Macro Tsimmis

intelligently hedged investment

BUY iShares Dow Jones US Technology ETF (IYW)

Posted by intelledgement on Tue, 29 Sep 09

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 maneuver 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 ex-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.

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