Global Alpha

Seeking Breakeven Inflation

2009-08-10T17:06:00.001-07:00

Seeking Breakeven Inflation

If you are in the camp that thinks that all this government spending and a resurgent global growth (after this recession is over) will cause an above average inflation scenario, and want an investment strategy that could help in such a scenario, then read on.

There are several ways one can hedge against inflation. One can invest in commodities, gold, oil, and the more traditional US TIPS. However, each comes with its own flavor of risk and a variety of factors that can cause the returns of the strategy to differ from just “Breakeven” inflation (terms are used interchangeably with inflation expectations).

What is breakeven inflation (BEI)? The difference between the nominal yield of say a 10 year Treasury, and that of a 10 year inflation indexed bond is a measure of expected inflation. Technically speaking, BEI is the rate which will equate the return on the indexed bond to the nominal bond. The current 10 year BEI is about 2%, which is close to the long term average.

So how does one invest in a BEI strategy using equity ETFs? Simply buying a TIPS ETF, though good for hedging inflation in general, may not track BEI well because TIPS (bonds) are affected by, among others, interest rates, which can rise once the economy gets back on its feet. For example, investing in the TIP ETF around Feb of this year ($99), through July end would have given a return of slightly under 2% ($100.4). The BEI in the same period went from 1% to 2% (100% change). The ETF strategy outlined below would have returned 100% ($1 to $2). All numbers rounded for simplicity.

What is the trade (do not skip the associated risks part of this article)? One way to implement it is to long (buy) TIP and short (sell short) IEF. Your net investment is about 1$. The way to make money on it is to lever it up. Leverage is, ironically, a 2X levered four letter word now. But you cant blame the knife for the crime. The leverage depends on your risk appetite and capital. The performance of this trade vs the 10-year BEI is shown below. The second chart shows the daily change in the BEI and the trade. As you can see, it has tracked the BEI trend reasonably well this year, with a daily percentage change that is similar too (with some exceptions when BEI is near zero).

Other ways to implement it would be to long IPE or WIP (World inflation), and short the various long-Treasury ETFs such as SHV, IEI, TLH, SHY, TLO with IPE, or BWZ, BWX with WIP.

You could get more sophisticated by duration matching the 2 sides of the trade, but given the variability in tracking using ETFs anyways, that may be overkill.

Note, if you can't short the ETFs, you could go long the short-Treasury ETFs such as TBT or PST. But then your ROI is dramatically reduced (less than 1% in the above example) to the point of being an exercise in futility, unless you trade on margin (I wouldn't recommend leverage + margin, that is a recipe for bankruptcy).

Also, if you have a deflation view, simply reverse the above trade.

What are the risks? We may not have high inflation, or worse, have deflation. In that case you lose on both sides of this trade (magnified by leverage). Bad scenario. Or, the trade may not track BEI in terms of direction and/or magnitude of return (as was the case late last year). Note: past tracking is no guarantee of future tracking. When the BEI is near zero, the daily change doesn’t track it even remotely. As with other leveraged ETFs, this is not a buy and hold strategy, but better suited to short term bets on BEI, which in itself is a risky bet given the uncertain state of the markets. Short term technical factors in the interest rates space can make this trade very volatile. This trade is not suitable for every investor.

Dow 1 Million Before My Kid Retires - Seeking Alpha

2007-12-02T06:56:00.000-08:00

Link to this article on Seeking Alpha
Dow 1 Million Before My Kid Retires - Seeking Alpha

Dow 1 Million, before my son retires

2007-12-02T06:26:00.000-08:00

Before you dismiss that as an absurd, attention grabbing headline (it is), allow me to present a few facts and assumptions, and the objective of this story. I assure you that by the end of it, you will agree with me, statistically speaking.

First, the objective of this exercise: to focus you to think long term and realize the power of compounding. Nothing new here, but when you do a few extrapolations, the numbers may amaze your perspective.

Second, the facts: the Dow has returned about 8% historically since 1928.
I crunched DJIA data from 1928 through 2007 during which it has gone from 300 to 14,000 (chart 1).

The annualized rate of return has varied based on the time span you use, as you can see in the chart below, but it is about 8% for the 80 year period. And that’s conservative. The annual returns for the post-war period are more like 12%.

The S&P has also returned an annualized 8% for the past 57 years, and a little over 5% (annualized) for the past 100.

Third, the assumptions: this is where it gets tricky. Agreed that past performance is no guarantee of future results, but the idea of taking large spans of time for the returns above was to smoothen out short term volatilities, depressions, recessions, irrational exuberances, boom and busts etc. You get the idea. Also (being the optimist that I am), I have assumed that we – as in mankind – don’t nuclear-wipe ourselves out or choke the planet. And if we hit the Singularity in 2050, then all bets are off.

So I am going to assume that the market will return a conservative 8% over the next couple of decades. Put another way, it means that the Dow will double every 9 years. Ah ha! With me so far?

The rest is merely extrapolation. Starting with a 14000 Dow in 2008, you can see below that the Dow will hit a million by 2064 (at the risk of dating my son, he will retire in 2070)! But wait, go out a bit more and you have a 10 million Dow by 2094. (chart below)

Do you think this curve is irrationally steep? I thought so too. So I put the past and future 80 year periods on the same chart with a log scale. Now do the next 80 years look like the past (chart below)?

So what do I recommend? Invest periodically with a discipline (don’t try to time the market), and be in there for the long term (as far as you can afford to). Even if you are a passive investor in a Dow or S&P ETF, you will do fine in the long run. And, if I am not wrong, stocks have historically returned more than real estate. Now you may sleep better too.

Disclaimer: the author is “long” the market

Emerging Market ETFs: A Look Under the Hood - Seeking Alpha

2007-05-31T20:02:00.000-07:00

Emerging Market ETFs: A Look Under the Hood - Seeking Alpha
When you are holding a mix of funds, it is very important to know what your net exposures are to specific countries, sectors, asset classes etc. Else, you could be overweight in some areas while thinking that you are well diversified.
This is look-under-the-hood analysis is similar what fundpeek.com does.

China Bubble Mania - Forbes.com

2007-05-31T19:52:00.000-07:00

China Bubble Mania - Forbes.com

China's Olympian stock-market sprint - MSN Money

2007-05-29T19:33:00.000-07:00

China's Olympian stock-market sprint - MSN Money
More speculation in the China market...

Hunt on for new investment play as BRICs crack | Reuters.com

2007-05-24T16:31:00.000-07:00

ANALYSIS - Hunt on for new investment play as BRICs crack Reuters.com
With investor risk appetite showing few signs of waning and many emerging markets promising sustainable economic strength, the hunt is on for other combinations of countries to tap into.
... Goldman has gone as far as identifying what it calls the Next 11 or N-11. It comprises Bangladesh, Egypt, Indonesia, Iran, Korea, Mexico, Nigeria, Pakistan, Philippines, Turkey, Vietnam.
... VISTA - Vietnam, Indonesia, South Africa, Turkey and Argentina

FNI: Chindia ETF

2007-05-20T16:31:00.000-07:00

Chindia ETF Exposes Investors to 40% of World Population: Financial News - Yahoo! Finance
... [FNI] weighting scheme is an improvement over the market cap weighting of the iShares India ETN (INP), where about 35% of the basket goes to three companies; Infosys, Reliance and ICICI Bank. For the China iShare (FXI) the top 5 companies come to about 40% of the basket.

Some more favorites...

2007-05-04T15:48:00.000-07:00

PRASX - Large exposure to India, Hong Kong, and some to Taiwan, South Korea and Singapore.
VGTSX - Diversified international stock.

Possible portfolio allocations...

2007-04-26T04:48:00.000-07:00

The below are for Alpha generation.
EWM - Malaysia
EEB - BRIC (Brazil, Russia, India, China)
EWJ - Japan
EWO - Austria (Eastern Europe play)
FLATX - LatAm (Latin America)
INP - India
VWO - Emerging Market

Also look into Australia and Singapore.

Other broad allocations (for Beta) are:
S&P 500 ETF such as SPY
MSCI EAFE ETF such as EFA
And some bonds in PRFHX, PHK

Additional disclaimer - though the risk level will vary depending on the percentages in each investment, this is an aggressive portfolio and not recommended for all investors.

A Gassy ETF Comes To Market - Forbes.com

2007-04-26T04:32:00.000-07:00

A Gassy ETF Comes To Market - Forbes.com
...nearly half of last week's inflows to Asia (excluding Japan) equity funds were accounted for by Singapore Country ETFs and funds, which remain on a tear, and Australia Country ETFs and funds also accounted for a significant share...
Keep in mind that Japan still accounts for just over 40% of Asia's total market value, so if you invest through a broad-based Asia-Pacific ETF, your portfolio performance this year will be pulled down by Japan's weak performance.

Smart Money Flows Into Tech - Forbes.com

2007-04-24T19:47:00.000-07:00

Smart Money Flows Into Tech - Forbes.com: "...global equity funds and ETFs have received $57 billion year-to-date, which is 3.3 times the $17 billion year-to-date inflow into U.S. equity funds and ETFs. Since the beginning of 2006, a staggering $232 billion has poured into global equity funds and ETFs--4.1 times the $56 billion inflow into U.S. equity funds and ETFs."

Reasons to Worry About China Stocks

2007-04-24T19:42:00.000-07:00

Reasons to Worry About China Stocks
Some technical patterns that point to a near-the-peak Chinese market.

China ETFs: Bubbling Up: Financial News - Yahoo! Finance

2007-04-23T19:54:00.000-07:00

China ETFs: Bubbling Up: Financial News - Yahoo! Finance
...any number of things can start the trouble: the Chinese banking system is famously riddled with non-performing loans. Property values have skyrocketed in comparison with wages. Chinese borrowers in Shanghai now regularly commit over over 50% their earnings to paying mortgages. Capital in China is often allocated for social and political reasons rather than economic efficiency.
The artificially undervalued yuan skews the economy to export, depressing domestic demand... the yuan remains 40% or more undervalued. The positive side of this for investors is that yuan-denominated assets will be worth more as the yuan is allowed to appreciate. The risk is that so-called hot money is already chasing this trade.

VWO - Vanguard Emerging Markets ETF

2007-04-19T04:17:00.000-07:00

VWO - Vanguard Emerging Markets ETF
Good ETF for exposure to Korea (15%), BRIC (40% in Brazil, Russia, India, China), and 20 other countries. Low expense ratio (0.30%). I am long VWO.

PHK - PIMCO High Income Fund - another place to park money

2007-04-18T20:17:00.000-07:00

PHK - PIMCO High Income Fund
Good for some relatively low-risk income. Has a 9+% yield. Invests in the upper tier of the below investment-grade (a.k.a. "junk") credit spectrum , average rating BB. Average duration is less than 5 years.

Analysts see Latin American stocks moving higher | Reuters.com

2007-04-15T09:46:00.000-07:00

Analysts see Latin American stocks moving higher Reuters.com
Hmm... increasing chatter about LatAm. And new market highs there.

ETFs: The Funds from Outer Space: Financial News - Yahoo! Finance

2007-04-13T06:41:00.000-07:00

ETFs: The Funds from Outer Space: Financial News - Yahoo! Finance
Good primer on ETFs - basics, pros and cons etc.

Brazil stocks rise to record; Mexico stocks close at record high

2007-04-11T04:11:00.000-07:00

Brazil stocks rise to record
Mexico stocks close at record high
Lot of chatter (and record highs) about Latin America recently. Is the party over? (I have been long FLATX for a few years)

PRFHX - Where to park money

2007-04-11T03:59:00.000-07:00

PRFHX - T. Rowe Price TAX-FREE HIGH YIELD
Yes, its high yield, but it averages about 6+% tax free returns, with low risk ("junk" municipal bonds). Its not a bank deposit, but I prefer it over places such as ING Direct etc. Credit for this tip goes to my close friend, Shirish Jamthe.

GLOBAL MARKETS-World stocks recover their February/March losses | Reuters.com

2007-04-11T03:25:00.000-07:00

GLOBAL MARKETS-World stocks recover their February/March losses Reuters.com
Buying when the market dipped in end Feb 2007 helped.

The Shanghai Stock Index Bubble: Financial News - Yahoo! Finance

2007-03-31T16:10:00.000-07:00

The Shanghai Stock Index Bubble: Financial News - Yahoo! Finance
Interesting (but long) article about the interplay between the Chinese market, money supply, foreign currency reserves and the like.

Investing in India: Can Market Timing Help?: Financial News - Yahoo! Finance

2007-03-27T06:57:00.000-07:00

Investing in India: Can Market Timing Help?: Financial News - Yahoo! Finance
Market timing won't help in the long term (10 years).

Comparing India Funds: INP is the Way to Go: Financial News - Yahoo! Finance

2007-03-25T08:37:00.000-07:00

Comparing India Funds: INP is the Way to Go: Financial News - Yahoo! Finance
INP is my favorite for investing in India (I am long INP).

Global markets tumble as China fear spills over - MarketWatch

2007-03-01T16:35:00.000-08:00

Bingo! Prediction correct.
Global markets tumble as China fear spills over - MarketWatch