks good here, at virtually the same price we got it at back in January 2007. Meantime, conditions for business in Malaysia remain strong. Their per capita GDP is up from $14,200 in 2006 (the latest number we had in January 2007 was $12,900 in 2005) to $15,300 in 2008. For comparison’s sake, they are just behind Russia ($15,800) but well ahead of Brazil ($10,100), China ($6,000), and India ($2,800)…not to mention Mexico ($14,200), Turkey ($12,000), and Thailand ($8,500), to name a few. The BRIC countries are all growing faster, and GDP growth was down in 2008 to +5.1%, but that still looks good from here (the USA was +1.3% in 2008).

The iShares MSCI Malaysia Index exchange-traded fund (EWM) is heavily weighted towards financial services (31%) and industrials (20%), aptly reflecting the sweet spots of the Malaysian economy. There is also significant representation for consumer staples (15%), consumer discretionary (13%), utilities (13%), and telecom (7%), reflecting the high income levels of the populace. The P/E ratio is running around 16 and the yield is 3%. EWM is moderately traded (1.2MM shares/day).

Previous EWM-related posts:

• BUY MCSI Malaysia Index (EWM) (2 Jan 07)
• SELL MCSI Malaysia Index (EWM) (10 Mar 08)

SELL ProShares UltraShort S&P500 (SDS), Short QQQ (PSQ), & Short Dow30 (DOG)

We still believe there is a lot more “down” coming, but for the time being the bulls are clearly in charge here, and we remain chastened by our error in staying short during the rally last November-December, which cost us a 29% haircut.

So despite continued rising unemployment, falling house prices, deepening government debt, and  a weakening dollar…despite looming commercial real estate and credit card default issues…despite government policies that seem tailored to extending and worsening the economic decline (bailing out failed institutions, failing to address serious systemic flaws with respect to the market for synthetic “securitizationed” equities such as credit default swaps and mortgage-backed securities, not to mention the naked short-selling scandal, increasing health care and energy costs and raising taxes on business)…we are cashing in our short chips here to ride out the bull-market storm. This market is too volatile to ignore sentiment which can drive two-or-three year’s worth of “normal” movement into just a few weeks…even if such a move is in the “wrong” direction.

We’ll be back.

Previous index short ETF-related posts:

• BUY ProShares UltraShort S&P500 (SDS) (19 Nov 08)
• BUY ProShares Short QQQ (PSQ) & Short Dow30 (DOG) (12 Feb 09)
• SELL ProShares UltraShort S&P500 (SDS), Short QQQ (PSQ), & Short Dow30 (DOG) (10 Mar 09)
• BUY ProShares Short QQQ (PSQ), Short Dow30 (DOG), & Short S&P 500 (SH) (21 May 09)

BUY ProShares Short QQQ (PSQ), Short Dow30 (DOG), & Short S&P 500 (SH)

We’re back short as of the close today.

When we hit the eject button on the short positions in March, we expected to be back here sooner or later. We believe that the optimism the market has reflected in the 37% surge in the S&P 500 index between 9 March and 8 May has been sadly misplaced. The collapse of the residential real estate bubble is still ongoing, with concomitant credit card debt defaults, decreases in consumer spending, a continuing rise in unemployment, and coming soon will be a spate of commercial real estate defaults.

Furthermore, the new US government has disappointingly extended the policies of the previous administration to attempt to prop up the zombie banks and keep the easy credit spigots open. While these policies have been successful in staving off “systemic risk” defaults, they will only postpone the day of reckoning and, by throwing increasingly less good money after bad, are debilitating the already-weak dollar as well.

We are going with the Proshares Short QQQ (PSQ) ETF, whose managers “seeks daily investment results, before fees and expenses, that correspond to the inverse (opposite) of the daily performance of the NASDAQ-100 Index,” their Short DOW 30 (DOG) ETF, aimed at achieving “daily investment results, before fees and expenses, that correspond to the inverse (opposite) of the daily performance of the Dow Jones Industrial Average Index,” and their Short S&P 500 (SH) ETF, which seeks daily investment results, before fees and expenses, that correspond to the inverse (opposite) of the daily performance of the S&P500^® Index.”

One strategy note: we seek to invest congruent with long-term, macro trends which, typically, should result in relatively rare adjustments to the portfolio lineup. Obviously that has not been the case in the last nine months or so, during which time we have switched from long to neutral to short to neutral to long (for five days earlier this month) to neutral to short! This unusually frenetic maneuvering is a function of off-the-scale levels of volatility, as outlined in this recent Motley Fool article. The specter of systemic risk has made it extraordinarily hard to assign valuations, and in the fog of this uncertainty, when you have the market moving as much in two or three days as it “normally” does in a year, more frequent adjustments are appropriate.

For example, while it would have been rational to ignore the rally that started in March and stay short—because eventually when reality reasserted itself, the market would come back down to us—by divesting ourselves of the short positions, we afforded ourselves an opportunity to reacquire them here, at a 25% discount. That is too big an opportunity to ignore.

SELL MSCI Brazil Index (EWZ) & Global Energy Sector Index Fund (IXC)

OK, the danger of irrational exuberance appears to have abated here, so we are cashing in our updraft insurance. The reality is that we are in far worse shape than justifies a +35% move in the market. We are back to neutral here and eying the short ETFs closely.

BUY iShares S&P Global Energy Sector Index Fund (IXC—again)

In a world where rising energy demand outstrips supply, the macros dictate being long energy, as we said back at the inception of this portfolio. Tactically, we dropped the position when we entered the storm shelter last year. We are reinstituting our position here not because we think the storm has passed, but because while in the eye of the hurricane here, the market is making a serious move northwards and—just in case we are wrong about this recovery having legs—we are protecting ourselves against that risk.

We are still in a downward trend, and there are still shoes overhead but for now, the sun is peaking through so it’s time to make hay. The stress test results whitewashing the banks seem zany to us, but the market is seeing everything through rose-colored glasses just now. We could be seeing a replay of 1933-37 when, starting within a few months of the inauguration of the new administration, the market rallied furiously, even though the depression was far from over. If the speeded up 21st century depression-related market collapse lasted 21 months as opposed to four years (1929-1933), then this false dawn, which lasted four years back in the thirties could persist for up to two years here. We doubt it, but the risk is significant enough to be positioned appropriately.

BUY MSCI Brazil Index (EWZ—again)

The strategic rationale for being long Brasil has not changed since 2006 (when we first initiated that position). Tactically, we dropped the position when we entered the storm shelter last year. We are reinstituting our position here not because we think the storm has passed, but because while in the eye of the hurricane here, the market is making a serious move northwards and—just in case we are wrong about this recovery having legs—we are protecting ourselves against that risk.

SELL UltraShort Consumer Goods ETF (SCC) & UltraShort Consumer Services ETF (SZK)

We still believe the macros point down from here. However, the current rally is very strong and there are a number of factors supporting it:

• Several financial services companies reported last month that they are now profitable
• Timothy Geithner’s bank rescue plan has been better received than most anyone expected (although it doesn’t look so hot to us)
• Today’s announcement of mark-to-market reform will help the companies who hold toxic assets to at least appear to be in better shape
• The Obama administration is having a good patch here, exceeding expectations at the G20 meeting
• Emerging markets have been in rally mode, more or less, since 20 Nov and the most recent Chinese Purchase Management Index numbers have been positive
• There are still substantial short positions out there, and if the market heads north from here, short covering may well fuel the rally

Looking specifically at consumer spending, we still see strategic issues with housing prices falling and unemployment rising. However, for now, the horizon is brightening: consumer spending has ticked up, and the positive effects of lower energy costs, the forthcoming tax cut, and lower mortgage interest rates could keep the party going in the short run. Plus there is talk of a government mandate to force lower credit card interest rates. Such a move would be tricky, as it could hurt the weakened financial sector, but if it happens, it is likely to stoke consumption spending. Even the prospect of such an eventuality could propel consumer goods and services providers share prices higher here.

In the end, we expect all this brightness is likely to turn out to be a false dawn. However, we are in a period of profoundly extreme volatility, and following the same logic we used last month in dumping our index shorts, we are stepping aside here. If the market melts down and we have to reacquire these ETFs at a higher price, well that is a risk we are willing to take to lock in the profits we have on these positions, and avert the risk—more likely, in our opinion—of a sharply higher move. We expect to buy these ETFs again and are betting it is more likely we’ll get a chance to do so at a lower price than today’s, and not have to settle for a higher one.

SELL ProShares UltraShort S&P500 (SDS), Short QQQ (PSQ), & Short Dow30 (DOG)

In the face today’s big rally, with market indices pushing +5% here, we are cashing in our index shorts and taking our profit. We do not believe that the secular decline is over, but a sharp bear market rally as happened last November-December is a reasonable probability here. We rode that one out with our short positions intact and it cost us a 29% haircut between 20 Nov and 31 Dec.

Worst case, this rally turns out to be a one-day wonder and we sheepishly have to pay for a taxicab to hustle us to the next stop so we can get back on the short train. The preferable scenario would be that the train just sits here for awhile and we get an opportunity to regain our seats at a discount. Either way, we are avoiding the risk of another big setback.