Thursday, December 24, 2009

Yahoo/Dynamic Asset Allocation

1. Yahoo (owned): RB just said that the Nerd better not sell the RB's Yahoo for a $50 profit. Bought 100 Yahoo at Open/Bought 50 ETF PIQ at $19.81/Added 50 ABWPRA at $19.42 LB only hopes that no one read the No Wit's explanation for why it bought YHOO. LB noted that the RB was allowed recently to buy shares in this non-dividend paying stock as a sop, sort of like giving a baby a pacifier to keep it quiet.

Morgan Stanley resumed coverage of Yahoo with an overweight rating. The analyst is Mary Meeker. She is expecting material sequential revenue growth in the 4th quarter after several negligible or negative sequential revenues growth.

The LB will impose Order. Chaos only appears to exist.

2. Static vs. Dynamic Asset Allocation: Possibly the most important decision an investor will make in their lifetime is whether to follow a static or dynamic asset allocation model. Some investors never make a coherent decision one way or the other. Instead, they just jump back and forth, moving assets from one hot asset class to another only after a large move. An example of that phenomenon now would be the herd movement by individuals into bond funds and out of stocks. Other investors never have an asset allocation plan, or anything that would resemble a plan, as distinguished from moment to moment decisions on which hot mutual fund or individual stock to buy.

In that later linked post, I show how using the VIX Asset Allocation model, which is one tool in my Dynamic Asset Allocation process, would have substantially improved historical returns in a simple asset allocation scheme using just two ETFs, one for stocks and the other for bonds. The reader could plug in numbers for a broader stock ETF, such as IYY, a total stock market ETF. I used SPY and IEF since those ETFs had been around long enough to use from 2002 to the present. BND, Vanguard's ETF for the total bond market, is a newer product.

There is a reason for bringing this subject up at the end of this year. The most important issue for dynamic asset allocation in the next decade will be the decision on the amount of exposure to bonds, irrespective of an individuals age, as well as the kind of bonds or bond like investments that would need to be over-weighted or under-weighted.

In a static asset allocation model, there is no adjustment made based on what is happening in the real world. The central theme for that model is that allocation is based on circumstances unique to the individual, as if the world revolves around you at the center of the universe. This kind of model may be adequate during a long term secular bull market in the two major asset classes. As seen over the past decade, the static model does not work well when one of the two major asset classes fail. Bonds have done just fine over the past decade, and I would argue that bonds have been in a long term secular bull market since 1982. As a result of that bull move, yields are very low now particularly on government bonds from virtually all developed nations. The asset class that has failed over the past decade is of course stocks. And by failure, I am just referring to my standard definition of a long term bear market, a movement up and down over a 10 to 15 year period, that ultimately ends up going nowhere. The static model would not have made any adjustment in exposure to stocks based on external reality.

When I started to think about investments, I was a teenager. At that time, stocks were in the final phase of a long term secular bull market starting in 1950. Bonds had not kept up. In fact, I have mentioned in prior blogs Roger Gibson's statement that long term treasury bonds had actually started a long term secular bear market around 1946: For BND: Is it Safe is not the Right Question. Instead Ask What are the Risks & Rewards/Assume Lost of Principal Possible How reasonable is a prediction of a 2% 10 year treasury yield and 475 on the S & P 500 I have bought his book Asset Allocation but have not had a chance to read. I would add this comment now. During the inflationary period starting in the mid to late 1960s and ending in the early 1980s, both bonds and stocks failed as an asset class. There can be no dispute about that statement. If someone had retired in 1965 depending on a target fund to fund their retirement, they would be in a world of hurt. Only a dynamic asset allocation, which is admittedly more difficult to implement, would have worked during long term bear markets in a major asset class.

Contrary to the opinions of many financial advisors, adding foreign stocks and commodities (or more esoteric asset classes) will not cushion the fall, but may only add to it. This would especially be the case where there is a high positive correlation between asset classes during a bull move, and then some external event causes a major shift downward for all of those positively correlated asset classes. I generally discuss this type of topic using the words positive or negative correlation, or just "non-correlated". So anyone interested in that topic could use the google search box at the top right hand corner, and enter a search term. I just entered "emerging market non-correlated" and came up with this post: Emerging Market Currencies and Bonds as Non-Correlated Asset Classes/Links to Performance Data on Target Funds & More on Their Many Failures & a more general discussion at Instability & Volatility in Asset Correlations

The dynamic asset allocation process does take into account the individual's age, risk tolerance, and financial needs. The key difference with the static asset allocation model is that the dynamic process has to adjust based on what is actually happening in the real world.

When making asset allocation decisions, I am dealing with a large number of variables, planning for future contingencies, and constantly evaluating new information and how it may impact allocation decisions. It is a constantly evolving process. For example, I ask myself what would happen over the next decade if I weighted bonds based on my age, used primarily a total bond market index fund that pays me around 4% and some of the TIP ETF, at a time when the 10 year TIP coupon is hovering just over 1%. Would that achieve my goals over the next 10 years? While the future is unknown of course, I still have to plan now using possible and more probable than not scenarios. This is just my opinion, but I believe the bond asset class will soon begin a period where prices fall and yields rise, and the fixed coupon bond class will at best maintain a stable value after adding back interest payments starting today and ending 10 years from now. I have sold all of my bond ETFs, TIP, WIP, BWX, BND, SHY, BSV, etc. and have started to prepare last October for what I believe will be the most likely scenario for the upcoming decade, falling bond prices and rising yields. This has meant buying individual bond issues when they fell to substantial discounts to par value starting in October 2008 and to emphasize more floating rate bonds and equity preferred stocks. At some point, when I view the risk/reward tilted back more in my favor, I will start to buy the 10 year TIP again in my retirement account. I doubt that I will be adding a security like BND at anytime in the next five years. But, as new information is digested, I will have to adjust what I am planning for now, and that is the essence of dynamic asset allocation.

Even over the past few months, I have made adjustments. For example, I noted in a post from last December that I would not be buying a stock ETF until I received a green light from my Vix Asset Allocation model. A FEW MORE COMMENTS ON DYNAMIC ASSET ALLOCATION I later made an adjustment and decided to go ahead an add a few low cost stock ETFs when prices were still low, and then later sell some stock mutual funds after a prolonged bull move. This adjustment was discussed in March 2009 and in several posts thereafter: A Good Month But Another Awful Quarter I later added several stock ETFs such as VEU, VTI and VV from Vanguard.

I may not have another post until next Monday. In the meantime, Headknocker is going to have to find a Head Trader willing to take some tax losses to offset at least some of the gains this year. HK has reminded all HTs that it is only necessary to wait more than 30 days, and the position can be bought back. Using FIFO accounting, this may be an opportunity to lower HK's tax bill in 2009 and lower the cost basis of some of the positions. Most likely, 2009 will be the best year ever at HQ, with the trading operation up 42% year to date with almost 30% in cash now earning next to nothing. Having cash, however, did provide the psychological cushion for buying stocks in March, even though the cash allocation was not the primary source of funds for those purchases. A liquidation of virtually the entire position in individual short term bonds maturing in less than five years provided most though not all of the funds. In retrospect, it would have been better to keep those bonds, and to use part of the cash stash. But, sometimes, even for a highly developed LB, psychological issues and a security blanket have some influence. The kind of results experienced in 2009 will most likely never be repeated again. The buying opportunity in floating rate securities, bonds, and stocks was just one of those rare shoot the fish in a barrel opportunities.

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