Putting the pieces together...

A David Rosenberg Portfolio

McKinsey Global Institute is one arm of the highly respected McKinsey & Company, which is sometimes referred to as the rich man's IMF. This attribution is not because of dollar values, but because they are problem fixers who don't carry the stigma of being advised by IMF. A good friend worked for them in Korea in the late 90's where they were hired as part of Korea's workout after the Asia Crisis of 1997-9. Not that McKinsey solved it unaided, but they were a major contributor to Korea's recovery.

McKinsey has recently released a reworking of their firm's analysis of the de-leveraging process and probable time course for developed countries, and those impacted by them, since 2007-2009. Much is based upon the historical research published in the past few years, some of which has been discussed here. You can read a summary https://www.mckinseyquarterly.com/Working_out_of_debt_2914 or at http://www.johnmauldin.com/outsidethebox/?tm_source=newsletter&utm_medium=email&utm_campaign=outsidethebox .

Basically it's going to take longer than most people think to emerge from the credit crash. You know my bias is that currency debasement will result in continued dollar inflation, but I have been acknowledging that there is also at the same time a deflationary force in the public sector. McKinsey fleshes this out.

David Rosenberg ex-Merrill Lynch and now at Gluskin Sheff in Toronto has neatly outlined the investment implications of a McKinsey style world: http://www.zerohedge.com/print/443141 In an email to a friend I distilled what I see as a practical portfolio based upon some of Rosenberg's ideas for a typical private portfolio, in my case for a retired investor. In fact it's not too far from my current portfolio. In one sense it could be a "set and forget" package, but it could be traded as desired in several particulars.

"Rosenberg always sounds fresh, and I keep learning from him. Three of his list items make lots more sense to me all the time:

"2. Deflation trumps inflation as the primary trend in a deleveraging cycle. This means an emphasis on defensive sectors with earnings stability and predictability characteristics. It also means a focus on squeezing as much income as possible out of the portfolio. This is why "income equity" strategies make so much sense."

To me this means keep and thoroughly appreciate and enjoy the annuitites and the IRA's which are still shelters."Income equity" strategies means investing in a spectrum of long stocks/short options vehicles. I have 3 closed-ends which do this: ETV, EXG, and GGN in mostly US, mostly non-US and gold and other resourcestocks. CEF's doing this can be traded across a volatility and discount narrowing range in non-taxable accounts. CEF's don't have to liquidate their holdings to buy out their shareholders in a rout. The shareholders liquidate themselves which gives us the tradeable panic volatility excursions.

""5. In this post-bubble environment, policy rates will remain near the floor for years. As such, the risks of any sustainable bear market in bonds are very low since the cost of carry is so vitally important to the fixed-income markets, especially for longer duration product (keeping in mind that yield curves are still steep by historical standards).""

 

Excellent idea along black swan lines. Keep most of your money liquid, but put a meaningful portion in leveraged long tbonds. My favorite is Vanguard's EDV, but WHOSX is very good or any low cost long term treasury mutual. These also do well in tax-sheltered accounts. you could do the same with munis for taxable accounts,,,,the same yield curve aberration.

""6. Keeping policy rates low means that real rates will remain negative. Even if the CPI turns negative, the central banks around the world will de facto ease policy by printing money. In this sense, the secular bull market in gold bullion remains intact and, as such, dips should be bought (especially dips below the moving averages).""

and.....

""7. Global deleveraging cycles almost invariably bring on heightened geo-political tensions. This is why the oil price has such a high floor established underneath it. Protectionism will continue to emerge as a new normal, as part of the globalization trend gets reversed. Exposure to crude oil and materials makes good sense from a strategic point of view.""

These are one and the same idea and speak well for themselves. A good portfolio could be 70% tbills or short term TIPs bonds, 10% buy/write equity funds, 10% long term treasuries, 5% gold, 5% commodities or just 10% gold. This would be good for anyone over 50-55 years of age. All are thoughts incorporating both the deflationary and inflationary aspects of current reality within an income portfolio.

Read the McKinsey and Rosenberg articles for background and detail.

2cs and OTHER SENTIMENT MEASURES

2CS has been as low as 75 recently, and it got much lower at highs in February 2011. But some other market-based measures now are where they were then in 2011 and never again thereafter. So I have cut out or trimmed most of what I think would take big hits in a downturn. Keep in mind that I am investing IN retirement, so my absolute challenge is to avoid big hits. Younger people or risk traders may have legitimate long term vistas which warrant staying put. Nor am I making recommendations for others, just writing what I think and do for myself.

Long Wave Thoughts 2012

Yesterday I had an exchange of emails with a former colleague at the late University of Colorado Long Wave site in the later 1990's until about 2003 when it became such a rant site that UC closed it down. Initially that site discussed the history and progress of Kondratieff's economic long wave as it applied to macro economics and to crude goods prices, interest rates, wages and incomes and gross national product. It was eventually dominated by bearish equities analysts apparently looking for some academic exposure. The fact was and is that equities are not valid price series for measuring the ebb and flow of the economic long wave.

Most of the bears missed the fact that the great bull market from 1982-2000 took place during the disinflationary Kondratieff long wave declines of interest rates and commodity prices. Their concept was deficient and demanded an economic crash like 2008 to signify a "down wave". They kept trying to fit their beliefs into the Kondratieff wave by insisting that the wave was on hold for 20-25 years! In fact the inflationary wave had peaked from 1973 to 1980. The effect of all this pseudo-Kondratieff babble was to discredit the long wave. Several gold-sellers also adopted Kondratieff parlance to push gold sales and further discredited the very idea of a long wave.

Other than David Barker of https://longwavedynamics.com/ , there are now very few current long wave analysts compared to quite a few from the 1960's to 90's. I subscribe to Barker's very thorough newsletter. Barker has his own version of the long wave which owes a lot to the late P. Q. Wall who popularized the "seasonal" concept of spring, summer, fall and spring in each long wave, borrowing from Oswald Spengler, the popular gloom and doom German philosopher of cultural Armageddon in the 1920's and 30's. Barker's main thrust, regrettably, is stock market analysis of the much shorter Kitchin and Wall cycles, but it is useful for short and intermediate term stock traders looking for tradeable cycles. He sees the Kondratieff down wave from the 1970's not ending until 2013-14, which I see as far too long and an unacceptable distortion of Kondratieff's concept which described half wave cycles of approximately 27 years up in rates and crude goods prices and approximately 27 years down.

The 1949 Long Wave low led to the late 1970's high and suggested 2002-04 as the next low. Although some commodity prices made their bear market lows in 1998, most them gradually made their lows by 2003, and so too, seemingly at the time, did interest rates. All the metals, grains, meats, energy, and tropical foods have long since made lows and given major gains the past decade.

Bond yields broke with the Kondratieff wave in 2008 after having made their last previous lowest low on schedule in 2003. http://screencast.com/t/Rzr7CvXcDhX The liquidity panic of 2008 understandably caused a massive flight to safety, and only US Treasury bond markets had the size and depth to accomodate many trillions of panicked capital looking for safety. The rapid unwinding of this panic trade from almost 2% on the 20 year bond to 5% in a few months in 2009 promised to signal that the main Kondratieff inflation wave vehicles were back in synchrony. But continued panic by the US Federal Reserve and trillions of dollars of quantitative easing has kept rates near the 2008 lows and attracted much capital that concludes that things must be very bad indeed if the Fed is still panicked.

So we have a bifurcated economy with inflation in the private economies of the world but deflation in government economies. The large banks in North America and Europe are effectivly bankrupt and wards of the state. They are under enormous pressures to raise capital, cut non-banking operations (speculation), and loan, loan, loan. But their reserves are all they have, so they are leaving them safely back at the Fed. Despite Fed printing and "loaning" to the banks, only a small part is leaking out to speculative hedge funds. Governments themselves are increasingly seen as close to financial implosion.

Meanwhile, private corporations are doing relatively well and are self-financing or re-financing with very low yield bonds. World private inflation and growth proceeds, as it has since 1999-2003, with demand from emerging nations as well as from re-tooling in many industries. This dichotomy prevents, or at least has prevented, either the inflationists or deflationists from being correct overall. Nevertheless, gold and most prices are far above the 1999-2003 lows, so we may safely say that Kondratieff is still at the helm and will stay there another decade. Even so, and although inflation will continue, overall world economic growth will remain positive but modest for a few years. This will have a negative effect on stocks, moving from country to country in "confidence moves", until an all-out inflationary binge develops when bank reserves finally get loaned out.

NEWER HEDGING VEHICLES

My old cyber-friend, Bill Luby, also known as Professor VIX, just published a chart of several recent (2011) stocks which hedge based on volatility avoidance. Since we have discussed many traditional methods for reducing volatility risk, this is quite interesting: go to Bill's site via "Blogs I Like" in the left-hand column to click through to his site. Look at his January 13,2012 blog post.

Stock Market Sentiment Update

2.cs was 84 last night, the lowest it has been since last July (2011). Also total equity to index cboe options (puts + calls) is higher than it's been since July 2010,,,yes, 2010.... froth is back in this and other indicators I do.

But volume studies are not high enough yet to confirm topping. It needs a few blowout upside days now, or a pullback into mid next week and another run after that.

Another Emerging Markets Fund

WisdomTree's Emerging market currency fund (CEW) is also worth a look, particularly now since it took a big hit from August to October and then went ex-dividend for its annual dividend (>5%) in December. You can make a Harry Browne type sector play with emerging market stock, bond, and currency funds. Add a bit of GDXJ or GGGG for emerging country golds, and there you are! :)

CEW is a 30 day or less duration basically "money market" fund. http://www.wisdomtree.com/home.asp Look at their recently re-balanced portfolio.

Emerging Market Balanced Approaches

As with most things there are differences of opinion on the intermediate term probabilities for emerging markets. Some say emerging markets will be done in by developed country credit woes and recessions, while others point to emerging market economies as being relatively debt-free and and with manageable national budgets and rising middle classes with money to spend.

Regardless of these issues, the fact remains that emerging markets are where the growth is and will be for a long time, so that is where you want to invest some part of your growth portfolio. A recent copy of Aberdeen Asset Management's Bulletin pointed out that in 1870 Aberdeen started investing in North America because that's where growth was lifting off the runway. And that's the case for emerging markets today. For an example, look at Indonesia Fund's chart for the past decade: http://min.us/lbnNVGomGtiG7W

Do you really want emerging market stocks or bonds? Why not both? Go for balance, as you do with domestic or developed country securities. Three funds that have been operating at least ten years are featured on the next chart. Matthews Asia Growth and Income (MACSX), Aberdeen Asia-Pacific Income (FAX), and Templeton Emerging Markets Income (TEI) have generated above 11% annualized total returns for ten years, far surpassing Pacific/Asia, Emerging Market Bond, and SP500 indexes over that period: http://min.us/lH5tGTRucOQ23

Read about them at Morningstar.com, or visit CEFConnect.com for FAX and TEI. Look at their portfolios. Note that their ten years total returns are nearly equal, but they got there by various routes. It should make sense to own, perhaps, equal portions of each fund. Another approach to watch is Fidelity's new emerging markets stock and bond fund, Total Emerging Markets (FTEMX). I prefer to wait on new funds, but this one bears watching.

I have owned FAX, TEI, and MACSX and will be adding back MACSX, which I sold last summer, to own them all again.

 

ADDED LATER: The current yields of the three funds are MACSX 3.03%, FAX 5.68%, TEI 6.58%. Equal dollar amounts of the three funds would give you 5.05%.