Changing Portfolio Mix

The chart shows the composition of my Mom's portfolio over the last 5 years. The main trend has been a reduction in the allocation to cash. The portfolio she inherited from my father, who died in 2002, was very heavy in cash. It had between one and a half and two times as much in equities as the March 2003 position, but no alternative investments and little if anything allocated to bonds. The equities were in a separately managed account with a UK broker who wasn't exactly much good... By March 2003 we had about half the portfolio in an account with a well known investment bank, the rest mainly in cash and mainly in Sterling. Over time we shifted more to the investment bank, then changed banks and allocated part of the portfolio to a small independent broker who provides access to US based separately managed accounts. In late 2005 I prematurely reduced our equity allocation (with the pretext of rebalancing) and increased our bond allocation. Since then we have increased the equity allocation further through the independent broker.

Our next major change to the portfolio I think should be to reduce the bond allocation. I don't see bonds performing as well going forward as they have in the last 25 years or so. There is a limit to how low interest rates can go so that yields are now low and capital gains unlikely. The question is how to reallocate the money now in bonds. My Dad's approach was very conservative in his later years, which isn't surprising as he was 15 years older than my mother. But it is a mistake to allocate a portfolio based on your age alone when you are leaving it to family members who are much younger. My father was a much more aggressive investor when he was younger (and poorer). So it is probably also a mistake to allocate the portfolio based on my mother's age alone (Seventy-six). Rather we should think like a university endowment or similar fund.

On the other hand the 110 rule of thumb implies that a 76 year old should have 34% of their portfolio in stocks and we only have 26% actually even now. So we can certainly increase our allocation to stocks further without doing anything unusual. On the other hand, including our alternative investments in the stock category puts us at 46% in higher expected return assets.

How low should we go with the bonds? Given we have 17% in cash?

P.S.

I started a new category today "Family Finance" to cover the finances of our extended family.

International Equity Managers: The Data

This is a synopsis of the key data I received on the three potential international equity managers. In a "wrap account" of this type we pay the same fees irrespective of the manager we choose. We pay less percentagewise as our account gets bigger. From this data it is a pretty clearcut case, in my opinion. Thomas White is the best manager. Though McKinley did very well in 2007 their longer term performance is less attractive. My main question is: "If Thomas White are so good, why are they so small?" (being small probably helps them be good). The portfolio was founded in 1991, so they have had time to grow. However, the firm also has other assets under management including two mutual funds - total assets are on the order of $1 billion. The figures for the other two managers are total assets under management, not just in the program in question (Neuberger-Berman is a division of Lehman Brothers while the other two firms are employee-owned).

From the blurb:

"All of the company's portfolios share a common value-oriented
investment philosophy and process. The basis of its investment process
is in-house stock research produced by the company's research division,
the Global Capital Institute. The Institute is recognized worldwide for its
expertise in valuing domestic and international companies. Initially
designed for Sir John Templeton in 1976 by Tom White and his
associates, the firm sells this research to several of the world's largest
investment managers."

Thomas White's international mutual fund. TWWDX has lost 9.4% YTD, so their down capture ratio in this period has been much worse. Portfolio turnover for this fund is 46% which is acceptable.

Neuberger-Neuman's blurb would describe the process of most mutual funds. The managed account only invests in ADRs. Their international mutual fund's performance bears no relation to that of the managed account, so no insight is possible there.

McKinley uses a quantitative growth approach - they claim to apply "modern portfolio theory" to finding inefficiently priced securities. I wonder whether this puts too tight of a straightjacket on their ability to find value? Digging into McKinley's website, I found that the portfolio in question is also in fact a growth oriented ADR portfolio. As you can see from the pdf it is rather volatile. Since inception the fund outperformed the market strongly- 11.26% p.a. vs. 8.4% p.a. and had an alpha of about 3.3% and beta just above one. But this result is largely due to the first two strong years when the fund was probably much smaller than today. Performance has declined despite 2007's excellent results.

I'd like to be able to see results for January for McKinley and Neuberger-Neuman before making a decision but that would mean waiting another couple of months to invest as data is released quarterly. Given the information available, I'm deciding to invest with Thomas White.

Trading Update for Tuesday

With the NDX up today, we don't look like getting to oversold in this round and with Thursday still forecast as an up day and the Wednesday effect perhaps bringing that forward a day, seems it is the time to get long again. In fact one of my indicators for the SPX is formally long for Wednesday. So I sold my Beazer puts and bought some Google shares near the close. Google's chart looks like it could have bottomed for this bear market or at least for a little while. There are a nice five waves down from the February high. Still, I'm treating this as a trade.

In case you think mid to late March is still too early for calling a bear market bottom, Bespoke point out that most stocks are already in serious bear market territory. Energy and a few large caps are holding the indices up.

New Investment for my Mom

Occasionally, I've mentioned that I advise my Mom on investing. We've now completed our allocation of funds to the Aletheia separately managed account - we initially invested the minimum $100k and then added $10k a month for ten months. Dollar cost averaging paid off with the combined value of our Aletheia and money market accounts with this firm having gained 2% while the S&P 500 lost about 5% over the same period. Aletheia is a manager of US shares. I now plan to add an international equities manager. We will initially invest $100k and then over time will likely transfer some money from our other accounts to reach $200k invested with this second manager too. We have $58k in a money market account that we could transfer right away. We also have a structured investment note that will mature this year (this is similar to the Man investment I discussed). We could move $50k of that and reinvest the rest in another alternative investment to be advised by UBS.

I recently reviewed my Mom's investments for the first time since May 2007 (my mother brought out to Australia a required security device for accessing one of the accounts). We are about flat with May 2007 currently performancewise. Everything is doing fine with one glaring exception. A Janus short-term bond fund that is supposedly down 27% since May. The only way this could be true is if they stuffed a huge chunk of the fund into short-term mortgage backed securities of dubious quality. It appears, though, that the reason the fund is down is because the price of the class of fund we own is quoted in Euros and UBS's account display is forgetting to convert this fund from Euros to US Dollars! I'm getting my Mom to follow this up with UBS. Check that your broker is using the right data if you find any discrepancies like this!

I'll report more on the international managers in another post.

SPI Trading: Day 2

I planned to do live trading again today. My idea about what would happen at the open was correct - A pop up followed by a decline, but I missed the shorting opportunities, the first time because of caution and the second time because of inattention. Then I tried some simulated trades and lost three times in a row (-$10, -$185, -$225). No disasters, but I knew these were low probability trades, which is why I didn't try them with real money.

On the investing side, we are getting close to the potential buy point. The model is signalling Thursday as the beginning of an uptrend in NDX, SPX, and AORD. The Wednesday effect means that this could be brought forward. However, if we get into oversold territory then all bets are off until the market decides to reverse itself. The lowest my proprietary stochastic for the NDX can go on Tuesday is 23.4. But then even a decent 15 point bounce on Wednesday would still leave us oversold. But if the market falls less on Tuesday then even a small bounce will keep us out of oversold on Wednesday and then the reversal would be intact for Thursday.

NDX is getting close to the January lows but, based on the triangle formation since the January low, we should expect a low of 1610-ish. SPX is further from its lows. Stochastics on the weekly charts have also crossed and are now moving down, which is a necessary precondition for a meaningful low. The All Ordinaries is behaving very much like the SPX.

Bottom-line - if the market only sells off a little on Tuesday expect a bounce starting Wednesday. This week will not be the ultimate low. A strong sell-off on Tuesday is likely to result in the current downtrend producing the ultimate low for this bear market.

February 2008 Report

All figures are in US Dollars (USD) unless otherwise stated. Performance this month was more mixed than in recent months - net worth rose in US Dollar terms but fell in Australian Dollar terms due to the strong rise in the Australian Dollar this month. Investment performance was also positive in USD terms but not in AUD terms. Spending was high due to the wedding and "honeyweek" which took place this month.

Income and Expenditure



Expenditure was $7,271 - core expenditure was $4,067, which is higher than in recent months. This included $334 of implicit car expenses - depreciation and interest.

Non-investment earnings ($11,664) were dominated by the inheritance we received this month.

Non-retirement accounts lost $2,507 with the rise in the Australian Dollar offsetting $6,545 of what would otherwise have been a loss of $9,053. Retirement accounts gained $5,214 but would have lost $1,183 without the change in exchange rates. The differential between these accounts is due to the strong exposure to bonds in our retirement accounts and the stronger exposure to equities in our non-retirement accounts. Trading contributed $782 in realised gains.

Net Worth Performance
Net worth rose by $US7,419 to $US445,174 and in Australian Dollars fell $A12,976 to $A475,156. Non-retirement accounts were at $US226k (a gain of $1,400 or 0.6%). Retirement accounts were at $US219k. So we made progress on our first and third annual goals as net worth increased and non-retirement net worth increased by more than the MSCI index rose for the month (0.3%).

Investment Performance

Investment return in US Dollars was 0.62% vs. a 0.33% gain in the MSCI (Gross) World Index, which I use as my overall benchmark and a 3.25% loss in the S&P 500 total return index. Returns in Australian Dollars and currency neutral terms were -3.65% and -2.34% respectively. Both the MSCI and our portfolio outperformed the the S&P 500 this month due to the fall in the US Dollar. So far this year we have lost 2.07%, while the MSCI and S&P 500 have lost 7.86% and 9.05%, respectively.

The contributions of the different investments and trades are as follows:



The returns on all the individual investments are net of foreign exchange movements. Foreign currency gains appear at the bottom of the table together with the sum of all other investment income and expenses - mainly net interest. This month trades resulted in modest gains or losses. The strength of the resource sector led to a nice gain in the Colonial First State Global Resources Fund. Completion of the takeover of Symbion by Primary Healthcare also produced a decent gain. Major losses were again dominated by the woes of the Australian listed fund sector. In particular the near collapse of Credit Corp (CCP.AX) hit the Clime fund (CAM.AX) hard due to its concentrated position in this company. Clime sold out its position in the middle of the month, but it seems that its other positions which had also been soaring high did not do well in the first couple of months of the year. Concentrated portfolio positions are dangerous when you are not an insider in the company and even then they are risky. I exacerbated things by doubling my position in Clime before it hit bottom. Seems I was as overtrusting in Clime's management as they were in Credit Corp's.

Progress on Trading Goals

Realised gains for the month were $782. This is the first positive month since June 2007! But the gains were entirely in securities trading as I didn't trade futures at all this month. I've only had two losing months in securities trading since last June (October and January). Anyway, it's nice to finally see a positive month in realised gains.

My three US trading accounts lost $1332 (or -2.33% which is better than the S&P 500 at -3.25%) and there is now $8047 to go till I reach breakeven across those three accounts, which is one of my annual goals. My Interactive Brokers account lost 0.77%.

So, I made progress on annual goal 5 (making money from trading) and slipped back on goal 4 (achieving breakeven in my US accounts).

Asset Allocation
Using the simple method of adding up the betas of each individual investment weighted by their portfolio allocation, at the end of the month the portfolio had an estimated beta of 0.52. Using a regression on the last 36 months of returns gives a beta of 0.76 to the MSCI or 0.61 to the SPX. Alphas are 0.9% and 5.7% respectively. A more sophisticated time series method yields a beta of 0.75 and alpha of 10.0% for the MSCI index. Therefore, we are doing well on our second annual goal (positive alpha).

Allocation was 35% in "passive alpha", 69% in "beta", 2% allocated to trading, 2% to industrial stocks, 5% to liquidity, 9% to other assets (including our car which is equal to 2.9% of net worth and otherwise mainly receivables) and we were borrowing 22%. Our currency exposures were roughly 58% Australian Dollar, 30% US Dollar, and 12% Other. We reduced exposure to industrial stocks this month and increased further our exposure to private equity and supposed "passive alpha" stock funds.

Summary
We made progress on four out of the five annual goals this month.

Started Post-Training SPI Day-Trading

My first trade today was successful. $A140 profit. Not a bad start. I was profitably stopped out of the trade. I noticed I was a bit more aggressive in moving my stop down (this was a short trade) than I was under simulation. If I'd given the trade more leeway a major move down came up in another ten minutes or so. As it was my trade only lasted 4 minutes for a gain of six SPI points. I missed the big move down and then hung around for a while, but nothing much was happening, so I called it a day. Around 3:30PM I had another look but couldn't find a high probability trade.

Lots to Do!

We're back from our "honeyweek" in Sydney (we stayed at this nice bed and breakfast place in Glebe) and there is lots to do. Little things like getting my watch fixed and getting the painting my brother gave us framed, more time consuming things like working out my February accounts and doing my US taxes, and longer term projects. I'm planning to start daytrading with real money this month and also get more academic stuff done. In particular, I have a PhD dissertation to examine sitting on my desk. I at least get paid a little for it. But in general, I'm hoping to get a bit more done than I have on this front. This month, maybe this week even, could be where I finally identify a bottom in the market and switch my mutual and retirement funds from a conservative to a much more aggressive stance. A triangle type formation in the NASDAQ index has broken to the downside. This looks like a final fifth wave from the October top is now underway. Patterns in other indices are similar. The first job (after having some coffee and reading the Berkshire Hathaway annual report) will be updating my models. Umm, seems like there's some laundry to do too :( There's also food shopping to do and Snork Maiden (or is it Moominmamma now?) would like to go to the Hall Markets which only happen once a month.

Daytrading Update

This is my equity curve from simulated trading of the Australian share price index futures since the beginning of the year. It's looking pretty consistent now, and I'll probably take it live after our wedding and "honeyweek" coming up soon. Of course, there is still huge room for improvement. I'm only capturing a fraction of the profits possible from trading a single contract. But at least they are profits.

U.K. Stock Research - Listed Private Equity

Digital Look is a great source for research on UK stocks. Far better than Yahoo's offering. I haven't invested in the UK yet, but been looking up info on a couple of companies and was recommended to check this site out by a poster on a Yahoo message board.

I was using the site today because of the takeover of a listed Australian private equity fund by the London listed Bear Stearns Private Equity Limited (BPLE). IPE is edging up today, presumably in reaction. BPLE itself looks like an interesting investment. I'll add it to the watchlist. My main concern is the Bear Stearns name. The biggest position is in a Bear Stearns private equity fund (8%).

Why is Our Net Worth Falling?

As you'll see from Net Worth IQ, our net worth has been falling in the last few months, despite a small bounce this month in US Dollar terms. Are we spending too much? Or is it due to poor performance in the financial markets? Let's look at the numbers:



These numbers breakdown our net worth into cumulative retirement contributions and non-retirement savings (current savings) as well as retirement and non-retirement account profits. I've posted a a chart of these data before, when things were heading in a very positive direction. Here's a chart of the current data:



Net worth reached a peak of almost $US478k in October and declined by $40k from then till last month. Looking at retirement contributions - I added about $10k in the last few months of my job in the US. Since October, Snork Maiden's employer has contributed about $3,000. So we are doing OK there. I made almost no net non-retirement savings, however, in the first half of 2007. Savings jumped by $10k in August due to merging my finances with Snork Maiden's and beginning to spend on the move to Australia. We spent down another $10k in September on the move. Since then we have begun to rebuild savings to $148k last month and this month $155k with the addition of the inheritance.

Of course if we add Snork Maiden's net worth in August to my savings in July we would come to $158k. The move to Australia probably cost us about a net $12k.

Both retirement and current profits peaked in October 2007. The Australian Dollar reached its peak in that month and the reversal in November partly reflects the weakening of the Aussie. Since then net returns on retirement accounts have been zero. But non-retirement accounts have lost $26k since November. Our retirement accounts are currently more conservatively than our non-retirement accounts.

So the fall in net worth since October is entirely due to some retracement in the Australian Dollar since that month and poor investment performance in our non-retirement accounts. We are living approximately within our means since settling down in Australia.

Inheritance from Germany

My mother just told me that our share of the proceeds from the sale of a property in Eastern Germany that our family jointly inherited with others came through finally to her bank account. She'll send on £4,000 to me (and £4,000 to my brother). For some reason she decided to keep £595, though originally we agreed that she'd pass all the money on to her two children. The amount is less than I expected we'd receive from this property - only about as much as we received from the first of the two properties. The main thing is that this saga that has been going on since 1995 I think is finally complete. Legal processes can be very slow. Our family lost this property when they fled Germany in the 1930s. The house served as an orphanage for some years. When I visited in 1998 it was derelict. So all we received was the value of the land - it was in a suburban area on large grounds. For 45 years after the second World War the communist government in East Germany wouldn't deal with any property claims. So it was only after the fall of communism that any compensation could be received. This is one reason I'm not much of a fan of property as an investment. I'm planning to invest the money in the US as part of our policy of reducing exposure to the Australian Dollar. The Man investment also will reduce Australian Dollar exposure.

Foreign Investment Fund Rules

In my post about the Man fund I'm thinking of investing in, I briefly mentioned Australia's foreign investment fund (FIF) rules. I think I now understand exactly how these apply.

The point of the rules is supposed to be to reduce tax avoidance. Without these rules, I could channel all my savings into an offshore hedge fund. If the hedge did not pay out distributions but instead retained all earnings there would be no distributions to tax under the regular tax code. Then I could retire and move out of Australia and because Australia only really taxes Australian residents rather than Australian citizens I could avoid ever paying Australian tax on the funds earnings. The solution the Australian Tax Office came up with is to require investors in foreign investment funds to pay tax on the unrealised gains of their foreign investment funds annually. The problem with this is that it eliminates the possibility of applying the lower long-term capital gains tax rate to these investments and also requires you to pay tax now on income you may only actually be able to receive in the future.

Luckily there are plenty of exceptions to this draconian legislation that incidentally provides nice protection to Australian fund managers whose funds are not subject to such a tax rule.

First, pretty much any investment in a foreign company or fund that is not registered or listed in Australia qualifies as a foreign investment fund. Yes, all foreign shares are counted as "foreign investment funds". But all "active businesses", US regulated investment funds, and foreign employer sponsored retirement plans are exempt (i.e. unlisted hedge funds and non-US investment funds of all types are not exempt). If you have less than $A50,000 of such foreign investments (including retirement plans) you are also exempt from the legislation. All my existing foreign investments are exempt (US mutual funds, US stocks, Belgian stock, and a US employer sponsored retirement plan (403b at TIAA-CREF)). I have well over $A50,000 of such investments.

But unfortunately the Man fund is not exempt as it is an unlisted fund based in the Cook Islands. There is, however, another exemption that can be used. If less than 10% of your total FIF investments (not counting employer sponsored funds) are of the non-exempt variety then those non-exempt ones are also exempt - this is called the "well balanced portfolio exemption". We have about $US59k in FIFs not counting my 403b. This means that currently we could invest up to $A7,000 in the Man fund and not be affected by the FIF legislation. Of course I could increase my exempt FIF holdings by using every last dollar of cash and available margin in my foreign accounts and then be able to invest more in the Man fund :)

What I don't understand is why they don't make this fund offered to Australian investors, an Australian resident fund.

Israeli Finance Comedy

This guy is funny, he also has a video in English. Israel is an important location for high tech startups.

Looks Like We're Going Down Again

This would be wave 3 of 5 in my Elliott Wave count. It arrived a couple of days earlier than I expected. I sold NNDS, BWLD, and RICK (NNDS and BWLD for gains and RICK at a loss). I also sold short LAZ. My US portfolio now consists of the following:

AAPL
BRK.B
BTF
FF
FLIP.OB
HCBK
HSGFX
LAZ (short)
LTR
LUK
NCT
PSPT
SAFT
TFSMX

I didn't feel confident enough to add more short positions into options expiry on Friday, which I had thought would be a positive event for stocks due to the number of outstanding puts.

Man OM-IP 3 Eclipse

This is a hedge fund investment I am considering. The kind of thing that is not available to individual investors in the US but is available here in Australia. UK-based Man Group is probably the largest managed futures manager. This product is a structured investment that consists of four elements:

1. An 80%+ investment exposure in AHL, Man's main managed futures program. This is a system trading one hundred plus global futures markets. In the last 10 years it has returned 16.1% per annum (5 years, 12.3%, 1 year, 20.6% as at October 2007 - the MSCI returned: 8.8%, 20.2%, and 24.8% respectively - Moom: 10.8%, 26.1%, and 34.6%). So it outperforms stocks in bear markets and underperforms in bull markets. Examination of periods of drawdown in the Australian stock market, show that the program always made money in those periods.

2. A 20%+ investment exposure to the RMF Commodity Strategies program. This program invests with 30 hedge fund managers investing in commodities via futures and stocks. In the last three years it returned 18.4% p.a. (MSCI: 20.7%, Moom: 20.6%) and in the last year 13.2% as at October 2007.

3. A 20%+ investment exposure (yes there is moderate leverage in the scheme) to the RMF Asian Opportunities fund of managers. This program invests with 14 hedge fund managers specializing in Asian investments. In the last three years it returned 16.4% p.a. and in the last year 24.3% as at October 2007.

Though all three of these programs have quite high month to month volatility, their maximum drawdowns are lower than the stock market - they have a smoother equity curve in the long-run, year to year. Of course, this being a hedge fund, the fees are sky-high: 2% and 20% for AHL and 1.5% and 10% for RMF, plus brokerage of 3% per year plus an initial load of 5% (CommSec will rebate 80% of the 4% sales commission they will receive), plus another 0.5% overall to Man, plus 0.25% to Commonwealth Bank p.a and some other small fees. But all the returns quoted above are after fees (not the 5% load presumably).

4. A capital guarantee provided by Commonwealth Bank of Australia. When the investment matures in eight years they promise to pay back at least $A1.00 per initial $A1.00 investment. The most you can lose, therefore, is the interest on your money (assuming positive real interest rates) - which is quite a bit over eight years of course. They will also lock in each year half of any new net profits into the guarantee. So say the fund makes 10% in the first year. Then the guarantee will rise to $A1.05 per share and so forth.

Advantages Opportunity to invest in a high alpha (relative to the stock market) diversifying investment of a type that retail investors usually have limited access to. The managers are high quality.

Disadvantages The investment is relatively illiquid. Prices are quoted once a month and shares can be redeemed monthly. Until 2011 there is a 2% fee for exiting the fund. The capital guarantee only applies for shares redeemed in 2016 at maturity. Taxation is not so favorable either - according to the prospectus the long-term capital gains tax rate will apply to the capital guarantee but all gains above that will be taxed as an unfranked dividend - i.e. at ordinary income tax rates. There is also the potential for Australia's draconian foreign investment funds (FIF) legislation to apply. These rules require you to pay tax on unrealized gains in foreign investment funds annually - there are lots of exceptions but this isn't one of them. But if you have less than $A50,000 invested in such funds you are also exempt. So I think, from my reading of the rules, I should be exempt.

What do you think? Would you invest in this?

P.S.

How would this investment be funded? It can be funded using a Commonwealth Securities margin loan with a 70% lending ratio. After all my recent purchases I only have $5515 in cash available on my margin loan. But I could easily invest $10,000 in this fund and still have a buffer before I'd get a margin call as the 70% loan ratio means the cash available will only be reduced to $2515. Though that is beginning to cut things close. But, on 13th March I should receive $A16,400 from Primary Health Care for my Symbion shares. So there isn't going to be any problem in funding either $10k or $20k for this investment. Longer term I want to reduce the size of my margin loan as margin interest is expensive compared to other sources of leverage. We'll have to wait for some of my recent trades to payoff first though.

Symbion, Allco, and Clime

Seems that the Symbion (SYB.AX) takeover story finally comes to an end today. Primary Healthcare (PRY.AX) announced that Monday their interests in the company including conditional acceptances exceeded 52%. Tomorrow was the deadline for reaching 50.1% and if reached declaring the takeover unconditional. I sent in my acceptance a few days ago when this deadline was announced. When I get the money I'll apply it to paying down my margin loan. Allco (AFG.AX) is apparently in talks with Macquarie Bank (MQG.AX). I bought more AEP.AX - a fund managed by Allco a few days ago. The fund is trading way under net asset value. I can't see any reason why it should lose value if Allco went under. In fact the fund managers have not been spectacular to say the least. So losing Allco management shouldn't hurt. One reason I guess the price has gone down is that shareholders have sold it to meet margin calls generated by the fall in other shares (which is part of the story of the fall in Allco itself's share price). Anyway, it's now fallen more than 10% below my recent price. Do I buy more? This seems a low risk trade, but maybe there is something I don't know. So I'm unwilling to overexpose myself to that risk.

Clime Capital (CAM.AX) share price fell steeply yesterday as one of their largest investments - Credit Corp (CCP.AX) fell 75%. This was after CCP announced that they were downgrading their profit forecast by about a third and initiating a strategic review. The chairman also resigned. But given the size of the profit downgrade the market's reaction seems overblown? The forward P/E is now just 3 if the company's forecast is realized! I ended up buying more CAM yesterday because I had a lowball limit order in place. Unfortunately, not lowball enough. The stock fell another 10% after that. The manager of CAM, Roger Montgomery is a Buffett worshipper. In Buffett's pre-Berkshire days he would often take large concentrated positions in companies and Montgomery does the same. Montgomery has been convinced that CCP was a good investment and after the price fell from $9 or so to $4 he was buying more. Maybe he's right, but this kind of result will make potential investors wary of investing with Clime (they also have unlisted products) if they are going to continue taking concentrated positions. I'm also an investor in the management company CIW.AX and it also fell steeply yesterday.

So it seems I'm not having much luck with my Australian stock investments. I guess, like Montgomery, I think I'll be right in the end.

Portfolio Construction

Currently our portfolio is allocated like this:



I've explained these different categories previously. Basically "beta" contains mutual funds that are likely to be highly correlated with either the stock or bond market, while "passive alpha" contains funds that are expected to have a lower correlation with general stock market movements and financial stocks whose underlying business is not directly investing in the stock market index. Hopefully, these "passive alpha" investments will generate alpha - a risk adjusted excess return. I call these passive alpha because this is an attempt to earn alpha by investing with other managers rather than through my own trading efforts. Industrial stocks are individual non-financial companies, trading is cash and any very short-term trading instruments, liquidity is cash not dedicated to trading (mostly in Snork Maiden's accounts), asset loans is our rental deposit and car primarily, and borrowing includes margin loans, credit cards etc.

At the moment about 25 percentage points of the portfolio is in stocks within the "beta" category and 43 percentage points are in bonds. When we reach what looks like a bottom in the stock market to me, I plan to switch out of all the bond-heavy funds into stock beta investments. We'll do this by investing in CREF's Global Equities Fund (instead of their Bond Market Fund) and investing in Colonial First State's Geared Share Fund (rather than their Conservative Fund). We'll also shift some of our holdings of the Conservative Fund into CFS's Future Leaders, Developing Companies, and Imputation Funds.

For those who've questioned my judgment that the market is close to a bottom, I'm not planning on buying US stocks in a big way. I will also add individual US stocks in a small way as I did around the 22 January bottom. On the buying list are: IBKR, XLF, BWLD, SSRX, RICK, GOOG, PBD and maybe SHLD, AAPL, and NCT.

I plan on maintaining this same rough allocation between passive alpha and beta, but the beta funds will include a large chunk of a leveraged fund - the Geared Share Fund (geared = leveraged in Australian lingo). In the longer term I plan on having a portfolio beta of about one with a big chunk of passive alpha investments. The goal would be to achieve 10% returns from the stockmarket beta in the long-term and hopefully 10% or so of alpha for a 20% total return. If you use leverage, you can be fully exposed to the stockmarket while also trying other strategies. A simple version of this is the increasingly popular 130/30 funds. A much more sophisticated approach is followed by Bridgewater Associates. What I am attempting is somewhere in between.

SPX Elliott Wave Interpretation

Obviously this interpretation is somewhat subjective but it's not based on looking at this chart alone. If this is right we should see some upside in the next few days followed by more downside. The ultimate bottom would be still 3-4 weeks off. I don't think it will be a lot lower than the wave 3 lows. E-Wave suggests the lowest it will go is about 1225-1230. If that is exceeded we need a whole new wave count.

There is a risk of missing the bottom here. I've posted a lot of bullish stuff recently. But I think I will wait till the next bottom on the weekly chart before taking on a lot more risk.

Realised Gains

As promised, I computed realised trading gains for the last two years:



I could take this back further - the data is coming out of the spreadsheets I use to prepare my tax returns. This data does not include retirement accounts. Going forward, this will be the measure of trading performance. The basic story is that at the beginning of 2006 I quickly built up $10k in profits and then promptly blew it up in June. I rebuilt it again in the next three months blew some up that Autumn, rebuilt and then held onto my securities gains during 2007. In late 2006 I started trading futures. Built up about $9k in profits by the end of June. Then proceeded to blow most of it up in the last seven months. The mean monthly gain over this period has been only $540 and the t-statistic that tests whether that is significantly different to zero is only 0.77. At the end of June I was looking at an average of $1165 and a t-statistic of 1.20. So I was fairly optimistic that my trading was heading in the right direction when I decided to move to Australia.

The challenge is to get things heading back in a good direction in the next few months.

Allco Equity Partners

Allco Equity Partners (AEP.AX) stock price has tumbled to yesterday's $A2.23 (The IPO price was $A6.00!). The most obvious reason for this is their investment in 204.4 million shares of IBA. The share price of IBA has fallen from 92 Australian cents on December 13th to 62 AU cents yesterday. A loss of AUD 61 million to AEP. But in the same period, AEP's market capitalization has fallen by AUD 133 million. On top of this it was already selling at a discount to net asset value. I suppose the price has been pushed down this far due to the negativity surrounding its parent Allco Finance Group (AFG.AX). But AEP has no borrowings and there is no reason for it to collapse even if its manager AFG went out of business. This is one stock I plan to add to in the near future. I sold half my position at $A3.96 on 31st October. In retrospect, I should have sold the lot :)

W-2 Arrived

My W-2 arrived today all the way from the US (together with statements from Ameritrade and HSBC). So soon I can do my US taxes. My records should be good enough to fill in the investment side of things - given the IRS doesn't have any record of my investments and transactions in Australia, accuracy down to the penny is not necessary. Hopefully, this will be my last US tax return. As I was only a temporary resident in the US on an H1-B visa I now revert to a non-resident alien. Taxes are deducted at source on my dividends and I don't need to pay capital gains tax or tax on interest in the US. If I had gotten a green card I'd have had to submit US tax returns and be subject to full resident US taxation until I fell out of permanent resident status. Which is why I didn't go ahead and complete the green card process.

I'll also do Snork Maiden's taxes. Her W-2 arrived at her former office in the US. It should be forwarded to us soon. The Australian tax year ends 30th June and taxes are due sometime in October. So we'll have this fun all over again later this year :)

January 2008 Report

All figures are in US Dollars (USD) unless otherwise stated. This month again saw falls in net worth due to negative investment performance, though our performance was not as bad as the market.

Income and Expenditure



Expenditure was $3,970 - exceptional expenses included expenses on the upcoming wedding - core expenditure was $3,323. This included $231 of implicit car expenses - depreciation and interest. Our core expenditure has been remarkably consistent over the last three months.

Non-investment earnings ($3,598) mainly consisted of Snork Maiden's salary. Her previous employer finally stopped paying her. Snork Maiden's retirement contributions from her employer were $872 - there were three contributions this month for some reason (but only two salary payments!).

Non-retirement accounts lost $11,713 with the rise in the Australian Dollar offsetting $3,739 of what would otherwise have been a loss of $15,452. Retirement accounts lost $405 but would have lost $2,938 without the change in exchange rates. This difference is due to the strong exposure to bonds in our retirement accounts and the stronger exposure to equities in our non-retirement accounts. Trading contributed $577 in my Roth IRA account and $82 to the non-retirement result.

Net Worth Performance
Net worth fell by $US10,905 to $US437,702 and in Australian Dollars fell $A23,167 to $A488,125. Non-retirement accounts were at $US225k. Retirement accounts were at $US213k. So we made negative progress on our first and third annual goals.

Investment Performance

Investment return in US Dollars was -2.70% vs. a 8.17% loss in the MSCI (Gross) World Index, which I use as my overall benchmark and a 6.00% loss in the S&P 500 total return index. Non-retirement accounts lost 4.94%. Returns in Australian Dollars terms were -4.64% and -6.98% respectively. In currency neutral terms the portfolio lost 4.10%.

The contributions of the different investments and trades are as follows:



The returns on all the individual investments are net of foreign exchange movements. Foreign currency gains appear at the bottom of the table together with the sum of all other investment income and expenses - mainly net interest. This month most of the most negative numbers are unlisted and listed Australian funds, while most of the best gains are from short-term trades or new positions.

Progress on Trading Goals

Asset Allocation
Using the simple method of adding up the betas of each individual investment weighted by their portfolio allocation, at the end of the month the portfolio had an estimated beta of 0.58. Using a regression on the last 36 months of returns gives a beta of 0.75 to the MSCI or 0.65 to the SPX. Alphas are 0.52% and 4.65% respectively. A more sophisticated time series method yields a beta of 0.65 and alpha of 10.1% for the MSCI index. There is less difference in the estimate of beta this month between the different methods. This maybe suggests that the Australian Dollar was less correlated with the stock market this month.

Allocation was 34% in "passive alpha", 68% in "beta", 2% allocated to trading, 8% to industrial stocks, 5% to liquidity, 3% to other assets (including our car which is equal to 2.9% of net worth) and we were borrowing 20%. Our currency exposures were roughly 59% Australian Dollar, 31% US Dollar, and 10% Other (mainly global equity funds).

Summary
At the end of the first month of the year we are on track to achieve two out of our five goals (2: Positive Alpha and 4: Gain in Ameritrade/IB Accounts).

Retest Underway

A new downtrend has started in the stockmarket that will test the low established in the week of 21st January. It is likely that at this coming low I will go massively long, unless indicators are telling me otherwise. My moves, up till now, have been very small in comparison. Take a look at the chart of GOOG - there are a nice 5 waves down since the beginning of 2008. The NDX now appears to be catching up in a 5th wave down. From an Elliott-Wave perspective, it's likely that the move from July to August 2007 is a three-wave wave A. We then have wave B from August to early November and since then wave C; with us now in the final wave 5 of C. We can apply the same interpretation to the SPX, except that wave C already got underway in October. The entire formation is an expanded flat. I long suspected that something like this was occurring since July, but didn't know how big each wave would be. Of course I could still be wrong, I don't use E-Wave as a primary method of predicting the market but just one way of putting what is happening into a framework.

My bigger picture is that this move is just wave 4 since the 2002 low and not a major bear market. Expect a bigger correction heading into the four year cycle low in 2010. But expect a bull market before that. Expect most people to be wrong.

The only move I made was buying some XHB puts yesterday. I'm not in a daring mood.

January Trading Results

Results for January are mixed but not bad. Any way I want to measure things I beat the market massively. The MSCI All Country Gross Index was down 8.17% and the S&P 500 Total Return Index down 6.00%. I'm not sure of my overall portfolio returns yet but they were much better than that.

Computing trading returns somewhat arbitrarily, as I have been doing resulted in a $658 gain for the month. My three US trading accounts gained $735 (1.55%) and there is still $5980 to go till I reach breakeven across those three accounts, which is one of my annual goals. In future, I'm not going to break out a trading rate of return separately from my portfolio return as I've decided that the numbers get to be meaningless as I invest more of my cash for the long-term and trade with borrowed money. I'll report the overall portfolio returns, the gain in dollars on my three US accounts, maybe the percent return on my Interactive Brokers account (-8.37% this month) and my realised short-term gains for the month (-$1803).

Bottom line: I made progress on goal 4 (achieving breakeven) and continued to slip back on goal 5 (making money from trading). That is if you measure the latter goal in terms of realised short-term gains. Soon, I'll put together a realised gains series for the last couple of years to get a better picture of how I'm doing. Here is the net equity in my three US trading accounts:



This view shows that the slump since June 2007 is nowhere near as bad as the trading results I've been reporting show. In fact, at this point I am up slightly on that month and if we measure from the big loss in July 2007, I'm not doing bad at all. Especially, when compared to the market. What has been happening is the positions in these accounts that I have considered to be investments have done well, while my short-term trading has gone badly. This shows the importance of diversifying across different styles.

Dumped the Hedge

Too late, but hopefully it was the correct move. Market still seems to be rallying at this point. I should still have a positive trading month for a change at this point.

P.S.

Bad move - I panicked right at the top...


P.P.S.

Really bad move. One reason I abandoned the hedge was that my model stop would have been hit at that point. But the market ended down on the day so I lost... I was up $1600 or so for the month yesterday. Today I'm just short of $600. If I'm lucky I'll have a positive trading month. At the least I beat the market massively :)

I think I'm going to revise the way I compute trading results in future (and redo the results for the last year and a half so all the data is consistent. At the moment it is pretty arbitrary what I am considering as being in the trading results and what is in the investment results. The plan is to include all exchange listed positions held for less than a year in the trading results. That means that there will be revisions to trading results when positions end up being held for more than a year. But this will produce results (including realized and unrealized profit) that are consistent with my trading cash flow results. I'll report the results with and without net interest.

NNDS Releases Great Results

One of my recent investments, NDS, released great quarterly results. With a record of rapidly growing earnings and free cash flow close to stated earnings, I think this firm deserves a higher P/E ratio. This is the third quarter in a row that the company has beaten analysts' expectations substantially. Maybe they'll finally get it and bid the stock up. On the other hand, RBC recently upgraded the stock to a "top pick", which can't hurt :) The company is a subsidiary of News Corporation with around a quarter of the company owned by other investors (Yahoo's number are all wrong) that develops television related technologies.

Hedged

Today's moves:

01/28/2008 15:02:21
Sold 100 XLF @ 27.7801

01/28/2008 15:03:16
Sold 100 IBKR @ 33.18

01/28/2008 15:06:33
Sold Short 300 SPY @ 134.3101

My Ameritrade account is now fully hedged. It still looks like sideways action is in store so I haven't gotten to short. Today the stochastics rose despite the forecast that they'd fall. I'm not surprised by that. It was going to take a major fall in prices to push them down today and I didn't think that likely with everything I've been pointing out.

You'll notice I did a straight short of SPY rather than use an inverse ETF product. This saves me margin interest. I don't know why the inverse ETF's are so popular. Of course it would be cheaper to short an ES futures contract, but that is more hedging than I need and psychological I like to see the hedge in the same account as the stocks it is hedging. That is silly but a lot of what I and other traders do would be silly to a truly rational profit maximizing trader.

NASDAQ 100 / Russell 2000 Divergence and the CBI Indicator

Rob Hanna presents lots of interesting studies on his blog Quantifiable Edges. His latest analysis has highly bullish implications. His CBI - capitulative breadth indicator - indicator is also on a buy signal still. My Nikkei model switched to short today but at the moment I think these models are not very reliable - they are often getting stopped out.

U.S. Tax Rebate Calculator

I found a link to this tax rebate calculator on Boston Gal's blog. It calculates how much of a rebate you should get under the U.S. stimulus plan. Snork Maiden and I should each get $600 unless there is a clause preventing them mailing a check outside the United States.

Symbion Talks to Resume?

Talks between Primary Health Care (PRY.AX) and Healthscope (HSP.AX) are likely to start soon on what to do about Symbion (SYB.AX). I followed EnoughWealth's advice and didn't send in my acceptance of the Primary takeover offer when I realized how conditional the offer was and that the two companies were not allowed to talk till after Australia Day. Maybe this fiasco will be resolved soon.

Short Term Trends: Asia vs. America

Though my US (NDX and SPX) models switched to short at Friday's close, the Australian and Japanese models are still long with no possibility of a short for several days in all likelihood. My guess is that this divergence means global markets will go sideways this week. In fact it is easy to see that if the indices remain unchanged for the next week, Australia will shoot up into the overbought zone as defined by the daily stochastics, while in the US the stochastics will decline. This isn't based though on any historically similar period - I probably should look into finding examples. I'd still expect plenty of volatility this week. But if this happens it will be another strong point in favor of the bottom being in.

The Australian market is closed today for Australia Day (which commemorates the arrival of the first British settlers in Sydney in 1788). But I'll be following Japan and the US futures to see what happens.

Ten Year Low in Bullishness

Ten year low in bullishness. As you'll see these low levels of bullishness tend to be at market bottoms not tops. The contrarian approach fades the crowd and the crowd is bearish now. Investment newsletter writers are too.

Is Apple a Bargain?

After the recent fall in price of AAPL, which I suffered from (but only with a 25 share position - my initial position in any single industrial stock is roughly 1% of net worth), you might think that AAPL was overvalued and saw a fall back to reality or perhaps it still has a way to fall. After all AAPL has a trailing PE of 28 now at the current price and so it was much higher at the recent peak in prices. Analysts are forecasting growth of 22% next year and in the next five years.

However, the correct way to value a company is based on the discounted sum of future free cash flows - cash earnings minus the investments required to maintain and grow earnings at the forecasted pace. If you need to reinvest earnings in order to grow them then you can't as an owner spend those earnings and they shouldn't count towards your valuation of the company. Only those earnings that could be paid out or used to buy back shares without jeopardizing the company's growth should be counted. When you dig into the cashflow statement of many companies you quickly find that the net free cash flow is close to zero or at least much lower than earnings. Take SBUX for example. Operating cash flow in the most recent year was $1.3billion but capital expenditures were close to $1.1billion. The difference - free cash flow was around one third of the $672million earnings number. This is why I won't buy Starbucks as an investment.



But as the table above shows, for AAPL, operating cash flow in the most recent year was $5.47billion and capital expenditures were only $735million. The $4.735billion in free cash flow exceeded the $3.496billion in stated earnings. AAPL is currently valued at 24 times that free cash flow. I wouldn't say that was a bargain, but for a growing firm it is not bad. It is a lot better than a whole lot of other growing tech companies out there. Some analysts play further games with AAPL's earnings by taking out the huge cash stash the company has ($21 per share) from the share price and generating a lower P/E on the remaining earnings. You couId do this with free cash flow too, I guess, though this always seems a convoluted justification for a high share price to me.

BTW don't worry about the "investments" in the investing cash flow section. These are just "short-term investments" if you look at changes in the balance sheet. Apple hardly does any acquisitions so these aren't an important factor in doing a cash flow analysis.

Please criticize this analysis. Maybe I'm completely offbase?

Recession and the Stock Market

According to the NBER the 1990 U.S. recession lasted from July 1990 to March 1991. This is what the U.S. stockmarket did during this period:



The decline in the market began, just when the NBER later claimed the recession had begun - July 1990. The market bottomed in September and October, falling from 369 points to 295 points. 295 is 79.9% of 369. The market went sideways for the year before the decline.

Now after going sideways for a year the market began to decline in October and bottomed so far in January:



The decline is from 1576 to 1270. 1270 is 80.6% of 1576.

I am not using this example to say that the market has bottomed, just that if this is a regular recession the market could have already bottomed. There are lots of doomsday scenarios for the stockmarket out there from the likes of Robert Prechter or Glenn Neely. Those guys could be right but given that valuations are not extreme as they were in 2000 and interest rates very low a much smaller correction of this sort is entirely possible (I'd say likely, but let's wait and see).

Why go back to the 1990 recession rather than 2001? Any recession signal in 2001 was embedded in the bursting of the NASDAQ bubble. I don't believe that the complete decline was due to the upcoming recession, but rather due to the extreme bubble valuations reached in 2000.

It will be interesting if the NBER will eventually decide that the recession started in October.

Stimulus

Not only does a large part of the stimulus package go to groups who are unlikely to spend it, but by the time they send out the checks any recession would be half over. The idea of sending rebate checks is to bring things forward from the time when people file their tax returns for 2008 in 2009. But here are two quicker methods of getting a fiscal stimulus out there:

1. Allow reduced with-holding of taxes from wages in anticipation of a tax rebate. Workers would instantly get a rise in take home pay.

2. If you have a national sales or value added tax you can slash the rate immediately reducing prices and increasing sales (supply curve moves to the right). The US doesn't have this option of course except for some federal taxes like that on gasoline.

Any problems with these policies?

Market Update

I should explain that what I've been trying to do the last several days is position myself in some longer term investments while trying to use trading tools to get good entries. If the market looks like turning down again I'm going to take defensive action and then try another shot at entry at the next low. Friday, US markets spiked higher and then fell back. About the time the opening gap closed and with things not looking like a real recovery was going to get underway I dumped half of my positions in IBKR, RICK, XLF, and BWLD. Today's action has brought forward the model's turning point and in fact it said to get short at today's close. This doesn't mean that Monday can't be an up day but you shouldn't count on it. I wasn't prepared for this and couldn't do anything more before the close - I will attempt to do so on Monday. I'm still up on trading for the month but gave back about half the gain today. My thinking - this is more speculative based on chart reading is that the next low defined by the 5 day stochs will be a higher low. This could be the point for really going long investmentwise if that low is higher and looks like holding.

The SPX weekly chart shows a tentative crossing of the stochastics:



The weekly candle is a doji. All in all a very indecisive read. Anyway, my research shows that weekly stochastics aren't very predictive of anything by comparison with daily ones. Something very interesting is that the McClellan Oscillator rose despite the negative index action:



The NYSE one fell but remained in positive territory. This is a somewhat bullish sign. At the 2002 bear market bottom, the McClellan Summation made a higher low:



Is it possible that the Summation is doing the same thing here?



The NASDAQ summation made a higher low in October 2002, but not now. This time it's at the lowest point in several years.

Update

We've bounced another $4k off the low point and are now only down $16k for the month. I've now made a profit of about $US750 in trading this month, which I hope I can hold onto. No trades for today but I've put a bunch of lowball bids in on Australian closed end funds to see if they get hit. Babcock and Brown (BNB.AX) bought a bunch of EBI.AX and EBB.AX which is a nice vote of confidence after the battering those two stocks have received. Interactive Brokers (IBKR) announced nice results but the stock sold off after hours. I didn't sell (maybe I'll regret this). Microsoft announced very nice numbers and soared AH and currently the NQ futures are up about 15 points. This also lifted AAPL a little AH. So the rally seems intact and my plan is still to hold till Tuesday's close and model depending sell a bunch of stuff and hedge then before the FOMC meeting.

Game Plan

Next Wednesday's FOMC meeting is one day beyond the forecast horizon of my model. At this stage the model is saying to be long till the close Monday or maybe Tuesday. Being long the FOMC meeting looks to be a high risk proposition. I am thinking to stay long through Tuesday and around Tuesday's close sell a lot of my shorter term trades and hedge the rest of my portfolio with SKF. So I would go into the FOMC meeting with a market neutral portfolio that could outperform if the Fed doesn't cut rates. After this week's emergency 0.75% rate cut it's hard to imagine them cutting again, and yet market participants seem to believe that. I'll also go into IBKR's earnings release Thursday afterhours US time long 200 IBKR. I'll probably sell half my position then either way, good or bad. It worked last time.

At this point we've bounced around $US20k off the bottom.

Boulder Total Return Fund

Is today's purchase. I used up the spare cash in my Roth IRA. I had been trying to trade that cash but the amount is small and it's a hassle. I classify this stock as a stock in the passive alpha category. The yield on this closed end fund is way higher than stated on Yahoo. Six times higher. At least that's what the fund says. 30% of the fund's net assets are in invested in Berkshire Hathaway. The fund also has quite a lot of financials, which may stage a bounceback here. I'll report in more detail on my other recent purchases soon.

Wednesday in the US was a crazy day in the markets. Despite the big fall in Apple Computer (and also a mysterious fall in NDS) we ended the trading day significantly up. Probably around breakeven for trading this month so far. The model is long for the next few days. Up till the FOMC meeting. Selling before the FOMC is looking like a good tactic at the moment.

Shift in Allocation

Things don't look as bad today as yesterday. At this point I've shifted 10% of the portfolio into stocks as well as a little into private equity, since the close of last month and increased beta by 0.14 points:



* Note: Private equity, hedge funds, and real estate are all mutual funds or listed stocks with the characteristics of those asset classes.

This has been achieved by reducing cash and increasing borrowing rather than selling other assets. I'll sell a little on a bounce in the market or if the bounce doesn't materialize. Only when the lows are successfully retested will I get really aggressive and start selling stuff to increase stock exposure.

After Hours Stock Trading is Dangerous

My stop order on AAPL didn't work. I then tried to sell and nothing happened. This was with IB. This is too dangerous. I doubt I try that again. I certainly won't on IB. AAPL price is rebounding now. At least I only have 25 shares! Perhaps, even more to the point there is no edge in going long into earnings. It's better to try to trade the number using a stop triggered by the price action after the announcement if anything. I'll probably hold until the next NDX model peak.

P.S.

I realize what I did wrong now. My mistake. Very stupid beginner's mistake. Anyway, trading after hours is still dangerous.

Bought LTR, FF, and BWLD

Was thinking about SHLD but decided against it. Short-term (at least) mistake. Thought about the bounce spread trade - long XLY and XLF and short XLE and XLV. But didn't like the idea of shorting energy at this point (when it was already down 4% on the day). So that one is on hold still. Overall added about 3% of net worth to my stock holdings (borrowing on margin). Nothing radical.

P.S. 3:44pm New York Time (EST)

I added trades of 200 XLF and 100 IBKR.

Strong Weak Sector Pair Trade

An interesting idea - one could do this with sector SPDR's.

Net Worth and Portfolio Update

Our net worth is down around $US39k (AUD 36k) month to date. The portfolio has lost 9.7% in USD terms or 7.8% in AUD terms. On the other hand, I estimate that the S&P 500 is down 13.9% (including the 61 points the futures are down currently) and the MSCI down 16.7% (If world markets fell 5% on average today). Percentwise, I've had worse months:

Sep-02 -18.21%
Sep-01 -15.56%
Aug-98 -13.61%
Jul-02 -13.13%
Jun-02 -11.94%
Feb-01 -10.05%

But they're all from the great millennial bear market and the 1998 correction. In dollar terms (rather than percentages) this is the worst, but in mid-August 2007 we were down more.

Focusing My Effort

Trading SPI (Australian futures) and the Nikkei futures under simulation today. Again, I make money trading the Aussie index but can't seem to get a foothold or handgrip on Japan. Maybe I should focus on practicing SPI trades going forward. I was interested in Japan because the contract size is very small. But if I have to use very wide stops it might not be such an advantage. I think I am going to be practicing for a while yet.

Markets are in "crash mode" around the world. Of course, I now regret buying AAPL and maybe some of my other recent investment purchases. But in total I didn't move that high a percent of net worth into stocks over the last couple of weeks because I knew something like this might happen. My hedge fund stuff is getting hammered alongside my regular equities. The only good thing is we have more than 40% of our portfolio in bonds still. And they are going up.

It's interesting that the S&P 500 started its descent from around the same level as the 2000 high and now the Dow Jones futures are roughly around the level of the 2000 high in the Dow. It'd be nice if those two points would bracket the correction. I won't do anything very radical in terms of buying until any low is retested successfully. By the way, the Australian All Ordinaries Index is now officially in a bear market.

Tried to Trade the Nikkei with Real Money

Did two trades. Both lost. I think I was overenthusiastic to put the trades on despite not very strong signals. Luckily I used stops properly. So I was disciplined at that end of the trade. Back to simulation mode.

Solution to the Trading Puzzle

A week ago I put up a "Trading Puzzle" on the blog, asking what simple strategies resulted in the blue and green equity curves. Today, I reveal the answer. I'm disappointed I didn't get any comments, as I know a lot of people looked at this post. OK, so the blue line is what happens with a stop loss order set at a 1.25% daily decline in the index. In other words, you stay long unless the index is down 1.25% on the day. When a 1.25% down move is hit you get out of the market till the next day. The green strategy is the same except that instead of getting out of the market you get short once the market is down 1.25% on the day. It's amazing how much difference this simple strategy that involves no attempt to predict market direction made this year. Stops can be important.

Investment Returns in the Millennial Decade

The source of this table is this week's edition of Barron's, which I subscribe to. US stocks have not been a good investment so far this decade. Of course if you dollar cost average in you would have bought quite a lot at lower prices in 2001-2004. even better if you'd tried to time the market any time in 2002. Dollar cost averaging the SPX over this period returned 3.81% by my calculation. The MSCI World Index (All Country Gross) returned 4.18% p.a. So foreign stocks weren't that spectacular either. Moom's return over this period BTW was 7.2% per year. As "The Fly" would say: "Odd, no?" :)

Leucadia National

I bought some shares in Leucadia National, which has long been on my watchlist. Essentially it is a listed private equity firm. They should find some good opportunities in current market and economic conditions. I'm classifying this as a "passive alpha" investment in the asset class "private equity".

Should I Go to Live Daytrading?

My last two weeks of simulated trading have gone very well. I'm trading in a disciplined and profitable fashion. Here are the results of my trading of the Australian Share Price Index Futures over this period (all amounts in Australian Dollars):



A movement of one point on the index results in a gain or loss of $A25. Commissions are $A5 each way. As you can see though I am profitable I'm only gaining a few points of movement a day. If I was prepared to give trades more leeway I could capture a lot more points. As the following statistics show I am averaging about $A250 a day, which is pretty much my medium term income objective:



But there is the potential to make much more. Mostly also I only made trades in the morning while some big moves happened in the afternoon. The trades also average out over each day, so that I only had one losing day and then only lost $A20. On average I made $A80 per contract or about 3.5 points. The z-score (t-statistic) for individual trades, which tests whether they are significantly different from zero is 2.21 and for daily totals 3.42. In both cases, based on the sample, the probability that the results are random is very low. I won about 3/4 of trades but am still seeing the average loss on losing trades being greater than average gain on winning trades.

This chart shows my "equity curve":



My Nikkei trading over this period has been even more successful, though it made far fewer virtual dollars. So what is the problem? This chart of all my simulated SPI trades shows what the issue is:



The first trade on this chart was made on 10th December. Things went well until two days of bad losses around the turn of the year. What happened then? I lost control, pulled stops and traded two contracts at once. In other words I blew up. The sample since then is relatively small. How do I know that I will retain my discipline with real money and not blow up again? The z-scores for the entire period shown on the chart are around 1.30 which leaves a moderate probability that the results are purely random.

You're probably wondering what the red line is. That's what the equity curve would look like if I had honoured the stops and not traded an extra contract.

AAPL Trade

Doing a small long AAPL trade. Price should rise into options expiry in theory after being beaten down - traders redeeming ITM put options push the price up as put writers cover their hedging short positions. And next Tuesday is Apple's earnings release.

First European Stock Investment

I bought 40 shares of Bekaert - a Belgian firm that mainly focuses on steel wire products (including tyre wires) as well as some high tech materials and coatings. They also have a research lab in China. The firm is 40% family owned and pays a decent dividend. An online acquaintance said he was investing and I think he is worth following on this. Yes I bought the shares on the Belgian Stock Exchange. With Interactive Brokers this is fairly straightforward. I just asked online for permission to trade Belgium which was instantly granted. I then placed the order in the usual way. Interactive Brokers then extended me a loan in Euros to cover the purchase. I didn't bother paying for Euronext data. You can trade an exchange without paying for the data through IB. Yahoo provide the data with a fifteen minute lag, which is good enough for long-term investing. If you are interested in European stocks the Yahoo UK site has far more information than the US finance site. I don't know why they can't link this info through to the US site. After all the UK site knew which stocks I'd most recently requested quotes for on the US Yahoo Finance site!

New Private Equity Investment

Yup, another new investment. ING Private Equity Access. I heard about this one from Enough Wealth. He sold 20,000 shares and still holds 80,000. I bought 6000. The stock is a fund of private equity funds. I am also invested in Allco Equity Partners, which is a single fund, though with its recent large investment in IBA it has more money in publicly listed stocks than private equity. My main reason for investing in IPE is that it is selling way below the book value of its investments. At some point hedge funds and private equity will no longer be the pariahs they've become since August and the price to book ratio should rise. I have more private equity investments on my watchlist. I only have 2.3% of my portfolio invested in these two stocks.

The larger question is whether the stockmarket is bottoming here?



Looking at the chart you can see three very similar candles at the end of the current move down and the previous two major moves down. On the other hand, the stochastics do not appear to be bottoming here. The model allows for up to 2 or so days of downside from here. The weekly chart has reached the lower Bollinger Band in a similar way to the 2006 and 2007 lows. However, in 2007 the market declined considerably after bouncing from the BB. There's not yet any good sign of a bottom in the McClellan Summation on a weekly chart. The same goes for the bullish percentage. So I am very cautiously adding these new investments here, putting 1% or less of the portfolio into each. I'm not doing anything radical yet.

New Investments

PeopleSupport and NDS. PeopleSupport is a takeover play. There is an offer for $17 on the table and it could be raised... maybe. The company's business is offshore outsourcing of services. I've owned NDS before, it's been beaten down in the recent market correction and seemed like a good point to buy in again. The company is majority owned by News Corporation and is in television technologies.

No Takers for the Trading Puzzle?

So far no-one has commented on the trading puzzle. The strategies are very simple. At the end of the week I will reveal all, whether I have any responses or not. I the meantime, my simulated trading of the Australian Share Price Index is going well and I am feeling more and more confident that maybe I really could do this. I will wait though till I have statistically significant results before going live. I am using very tight stops. The stops really define the risk/reward ratio and the size of the contract (near $A150,000) becomes less important. At the moment I am only getting a fraction of the return possible on a single contract because I am getting out of trades very fast. If I gave each trade more leeway I would have higher returns but also higher volatility or risk. I've averaged $A150 per day so far but recent days are much better than that. I'm also beginning to have some success trading mini-NIkkei contracts.