Health Care Stocks…In China

Until tonight, I was previously unaware that there was major health care reform in the works in a country other then the United States. Jim Jubak notes that the Chinese government plans “to spend $124 billion by 2011 to provide some form of health insurance to 90% of the population.” He also notes that “the decision to devote tens of billions a year to improving health care and providing a minimal level of health insurance is a remarkable sign that the government actually intends to do something about social insecurity in China.”

How could an investor profit from health care reform in China? First, according to Jubak, wait for Chinese stocks to cool off, as they are overpriced. When lower prices come, two names for investors to consider are Ping An Insurance (PNGAY – Get Trend) and China Medical Technologies (CMED – Get Trend).

This Week’s Reading

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Regular readers know that besides ETF portfolios and trading strategies I prefer to focus on big picture economic and investment articles. Below are four articles I found worth reading for this week, along with a brief summary of each and excerpts:

John Hussman’s Weekly Market Comment for this week is titled We’re Speaking Japanese Without Knowing It. The Japanese we speak? Propping up Zombie banks:

At a speech at the Princeton Club last week, economist Carmen Reinhart reiterated that by propping up unhealthy banks, the U.S. is unwittingly committing the same mistakes as the Japanese did in their decade-long stagnation, saying, “These are not zombie loans. They’re just non-performing. We’re speaking Japanese without knowing it.”

Later, he notes his primary thesis, and I think much of the reason why he tends to have a tempered view of the equity rally the past few months:

Historically and across countries, according to the IMF, 86% of systemic banking crises have ultimately required government restructuring plans that included closing, nationalizing and merging banks. Yet the policy response of the U.S. has been akin to putting a band-aid on an untreated infection. Worse, not only has the underlying infection been overlooked, but thanks to the easing of FASB mark-to-market rules early this year, we have at least temporarily stopped reporting on the status of that infection.

After the bubble burst in Japan in 1990, Japanese banks were not compelled to properly disclose their losses either. The predictable result is that the problems resurfaced later, but worse, because they had not been addressed.

This sort of “regulatory forbearance” – setting aside requirements for large loan loss reserves and timely loss disclosure – was helpful during the Latin American debt crisis of the 1980’s, but largely because it allowed time for negotiations with countries to restructure debt, first by rescheduling payments, and then ultimately through debt-equity swaps, exit bonds, and other major debt restructuring under the Brady Plan.

Forbearance only works, however, if you’re buying time to do something to restructure debt. Instead, we’ve celebrated bailouts and the easing of reporting requirements as if they are a substitute for restructuring. In my view, this is a mistake that will haunt us….

….The simple answer is that we have not solved the mortgage mess. We have temporarily buried it under a pile of public money, bailing out bank bondholders at public expense. As I’ve noted before, the best time to panic, in the financial markets, is before everyone else does. Similarly, the best time to consider responses to credit strains is before they surface. My sincere hope is that if, and I believe when, financial trouble resurfaces, we will be wise enough as a nation to prevent policy makers like Geithner and Bernanke from making the same bailout mistakes twice, protecting irresponsible lenders, and further burdening the nation with debt in the process.

With regard to the banking system, we still have no mechanism by which large undercapitalized banks would be able to absorb large losses with their own balance sheets, in lieu of going into receivership or default. The problem is that there is too much on the balance sheets in the form of debt, and not enough in terms of equity. Citigroup, with about $2 trillion in assets, continues to fund about $600 billion of that through debt to its own bondholders. Customers would never be at risk of loss in the event that Citigroup was to “fail.” The bondholders would. But we have chosen to defend the bondholders. A cushion on the balance sheet that can’t be touched is no cushion at all.

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Good article from John Mauldin on the “fourth turning” discussed by Neil Howe, author of The Fourth Turning, a widely successful and popular book that discusses how the Anglo-Saxon world has a pattern of four repeating generational types.

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Mohamed El-Erian of PIMCO warns us that the return of the old ways of thinking threatens recovery:

We are at the point of maximum confusion in the multi-year transition of the global economy, markets and policymaking. We have left the global growth regime that was driven primarily by debt-financed consumption in the US, but we have not as yet reached a position of more balanced, albeit anaemic, growth. Those who lack a robust anchoring framework, be they investors or policymakers, risk being misled and backtracking to outdated ways of thinking.

The signs of inappropriate reversion are multiplying. Confusing temporary factors for sustainable ones, a growing number of analysts have extended the ongoing stimulus/inventory bounce to a V-like recovery next year and beyond. The momentum for meaningful financial reform is stalling in spite of clear evidence that financial activities have far outpaced the regulatory infrastructure. And some banks are returning to the bad habits that almost destroyed them…

…These considerations serve to accentuate the inconsistency between market valuations and the reality facing companies and economies. Today’s markets – be they industrial country equities or corporate bonds – have priced in vigorous growth for 2010. Valuations assume companies will be able robustly to grow earnings through higher revenues, not renewed reliance on the cost reductions that have propelled earnings in the past six months. For that, they are depending on what is likely to prove to be an elusive high-growth scenario for 2010.

The longer it takes for investors and the policy consensus to shift to the appropriate analytical framework – one that factors in levels rather than just rates of change – the greater the risk of disappointment in 2010.

A ‘David Rosenberg’ ETF Portfolio

I previously noted some of David Rosenberg’s investment projections. Rosenberg is Chief Economist & Strategist for Gluskin Sheff. To summarize, Rosenberg’s themes were:

1.Commodities
2.Gold
3.Canadian dollar
4.Resource sectors of the stock market
5.U.S. sectors that have high foreign exposure (materials, tech, staples, health care)
6.Canadian sectors that benefit from lower import costs (consumer stocks) but lose export competitiveness (manufacturers)
7.Canadian bonds (a higher Canadian dollar will keep inflation low, hence reinforcing positive fixed-income returns)

A reader asked me tif there was a list of ETFs to capitalize on these ‘Rosenberg’ themes. To my knowledge, not until today! Please note, these are not comprehensive portfolio suggestions and are by no means meant to infer specific investment recommendations by this author or David Rosenberg. These are simply a list of ETFs for further research if you believe his projections are correct.

1. Commodities — There are numerous commodity ETFs, below are a few of the more popular ones. Before investing in a commodity ETF, please be aware of some of the extra risks involved.

  • GSG – tracks the performance of a commodities index that features 24 individual commodities. Free GSG trend analysis Here
  • DBC – based on the Deutsche Bank Liquid Commodity Index – Optimum Yield Excess Return (Index). The Index is a rules-based index composed of futures contract on six of the most heavily-traded and important physical commodities in the world – crude oil, heating oil, gold, aluminum, corn and wheat. Free DBC trend analysis Here
  • DBA – based on the Deutsche Bank Liquid Commodity Index – Optimum Yield Agriculture Excess Return (Index). The Index is a rules-based index composed of futures contracts on some of the most liquid and widely traded agricultural commodities – corn, wheat, soy beans and sugar. Free DBA trend analysis Here

2. Gold

  • GLD – SPDR Gold Trust, the investment objective of the Trust is for the Shares to reflect the performance of the price of gold bullion.
  • GDX – seeks to replicate as closely as possible the price and yield performance of the NYSE Arca Gold Miners Index

3. Canadian Dollar

  • If you are not comfortable playing the FX market directly, you could either seeking trading services that will provide the buy and sell indications for you such as Marketclub, or FXC, the CurrencyShares Canadian Dollar Trust, which seeks to track the performance of the Canadian dollar.

4. Resource Sectors of the stock market – See point 1 or seek individual companies or ETFs that track individual companies in the resource markets. One such example:

  • MOO – Designed to track the movements of securities of companies engaged in the agriculture business that are traded on global exchanges. The Index provides exposure to publicly traded companies worldwide that derive at least 50% of their revenues from the business of agriculture.

5. U.S. sectors that have high foreign exposure

  • materials – XLB, a SPDR ETF for the sector. Free XLB trend analysis Here
  • tech – XLK, a SPDR ETF for the sector. Free XLK trend analysis Here
  • staples – XLP, a SPDR ETF for the sector. Free XLP trend analysis Here
  • health care – XLV, a SPDR ETF for the sector. Free XLV trend analysis Here

6. Canadian sectors

  • I am not aware of liquid ETFs that offer exposure here – you may be better served seeking individual names. However, if you are interested in investing in Canada as whole, EWC seeks to track the MSCI Canada Index, a measurement of the Canadian equity market.

7. Canadian bonds

  • There is no liquid ETF focusing exclusively on Canadian Bonds. However, I have previously detailed the correlation of global bond ETFs. One could seek to invest in a diversified basket of global bonds via BWX or seek a currency investment in a rising Canadian dollar via point 3.

No Disclosures

A Simple Moving Average System on Vanguard Funds

I’ve previously detailed some successful simple moving average systems based on a 10 month SMA. The work is inspired directly by Mebane Faber, author of The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets. Simple timing systems have been shown to reduce volatility and increase risk-adjusted returns across multiple asset classes.

I decided to test a 200 day SMA system on a series of Vanguard Funds over the past decade from 9/28/99 to 9/25/99. After a fund closes above the 200 day simple moving average by 1%, a buy signal is indicated at the next months open price. When a fund closes a month below the 200 day SMA by 1%, the long position is exited. The twist of a 1% buffer above/below the 200 day SMA was added in order to reduce whipsaws and lower the number of trades.

Below are the results, including the Dow, with the Compound Annual Growth Rate (CAGR) for the timing system versus buy and hold and the standard deviation for both (SD). The 200-day system outperformed buy and hold more often than not; however, the greatest outperformance was in lower standard deviation, which equates to a less volatile portfolio. The moving average system’s CAGR suffered the most with bond funds and did the best with equity funds:

Data generated with the help of Gummystuff

For free trend analysis on any of the funds mentioned below, or any other stock, Click Here.

Buy/Hold 200-day MA Buy/Hold 200-day MA
Stocks CAGR CAGR SD SD
DOW ^DJI -1.1% -2.0% 25.2% 10.8%
500 Index VFINX -1.9% 2.8% 26.7% 11.1%
Total Market VTSMX -1.1% 4.1% 27.0% 11.5%
Wellington VWELX 5.8% 7.7% 15.6% 9.2%
Total Bond VBMFX 5.9% 5.1% 5.5% 5.2%
Short Term Bond VFSTX 4.7% 4.8% 3.3% 3.1%
Hi Yield Bond VWEHX 4.6% 4.0% 6.4% 4.5%
Long Term Bond VWESX 7.4% 4.5% 11.8% 10.4%
Long Treasury VUSTX 7.3% 3.9% 12.1% 10.8%
Intermediate Bond VBIIX 6.7% 4.9% 7.4% 6.9%
Value VIVAX 0.7% 5.3% 27.7% 12.0%
Small Cap NAESX 3.4% 3.5% 30.8% 15.8%
REIT Index VGSIX 7.7% 9.0% 41.4% 17.6%
Total International VGTSX 2.5% 10.9% 26.4% 13.6%
European VEURX 1.9% 10.8% 29.1% 14.1%
International Growth VWIGX 1.6% 9.1% 27.0% 13.9%
International Value VTRIX 4.3% 8.9% 25.6% 14.0%
Pacific Index VPACX 0.2% 5.8% 27.0% 14.8%
Emerging Markets VEIEX 10.3% 15.5% 30.5% 17.5%
Small Cap Value VISVX 6.7% 6.2% 30.1% 17.1%

No disclosures

Must Read: Rosenberg’s Case for Commodities, Credit, and Canucks

David Rosenberg of Gluskin Sheff just published a Special Report: The Case for Commodities, Credit, and Canucks (pdf). His work is outstanding, even if you don’t always agree with his bearish stance. He believes the equity market has moved too far, too fast and are only halfway through an 18 year secular bear market. Conversely, Rosenberg believes commodities entered a secular bull market in 2001. Thus, resource-rich Canada is set to outperform US equities. He also sees unemployment in an upward trajectory for the next few years and weak US dollar. Adam Hewison of INO also sees a weak US Dollar with the Dollar making a major low in Q4 of 2011, which may coincide with an upward trajectory in Gold.

Here is a summary of Rosenberg’s 24 page report, followed by his investment recommendations for protecting against a falling dollar:

Canadian credit cards

TWO OUT OF THREE AIN’T BAD

Now to be fair, while I was never bullish enough at the lows, I never advised clients to stay in cash either. There is more than one way to skin a cat, and frankly, even at the lows I never did consider equities to possess greater return potential than corporate bonds, which were priced for a much worse economic outcome (and that remains the case today, though the gap has narrowed). There was more than one report I wrote on this file in my last few months at Merrill Lynch, and several thereafter at my new digs, though the portfolio managers at Gluskin Sheff were on top of this story long before I came on board and our clients have been served well by this income-oriented strategy, especially for the comparable risks involved.

In fact, looking at the U.S. data, investment-grade credit — not junk, but good quality credits — have actually moderately out-returned the equity market so far this year. We doubt that is a factoid that you will hear on Fast Money!

And, I also published a series of positive commentaries on the outlook for commodities, and indeed, the CRB index, so far in 2009, is up more than 20% and the Goldman Sachs Commodity Index has rallied 30% — both outpacing the S&P 500.

So, I did miss the magnitude of the equity bull-run, but as Meatloaf said, “two out of three ain’t bad.”

BULL MARKET IN COMMODITIES = CANADA TO OUTPERFORM THE U.S.

We believe that commodities are in a secular bull market, and this is where Canadian outperformance relative to the United States comes into play — nearly 45% of the TSX composite index is in resources; almost triple the share in the U.S. Almost 60% of Canada’s exports are linked to the commodity sector, roughly double the U.S. exposure. This explains how it is that the Canadian equity market has managed to outperform the S&P 500 this year by a cool 2,000 basis points (in this sense, Canada is basically a low-beta way to play the emerging markets via commodity exposure).

HOW TO PROTECT THE PORTFOLIO IN A FALLING USD ENVIRONMENT

Remember, this is a premise. We are just conjecturizing. But it is interesting that the dollar is the only financial metric that is at the same level today as it was two years ago, and we are of the view that the risks are high that the greenback will be on a significant downward path in the coming year. In addition, it does look as though Asia’s secular growth dynamics are intact, and that is also critical to the constructive view on commodities and the Canadian dollar. With that in mind, investors should be thinking of how to hedge or protect the portfolio against this not-so-remote possibility, namely:

1.Commodities
2.Gold
3.Canadian dollar
4.Resource sectors of the stock market
5.U.S. sectors that have high foreign exposure (materials, tech, staples, health care)
6.Canadian sectors that benefit from lower import costs (consumer stocks) but lose export competitiveness (manufacturers)
7.Canadian bonds (a higher Canadian dollar will keep inflation low, hence reinforcing positive fixed-income returns)

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How Does GMO Define High-Quality Companies?

After looking at the GMO 7-Year Asset Class Return Projections that were posted here earlier this week a reader posed the following question: “the third item in GMO’s list is ‘US High Quality’. That is usually a term associated with corporate bonds, however, it is listed among the equities and could mean his idea of high quality US equities. Could you clarify please.

Great question! Below is the answer, straight from GMO’s website and a white paper The Case for Quality – The Danger of Junk. This might be a stretch, but it seems to correlate somewhat to the indexing approach taken by The Fundamental Index: A Better Way to Invest which focuses on the economic footprint of a company rather then its market capitalization. As an aside, I will be writing a review of The Fundamental Index: A Better Way to Invest very shortly.

And now, our answer:

How does GMO define quality companies? A company must meet all of the following three criteria:
�� low leverage
�� high profitability
�� low earnings volatility

Failure to meet any one of these criteria excludes a stock from the investable universe. To select stocks from this quality universe, GMO uses the stock selection approach that it has used since 1982 in U.S. equity portfolios. The methodology identifies companies that are able to maintain high levels of profitability over longer time periods than the market in general, thus mitigating the tendency for profits to regress to mean levels. In addition, this stock selection approach has the added benefit of differentiating between “good” and “bad” growth: only companies that can deliver returns in excess of their cost of capital should be rewarded for growth.

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New 1 Month ETF Momentum Strategy

I read another great strategy summary on CXOAG of a Combined Value-Momentum Tactical Asset Class Allocation, which they based on a 2007 paper by David Blitz and Pim van Vliet (titled “Global Tactical Cross-Asset Allocation: Applying Value and Momentum Across Asset Classes”).

CXOAG’s summary concludes that “value and momentum investing may work across a broad range of asset classes, and the two effects are independent enough that combining them may yield incremental outperformance.”

In essence, value and momentum can be considered two low correlated strategies which can increase performance. We can infer that an investor seeking a diversified portfolio may consider seeking a combination of at least these two elements.

How does the Blitz and van Vliet article define momentum? Two ways, 12-1 momentum (calculating the returns from the last 12 months minus the most recent month) and 1 month momentum. The 1 month momentum shows higher returns then the 12-1 strategy (and the value strategy). The paper studies a hedged strategy in which the top 25% performing stocks were purchased and shorting the bottom 25%.

How could an investor implement the 1 month momentum strategy? Screen for ETFs based on 1 month performance and purchase the top xx% and short the bottom xx%. The top/bottom 25% would be overwhelming for nearly all retail investors. However, a 1% strategy long/short may serve as a viable alternative. With 800+ ETFs on the market, below are the top 10/bottom 10 non-leveraged, non-inverse ETFs based on 21 day returns, according to ETFscreen.com. This screen could be further refined by diversifying across multiple asset classes (ie. so as not to consolidate positions among multiple ETFs in the same sector):

Symbol Close 21 Day Returns Trend
iPath DJ AIG Cotton TR Sub-Idx ETN BAL 33.68 12.04 Click Here
PowerShares DB Silver Fund DBS 29.17 14.12 Click Here
Claymore /NYSE Arca Airline FAA 27.4 12.94 Click Here
Market Vectors Gold Miners GDX 43.74 11.47 Click Here
Global X/InterBolsa FTSE Colombia 20 ETF GXG 29.25 11.73 Click Here
Market Vectors Solar Energy ETF KWT 15.01 12.1 Click Here
iShares Silver Trust SLV 15.99 13.89 Click Here
Claymore MAC Global Solar Energy TAN 9.92 12.6 Click Here
iShares MSCI Thailand Invest Mkt Index THD 41.78 12.92 Click Here
SPDR Metals & Mining XME 46.24 12.16 Click Here
PowerShares DB Energy Fund DBE 22.61 -8.68 Click Here
PowerShares DB Oil Fund DBO 23.68 -8.5 Click Here
iPath DJ AIG Nickel ETN JJN 25.36 -12.25 Click Here
iPath S&P GSCI Crude Oil ETN OIL 22.36 -8.99 Click Here
ELEMENTS Rogers Intl Commodity Enrgy ETN RJN 5.55 -8.11 Click Here
United States Gasoline UGA 30.34 -12.21 Click Here
United States Heating Oil UHN 23.36 -10.46 Click Here
U.S. 12 Month Oil Fund USL 34.89 -8.59 Click Here
US Oil Fund ETF USO 33.97 -8.61 Click Here
iPath S&P 500 VIX Short-Term Futures ETN VXX 50.86 -12.7 Click Here

The value angle and screen may be addressed in a future article, however it is a much more difficult element to screen. I will be continuing to write on both (value and momentum) strategies frequently on Scott’s Investments.

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Option Strategy Using Moving Averages

I’ve plugged the free site CXOAG before and will continue to do so as they publish new information which I find relevant. I recently emailed them the following question pertaining to a strategy of theirs involving selling slightly out of the money puts near the end of the month on small cap indices (which I detailed here and also added a link on the right hand side of the blog so readers can track it). Below is their response. To summarize, watch the 10 day SMA more closely if considering this type of strategy:

September 22, 2009 – Sell Index Put Options Only When Above Long-term SMA?

A reader asked: “Have you considered a test of selling puts on the Russell 2000 Index only when it is above a long term moving average, such as the 10-month, 200-day, etc?”


The Strategy Test (as revised) involves iteratively selling put options on the Russell 2000 Index on a monthly schedule determined by the turn-of-the-month (TOTM) effect, wherein the tendency of the broad stock market to exhibit strength around the turn of the month mitigates the risk of selling the options.

“Turn-of-the-Month Effect in Rising and Falling Markets” looks at the TOTM effect for the S&P 500 Index relative to a 200-day simple moving average (SMA). Results suggest that the TOTM return is roughly zero in falling markets, so it can still support options selling (but with no safety margin for at-the-money options). Based on this result, selling options only when above the 200-day SMA would likely reduce risk but result in long intervals of inactivity. Some of these intervals would be front-ends of uptrends and “doldrums” during which selling options is profitable. Extending the analysis to look also at the returns from the end of TOTM to options expiration would more fully relate it to the Strategy Test. Calculating a net result is feasible, but options on the S&P 500 Index have not existed for most of the historical period considered.

In general, the histories both of the Russell 2000 Index (22 years) and of extensive options trading are fairly short for analyses using a 200-day SMA (and historical data for options pricing is not freely available).

Because the Strategy Test trades are only a few weeks duration, “Turn-of-the-Month, Options Expiration and Trend” focuses on a 10-day SMA. This analysis suggests that the interval between options expiration and the beginning of TOTM may have the greatest downside risk when the market has recently been weak. Being above this short-term SMA is favorable (less risky) but not decisive for selling put options at the beginning of TOTM.