Investment-Strategy

Equity Choices vs Market Capitalisation

2015-10-10T00:36:00.000-07:00

Market Capitalisation weight or equal weights?

When performance is measured of a portfolio there is the absolute number - did I make money and if so, how much - and the relative performance. We all see many articles in the newspapers, newsletters and emails (as well as spam) telling us how to beat the market. If we have a pension we read reports of how the pension fund has done relative to the benchmark. When an individual constructs a portfolio do they look at market capitalisation weight of each stock or do they look to create a group of stocks or a portfolio that they expect to do well? I have listened to people say that it does not make any difference which way a portfolio is built. That all depends on how closely a security follows its country of quotation and how much independent life it has. This will be discussed in a coming blog. For now, let's look at the way some indices are structured.

A common global index is the FTSE All-World Index. This global index has over 3000 companies as constituents from approximately 50 countries. That is certainly a large set from which to choose. The index itself is market cap weighted so obviously some companies are much more important than others.

Below are two pie chart diagrams showing the breakdown of the index by countries. In the first diagram the companies are counted with the percentages indicating what percent in number of the 3000+ companies are in each country.

There is no surprise here that the USA represents the largest number of securities in the benchmark. What is probably a surprise is that the USA is ONLY 21%. Most people think that the USA is about 1/2 of the total index. Notice that Japan is the second most numerous country in the benchmark at 16%. This is only about 5% less than the USA. China is the third most numerous country and the others follow around the pin-wheel. There are some surprises here. If a fund manager had a list of the constituents and then built a portfolio from that list, the results could be similar to the pie chart. Or put it another way, the opportunity set is represented by the pie. If a portfolio were weighted like this pie in the exact proportion of the count, the result would be far away from the index. Note the following pie chart where market capitalisation is used to decide the weighting rather than counting.

The above market capitalisation weighted pie chart is more like what we would expect. The USA is still the largest country but now is 41% of the benchmark. Japan has dropped to 8% followed by China at 6%.

So the million dollar question is - Should I build my portfolio from the opportunity set of index constituents without regard to the index or should I pay attention to the country weightings? Much depends upon your goals. To be discussed in a later blog, but for now these two charts alone should lead to many thoughts.

2015-10-01T07:18:00.002-07:00

Stock Market investors should avoid October? Why?

Ah yes, the crash of '87. I remember it well with hurricane force winds in London, my office window blown in and the market in free fall. No cell phones and land lines were not being answered. Ah yes, the crash of 2008. Perhaps not as dramatic but memorable. Thinking about it in the real bear market of 1973/74 the market went up in both Octobers. What is the real October norm? Bloomberg says the average over the last 30 years for the S&P 500 is a POSITIVE gain of 0.86

Here is their spread chart - we should not assume that this October will be like the two outliers. A chart is worth a thousand words.

Microsoft - Windows 10 - How to analyse for investment purposes

2015-07-30T08:51:00.001-07:00

How to analyse Microsoft - Win10

Managing Microsoft must be a mind stumping problem. For a long time journalists have enjoying throwing mud at everything Microsoft does. Probably this was because they were the leader and therefore presumed to be fair game. As the company seemed to slip in dominance some more sympathetic reviews appeared. Microsoft has been dominant in many area for so long that it has been hard to think of them losing in their main areas. Apple is normally highly praised in reviews yet the corporate history is not pretty and they have stumbled many times in the past. Perhaps the big difference between the companies is that Apple has successfully captured the retail market and is a fashionable company. Microsoft is stuck in the business users or power area. When either company ventured into the otter space - Apple into business or Microsoft into consumer - they were less successful. The real problem for Microsoft now is that their software products, the bread and butter of the earnings, accomplish more than almost all of the customers need. The old days of must have major upgrades are long past. How can Microsoft make a company running Win7 and Office 2007 move to Win10 and Office 2016? The advantages are not great so how can the company keep earnings growing? Try phones with Nokia? Build hardware like Surface? Or turn bought products into rentals - ah ha - that might work. The pushing of Office365 with perpetual updates and cloud storage should move the customers into stable renters. Note that just released Win10 has regular updates that cannot be easily turned off. Microsoft wants to remove problems of security caused by customers not updating the software with forced updates. Once the customer becomes embedded into the OneDrive cloud it will be harder to move. Microsoft has also continued the strategy of eating the lunch of peripheral software producers. The new Edge browser is receiving good reviews and Defender makes it hard for Norton and others to sell their products. History does not repeat itself but rather it rhymes says Mark Twain. Computing in the 1960-70s was a large computer with significant ( by those day's standards ) storage somewhere and the user equipped with a terminal into that facility running rented software. Then the PC and all reversed in that everything was on your desk or even in your lap - software, storage, hardware - everything was yours right there. Are we rhyming back to the 1960s with storage in the cloud, software downloaded on demand and someone else controlling our updates? Is an iPad a terminal? At least we did not rhyme the Hollerith cards. The big question is if the rented software/storage as a service revenue can be large enough for such a giant company. Microsoft says Windows 10 is the last version - lets hope that is because it can constantly be upgraded rather than it failing.

Saudi Arabia should pump pump pump

2015-06-06T07:06:00.000-07:00

Conventional wisdom says that major oil producers, and we normally think about OPEC, should try to get the maximum price that they can for their only significant commodity. Most OPEC governments are heavily dependent upon oil revenues meaning the drop in oil prices will make a big dent in their income. So why is Saudi Arabia in particular not reacting as it normally does to oil weakness by reducing production?

See below their past strategy

Most recently, however, they have maintained production which some commentators believe is to hamper US tight oil production. The production cost of Saudi oil is always in dispute. An interesting quote on Gulf costs was made by an oil services CEO this week in the UAE ....

Nureddin Sehweil, an American educated oil services CEO based in the UAE since 1979, said these players can also onshore leverage the world’s lowest cost of production, estimated to be $2-$10 a barrel. “We do have a great advantage over many nations, neighbours and even in Africa and, for instance, in South America,” said Sehweil of Uni-Arab Oil Service In today's (6th June 2015) Gulf News published in the UAE

If he is right, then producing onshore oil with costs under $10 / barrel is still highly profitable.

I have been told many times in the Gulf that the real problem with oil is not that OPEC will run out of crude, but rather in the future there will not be a major need for crude oil due to alternatives or some new technology. With that thinking it is better to get the oil out of the ground and sell it using the revenue to invest. Holding back the reserves under the sand until no one wants them is bad long term investment planning.

A similar view was expressed by Bob Massie as reported kn the New York Times today in the discussion on the Norwegian Sovereign Wealth Funds decision to dis-invest in coal related companies. http://www.nytimes.com/2015/06/06/science/norway-in-push-against-climate-change-will-divest-from-coal.html?emc=edit_th_20150606&nl=todaysheadlines&nlid=69469489&_r=0

He cited research that suggests averting some of the worst outcomes of climate change will require leaving much of today’s fuel reserves unburned. This means companies with large fossil-fuel reserves could be forced to leave them in the ground.Those “stranded assets,” he argued, will be a financial burden on the companies.

Maybe the Saudis have more than one motive. They want to hinder US tight oil extraction, change the profit dynamics on alternative energy companies and sell their oil while they can.

Once again it is useful to walk in the other persons moccasins - that is image you are them and how they see the situation - when trying to understand global events.

Bob Massie is a longtime climate activist and a founder of the Investor Network on Climate Risk, an organization of institutional investors affiliated with the business environmental group Ceres.

See World Events from the other person's view point before commenting

2015-06-06T03:20:00.000-07:00

Recall the Indian proverb about walking in the other man’s moccasins before understanding him or judging. The understanding of world economic, political and investment events suffers from the observer applying his own present and historically learned views upon a completely different culture and situation. It seems that with globalisation of news we are suffering this problem more rather than having it reduce. I will try to give some examples. Remember not to shoot the messenger!

2015-03-24T04:47:00.000-07:00

What is RISK?

The word risk means many different things to different and the to same people. Investments are called risky if they have high annualised standard deviations. This is really a measure of volatility. An investor should be concerned about volatility only over the time period of his likely investment. We will develop this concept over the the next few blogs. For the moment, notice the chart below that shows the distribution of annual returns that an investor would have achieved by holding the US equity index.

The world continues to change fast in many ways

2014-09-26T09:29:00.000-07:00

The world is changing fast ....

To what am I referring?

RIM/Blackberry's rise followed by a fall?
The size of phones?
IT Power of phones?

All the above are true and it is exciting to read about the Blackberry Passport for all of these reasons. The change that caught my eye was something else .....

Chief executive John Chen on Wednesday unveiled a large-screen, square sized phone called the Passport to a Toronto audience. London and Dubai also hosted launch events.
No event was held in the US where analysts say there is little demand or carrier interest.

The shift globally to the East is demonstrated daily in economic and political events. We have seen a launch of the most important product from Blackberry in terms of their survival and they chose three cities - Toronto (near their home), London and DUBAI. Did you know that the GCC (Gulf Cooperative Council) states account for over 1/3 of the sales of the Blackberry Porsche phone.

Yes, the world is changing fast!

Gold and Monetary Base

2012-09-17T12:12:00.004-07:00

Gold prices are driven by a variety of factors with, unfortunately, the factors changing with time. Sometimes the factors are inflation related, sometimes money base, other times oil, politics, mining problems or several other influences. When a multi factor model is built the T-stats are poor if a longer time period is used of say 20 years, but these same reliability measures become very significant for selected periods. The real problem is deciding which factors work and when. I can tell you the answer for any period in the past - the real difficulty is saying which factor will work in the near future.

At the moment gold is responding to the monetary base level and Euro problems. But even these two useful factors wane from time to time.

Note below the excellent chart produced by ETF Securities and featured on many web sites in the last day or so. It clearly shows the relationship between money base in the USA and gold prices. With the FED entering QE3 we should assume that gold will rise - if the relationship holds true.

This same chart cant be produced on your Bloomberg as shown below. The relationship looks strong.

The relationship seems to be sound over the last four years. Now check the four years before to that - 2005- 2008.

Woops!

Gold was not being driven by money supply data. This is normal for a factor to become less significant when it is fairly stable. This relationship, however, should have generally worked since the theory postulates that a decrease in the real worth of a currency caused by money printing should debase that currency. Gold without such supply increase should rise in terms of the debasing currency. It did not happen. It is not that the relationship completely broke down but rather that other factors were more important in the gold price determination in 2005-2008.

Advice for the future is to think about which factor will be driving gold in your personal investment time horizon for your gold investment decision.

European Interest Rates still represent two camps

2012-06-12T13:33:00.000-07:00

If we remove the Greek and Portuguese extremes we can more easily see the other Euroland long yields on the chart below.

From March onwards the flow of investment and speculative money has been from Camp1 with the high interest rates and perceived risks to Camp2 with the low rates and less perceived risk. The result has been that both Camp's rates are now "incorrect" for their underlying economics. This disparity can only be fixed by a change in investor perception caused either by a lapse of time with no change OR a believable action by governments to correct the imbalances or restructure the Euro. Euro FX has turned into a betting shop on countries leaving the Euro either walking out or departing feet first.

Germany benefits

Germany already has a significant cost advantage against Southern Europe built up over a decade of relatively better cost controls as demonstrated in inflation rates. The South now needs to reduce its costs, increase productivity or both. A large cost in many companies is the cost of financing. With banks linking borrowing to a base rate and corporate borrowing linked to the countries soverign rate, the South needs its interest rates to be below Germany or at least the same. But look what is happening to the South's interest cost ....

The above chart shows the spread between each countries 10 year interest costs and the German rate. How can someone compete while paying 4% more than their strongest competitor?

Greek Tragedy

2012-02-15T20:40:00.000-08:00

With these unprecedented levels of unemployment and long yields, how can any government accelerate an austerity program? Either of these indicators will lead to riots if they do not decline soon. As more relatively highly paid government employees are made redundant, how will the consumer sector recover and growth return to generate the GDP and tax revenues needed? Is this only a Catch-22 or is it also a Greek tragedy?

Peak or Not Peak Oil -Yergin vs Finite Worlders

2011-12-16T02:13:00.000-08:00

Daniel Yergin is well known as an expert on energy and particularly oil. In a recent 15 minute interview with Ron Insana he was optimistic on the supply of energy for the world but with some caveats. The full interview is on many places on the web and easily accessed on YouTube searching using the words Yergin and Insana. The main points Yergin made were;

Energy transition is well underway in the USA - the key over the next years is innovation not resource finds
Shale gas is immensely important representing 30% of all gas.
Shale gas has saved over $100b on the import bill
Hubbard’s Peak is 20-30 years away
Technology is now more important in supply forecasting than geology
China will be the largest energy user in the world in a decade
Renewable – Yergin did not sound so confident – reasons were
Innovation is key yet it is unpredictable
Politics is very important particularly subsidies or tax concessions

Not everyone agrees with Yergin which will be discussed in following blogs.

UK Economic Recovery - Worse than past cycles?

2011-11-24T10:02:00.000-08:00

Judging by the morose economic commentary in most publications one would think there is a competition to be more downbeat on the prospects of the UK. Such journalism can bring charges of creating the news in a self fulfilling style rather than praise for analysis and reporting. A graphic comparison of past economic recoveries makes for a more fair comparison. The above chart by The National Institute of Economic and Social Research shows that the present recover - BLUE - is indeed worse than the 1973 and 1990 downturns but on par with the 1979 recession. Considering the Euro scare it is amazing that it is not worse.