When the bad outweighs the good, we sell

Posted on: May 21, 2010 in: Uncategorized with 0 comments

The following is adapted from our letter to our clients of 20 May 2010.

Hi John,
A quick heads up on your portfolio.

Markets have been falling for days, mainly due to the trouble in Europe.
We resisted selling our positions until now because the fundamentals – things like earnings, employment, and industrial activity – have all been strong.

But we finally decided to sell the following ETFs:

  • US S&P 500 (IVV)
  • US Russell 3000 unhedged to CAD (IWV)
  • iShares Brazil Index (EWZ)
  • iShares Latin America (ILF)
  • iShares Australia Index (EWA)
  • SPDR Emerging East Asia (mainly China, Taiwan and India) (GMF)

We kept Canadian equities (TSX 60) (XIU) and India equities (EPI) and of course, we didn’t touch the various bond ETFs. I’ll explain why we kept those later. I’ll also tell you what we bought. But first, let me tell you why we sold.
Several key indicators are signaling that stocks will fall further:

  • Copper, as an industrial metal, is a leading indicator of economic activity. Its price has fallen sharply below its 200 day moving average.
  • Lumber is the same. Recent housing numbers showed new sales up but new starts down.
  • The DJ Transportation Index tells you how well truckers, railroads and shippers are doing. Again, they are a sign of economic activity. The index is down to its 200 Day Moving Average
  • The same applies to the Baltic Dry Shipping index which measures world shipping freight.
  • US Inflation is at a 44 year low. If oil prices continue to fall, it will slip into deflation which would be bad news for stocks.
  • Chinese equities are about 15% below their 200 day moving average
  • The VIX (Volatility) Index, which measures volatility of the S&P 500, has turned sharply higher in the last week, indicating that investors are very worried
  • Finally, the yields on Canadian and US government 10 year bonds have fallen below the key 3.50% level as investors demand for them rises. This is another indicator of investor’s fear.
  • On the positive side, the falling markets have pushed up the value of the US Dollar against the Canadian. We had bought US dollar securities so we have benefited from this.

    We kept Canadian equities because compared to the US and Europe, Canada is the new safe haven. Canadian equities fared quite well over the last three years and they recovered faster than other markets on Asian commodity demand. So while they may suffer in the near term, we don’t want to miss out in case the rally resumes. Plus, our decision to sell might be wrong (Yes, hard to believe but its true :)).
    We kept India because it is another safe zone. Its currency is not fully convertible (sort of like my old Subaru Forester – its not convertible, but its sunroof is huge). Its banks are very conservative. Foreign access to its equities is tightly controlled. Access by Indians to foreign markets is tightly controlled. Exports make up only about 1/5th of its economy. Domestic demand is strong. Government policies and finances are reasonably and relatively sound. (I take no credit for any of this – I left the country when I was 4.)

    Finally, to replace what we sold today, we bought an ETF on the Volatility Index. If markets continue to struggle, then we will benefit from the higher volatility levels. By the time we bought the VXX, it was already up 10% on the day. By the close, it had climbed another 3%. As you can see, volatility is volatile. Two weeks ago, it was half what it is now. We’ll be watching it carefully for any signs of a pullback.

    Let me know if you have any questions.

    All the best,
    Tel: 416-740-3335

    Disclosure: No positions in IVV, IWV, EWZ, EWA, ILF, GMF. Long EPI, XIU.TO (similar US ETF is EWC), and VXX.

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