Monday, October 29, 2007

Move out of both the US and Canadian Dollar?

Sometimes, you've got to recognize good fortune and take advantage of it. Other times, you've got to move to avoid trouble.

For my blog readers, who seem to be mostly a mix of my fellow Canadians, and my "American Cousins" (yes, I really have some), it seems to be a time for both.

Firstly, the Canadian dollar is now trading at high levels, and just today punctured levels not seen since the currency starting floating in 1970. In other words, a modern era record high. So it may seem unusual that now is the time I'd begin suggesting that it's appropriate for my fellow Canadians - likely with much of their wealth invested in Canadian companies - to begin looking outside the country.

However, while I fully expect that the currency may well continue its climb, prudent investing requires re-balancing, particularly when something has appreciated dramatically. A once in a 37 year event (record high currency) qualifies.

So, I'd suggest that many of you start looking at ways to diversify at least some of your investment portfolio outside of Canada. While this might hurt returns over the short term (no one can really "call the top" of any currency assent), it looks to me to be a prudent move over the longer haul. In other words, buying international assets when they look cheap to us.

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Secondly, for my American Cousins, unfortunately, I wouldn't recommend getting more heavily into US assets at this time. Let's face it, the American fiscal situation is a mess, with the national debt at unprecedented levels (roughly $27,000 per person) and projected to continue growing, and many Americans themselves hampered by heavy -unprecendented really - levels of personal and mortgage debt.

Combine these twin bombs of debt, personal and federal, with many recent announcements by central banks the world over that they intend to reduce their holdings of US currency, and where do you think the currency is headed?

Or perhaps another way to put it would be: Do you really think you're smarter than the these central bankers who are leaving the US currency like a plague?

So, to both my fellow Canadians and my American cousins, I think that now is a good time to begin looking at other internationally-denominated investments. Reducing exposure to your Canadian or American assets at this time seems prudent, and likely to boost long-term returns.


The Confused Capitalist

Wednesday, October 24, 2007

Thinking Ahead: Ten Years Out

One of the themes I've tried to engage readers in here, is that by playing some fairly obvious trends, and coupling those with reasonable valuations, is a relatively easy way to outperform the market.

One theme I've pounded on over the past one-and-a-half years is the emerging market theme. It doesn't take too much heavy lifting in the thinking department to realize that with soaring GDP growth rates of 8-12% annually in some of these countries, expecting their stock valuations to follow isn't much too much of a mental stretch, even for weak thinkers like me.

So, thinking ahead, and about 10 years out is a good target, it becomes much easier to think that an overweighted emerging markets position is likely to be both prudent, and very profitable. Now, the graphic above showing firestroms in California (currently displacing one million people) obviously suggests that this posting isn't about emerging markets.

That's correct - this is about alternative energy production. While climate change and global warming have been warned about and was easily readable in the popular media 20 years ago(Time Magazine, for instance, awarded Planet Earth as "Man of the Year" in 1989, due primarily to concerns about global warming), it's only recently that most people are finally waking up to the severity of the problem.

As the problem continues to grow in the public mind, so too will the demand for solutions. These will be invoked on a political and individual basis. As the negative consequences of inaction become more and more and more visible and the predictions more dire, many will begin making personal change AND demanding societal change. This is inevitable.

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What is also inevitable is major changes to our type of energy consumption and to the pattern of use. For instance, emerging economies will begin to use far more energy than in the past. This is good for them, but not good for the planet. The energy hogs of the planet - that's us in the western world - will finally begin to reduce consumption outright - not just on GDP weighted basis. Since we were "first in" to this pattern of inefficient energy use, it also is right that we strive to be "first out" of the pattern.

This brings us to our investment opportunity. Looking ten years, does anyone see a world in which the general populace isn't pressuring the politicians to fund alternative energy, to create incentives/disincentives to change energy use, and possibly even to restrict certain types of energy use? Perhaps rationing, a popular method for "spreading the pain" and acknowledging that we're all in this together, will become popular.

In any case, I personally cannot envision a world in 10 years where alternative energy isn't a significantly larger economic sector than it is today.

Of course, my much beloved ETFs provide a way to play this trend while avoiding single company risk. The recent launch of three ETFs targeting this sector might lead some to utter the usual cliques and say that this is a clear sign that this market segment has "topped". Yet the reasonable valuations, societal trends, and my common sense, tell me "no", that is not the case at all. And that is why I am willing to significantly overweight my portfolio to this segment.

While I do not pretend this is a comprehensive list, here are three ETF names in this sector:

Market Vectors Global Alternative Energy ETF (GEX) started trading on the New York Stock exchange. The fund, tracks the Ardour Global index (Extra Liquid), which is comprised of stocks in 30 publicly traded companies engaged in alternative energy production. These stocks are selected from a stable of 250 companies in this space. At least 30% of the names are not US-domiciled companies, and may therefore be attractive to those wishing some diversification out of the US currency. It is however, a relatively concentrated ETF, with 60% of the value being held in the top ten positions. Yahoo Finance shows the current PE as ~30.

Power Shares Global Clean Energy Fund (PBD) is based on the WilderHill New Energy Global Innovation Index. The Index seeks to deliver capital appreciation and is composed of companies that focus on greener and generally renewable sources of energy and technologies facilitating cleaner energy. The modified equal weighted portfolio is rebalanced and reconstituted quarterly. It currently holds 84 positions. It also has limited exposure to US companies, with only 26% of the ETF having US domiciled companies. Yahoo Finance shows the current PE as ~26, while information from PowerShares says the PE is ~42.

Finally, an all US domiciled companies is the First Trust NASDAQ Clean Edge ETF (QCLN)which started trading in February, covers five sub-sectors of the alternative energy industry: renewable power generation, renewable fuels, energy storage and conversion, energy intelligence, and advanced energy-related materials. The investment has above average concentration, with the top ten positions holding 55% of the value. It seeks to track the NASDAQ Clean Edge U.S. Liquid Series Index. Yahoo Finance reports the PE as ~25.

One caution with all of these ETFs is that they are presently quite small, none having assets of more than $100 million. But I predict that will change dramatically by the time 2017 has rolled around. Clean energy - a future whose time is now for the investor.


The Confused Capitalist

Wednesday, October 17, 2007

A random musing: profit margins

Much of the recent thoughts as to why we are heading towards a bear market - other than the usual phalanx of bears arguing the "edge of recession" - have centred on the extraordinarily high level of profit margins, arguing that this can't go on forever. As put succinctly:

"Profit margins are probably the most mean-reverting series in finance, and if profit margins do not mean-revert, then something has gone badly wrong with capitalism. If high profits do not attract competition, there is something wrong with the system and it is not functioning properly."
- Renowned Investor Jeremy Grantham

In essence, the bears argue that while the "PE" looks fine, the "E" in "PE" is bogus, and not supported by sustainable metrics. However, most marketplace observers cannot offer a compelling reason why margins have continued to grow (although there is some rationale offered here that makes some sense) at the back end of a long bull market. While I have no doubt that the lengthy margin expansion will reverse at some point, I wonder if corporate conservatism is having some impact.

That is, typically during most other bull markets, fat profits led company managers to buy into so-called "complementary" (not really!) businesses through buyouts and mergers, with poorly focused conglomerates emerging. This, I suspect, led to much poor business practice, including a focus on revenues, instead of contribution to the bottom line - i.e. margins that are accretive to earnings.

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However, the business mantra today is single-minded focus, "the mission" of the business if you will. Not much room for sloppy, drunken, buying binges that are covered up by growing ill-thought-out revenues, even at the expense of declining earnings and/or margins. Today, excess cash is more often deployed through share buybacks and, to a lesser extent, cash dividends.

With that thought in mind, I wonder if the button-down managers of today are primarily responsible for continued profit margins at extraordinarily high levels? And if so, for how long will they be able to keep up the admirable restraint before they, as a managerial collective, feel compelled to sow the seeds of their managerial genuis?


The Confused Capitalist