Business, Real Estate & Investing
By Jim Karger

2008 has indeed shaped up to be a difficult year for investors

Many expatriates in San Miguel live on their investments or income from their investments, and Atención publishes a market update and analysis every six months. The following is a six-month follow-up to my observations published here at the end of last year. The numbers cited below are as of May 23, 2008.

“2008: Shaping up to be a difficult year for investors” was published in December 2007. The title has proven to be accurate. 

US markets have floundered in 2008. The S&P 500 is down 5% year to date, the NASDAQ is down 7.8% and the Dow 30 is down 2.6% since the year’s beginning. These results are acceptable to most everyone I know, but most investors are willing to live with the ups and downs of the market and willing to accept a long-term return of about 8% per year (the historical return of the Dow Jones Industrial average) less inflation by keeping a “balanced” portfolio of equities and bonds. Some, however, want higher returns and are willing to accept different levels of risk to obtain them. If you’re one of these, read on. . . 

As I rebalanced the portfolio for 2008, I said in the December 2007 article that I would make four decisions.



-Sell all US index holdings because I believed the US would (once again) under-perform most other markets


-Lighten up on emerging markets because they had become too large a part of the portfolio due to oversized returns in previous years, maintained financials with the expressed intent that “if am I wrong, then I may sell and go short this sector”

-Maintain one commercial real estate fund (CGM), gold, three technology companies, and two bond funds

-Add to high-yielding stocks, health care, and hybrid-preferred issues (i.e., preferred stock issued by large money center banks that pay better than an 8% dividend yield)



Now it is time to take a look at the results of those moves for the first six months of 2008. Buy the ticket, take the ride.

How has the rebalanced portfolio fared? Here’s the report card.

Selling out US equity positions turned out to be a good move, but I couldn’t make myself sell Apple, Cisco or Starbucks because I like those companies. On reflection, I should have sold them, too; of the three, only Apple is holding its own. (Mine was the common mistake of buying or holding stocks in companies one “likes.” What I like and what makes money are oftentimes two different experiences.)

Lightening up the emerging markets was also a decent move. Emerging markets, except for a handful of countries such as Brazil and Russia, have been disappointing compared to their performance in 2007. While the MSCI Brazil Index (EWZ) is up 69.89% in the last year, the shares of the China 25 Index (FXI) are down 12.73% year to date. 

Mexico, by the way, has performed better than most emerging markets but hasn’t set the world on fire as it did the last few years. The Mexican Bolsa as tracked by EWW, an exchange traded fund (ETF), has provided a year to date return of 4.3%, better than the US and better than most emerging markets, which collectively are down 1.8% for the year. The only big winner in emerging markets has been Brazil, up 20.8% since the beginning of 2008. 

Maintaining financial stocks in the portfolio was a mistake. Trying to call a bottom in a market that is racing to the downside due to investor fear was like trying to catch the proverbial falling knife. I said in December 2007 that if I was wrong I would switch sides and go short the financials, but like many traders I felt the turn had to be “just around the corner” and held on—too long. Had I gone with my plan and reversed course and gone short the financials via the UltraShort Financials ProShares (SKF), I would have been up 69% in that sector instead of down about 30%. “Would have, should have, could have”— famous last words, and I should have known better.

Maintaining the gold position was a reasonable move. GLD, an ETF that tracks gold, is up 5.1% year to date. 

Maintaining a couple of bond positions was a “ho-hum” decision—a good place to park money but not to make much, at least not so far in 2008.

Adding to positions in oil and in high-dividend equities turned out to be my best decisions of late 2007 and the only reason the portfolio has outperformed the major indexes and is positive for the year. iPath S&P GSCI Crude Oil (OIL) is up 115.6% in the last year and 22.4% year to date. That said, all oil positions are up, to the surprise of many. Refiners are a good example. Because of the low crack spreads (i.e., the differential between the price of crude oil and petroleum products extracted from it), most refiners are down for the year. Exploration and production companies, however, have shot to the moon.

High-dividend equities also paid off, especially Frontline (FRO), a stock I have mentioned in earlier articles published here and elsewhere. A large oil tanker company, Frontline began the year at $48.94 and rose to $69.93 before pulling back to $64—still up 30% for the year. What’s even better, it is paying a 12% annualized dividend. Other high-dividend plays that have paid off include Pengrowth Energy, yielding 13%, and Baytex Energy Trust, paying out over 8% annually.

Health care as a basket of stocks, trading as XLV, has been disappointing, down 10% for the year.

The best of the fixed-income breed was not bonds, but rather the hybrid preferred issues I discussed in December, including Barclay’s Bank PKC Non-Cumulative Perpetual Preference Shares, yielding 8%, and Merrill Lynch & Co. Non-Cumulative Perpetual Preferred Shares, yielding 8.5%. Being “non-cumulative,” the companies issuing these securities cannot delay paying the dividends that are taxed in the US at a flat rate of 15%, rather than at one’s marginal tax rate.

That’s how it looks from the rearview mirror, but now that we’re six months into 2008 the question is where to go from here. 

Rounding the bend in 2008: A plan

The tax-rebate checks being sent by the US government may provide a temporary boost in consumer spending and the retail stocks that I have avoided like the plague could get a tradable boost, but I’m not biting. Meager wage increases, declining home equity and wildly escalating fuel prices have lessened Americans’ ability to engage in their favorite pastime: buying stuff. 

I agree with most observers on this one who predict sluggish (if any) growth through 2008. Falling home prices, tighter credit and rising fuel costs, combined with a weaker labor market, don’t portend good things for the US economy in the near term. 

The US consumer seems to agree. The Conference Board’s measure of consumer confidence fell to 60 in April, the lowest reading since August 1993. We all know why. Rising gasoline prices and falling net worth caused by plummeting home prices make the consumer feel poorer, mostly because he is poorer. The S&P/Case-Shiller home-price index is expected to show prices fell 14% over the last year in 20 US metropolitan areas. Projections going forward for the US housing market aren’t much rosier. Figures on sales of new houses will be released next week and are expected to show the pace of home sales fell to a 17-year low in April. 

Ironically, our cursed reliance on foreign oil could be reduced if the US government simply raised mandatory fuel economy standards by 7.6 miles per gallon. That arguably would yield more oil than is pumped in the entire Persian Gulf and imported to the US. But it appears more pain will be necessary before the US consumer is ready to give up his SUV, and more pain is on the way.

In short, US consumers/investors are depressed. The question for investors is, “Are they suicidal yet?” Traders look for what is called “capitulation” as a buy signal. Capitulation occurs when people sell just to stop the pain. Whether capitulation has already occurred is subject to debate. Regardless, history shows the market usually stages its recovery before, not after, the economy improves, if only because the stock market has nothing to do with the past or present and everything to do with the future—the discounted present value of a company based on anticipated future earnings. That combined with the fact that going against the herd is almost always more profitable than following them over the cliff leads me to believe that more pain is ahead in the short term but that the US market may begin its recovery sometime this year. 

With that in mind, my plan for the last six months of 2008 includes six considerations.

-Lighten up on energy. Oil has had a great run but a lot of that run has been caused by speculators, and I would be surprised if oil ends above $150 per barrel by the end of 2008 —not enough of an upward move from where we are today to make any more big bets in this sector for now.

-Hang in with high-yield. The 8.5% preferred issue dividend plays from the likes of Wachovia and Merrill Lynch may prove to be the pick of the litter in this investment environment. And while I’ve hung in with the high-yield preferred issues, I’ve lightened up on the mega-winner, Frontline (FRO), if only because nothing goes up in a straight line forever. If and when it pulls back to $50, I’ll buy more.

-Stay the course with emerging markets. They are risky and volatile to be sure, but places such as India, Brazil and Singapore illustrate the best hope of any economies in the world. 

-Add US index positions after being out of the US market for some time. This is a tough decision, but once I see the US market indexes move up and hold above their 200-day moving averages, I will be in for good or ill.

-Eliminate health care from the portfolio, if only because I seem always to be on the wrong side of that trade. I remember when Pfizer was a no-lose pick. It’s now a no-win pig, trading near its 52-week low. In addition, politics adds uncertainty to these stocks. The result of the US presidential election next November will have a huge impact on the value of these companies. 

-Green energy has, for the most part, been a poor investment in 2008, although there have been some notable winners. PowerShares WilderHill Clean Energy Portfolio (PBW), a collection of green energy plays, is down 24% for the year. However, green energy is the future and so I am going to wait to see a turn-up in alternative energies and jump in. 


Bottom line

Like most active investors and traders I made some good decisions going into 2008 and a few bad ones, too. On reflection, I only regret one decision: not following through on my stated intent to short the financials if they kept moving down. I didn’t do it even though I said I was going to do it. I paid the price for my lack of conviction and I learned an important lesson—again: map your plan, write down the reasons behind your decisions, and then follow through, no second-guessing.

Jim Karger is a contributor to Atención. He is not a stockbroker or investment advisor and does not provide investment advice, nor does he trade for the accounts of others. You should not trade based on any of Karger’s observations in this column. Any decisions about your investments should be made only after your own research and/or consultation with your investment adviser.

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