January 16, 2009

Predictions for 2009

Dear Friends & Fellow Investors

Weekly Snapshot
• European Central Bank (ECB) cuts rates by 0.5%
• Russian Ruble hits low of 32.65 against US$
• Citi reports a Q4 loss of over $8bn, Deutsche Bank’s Q4 loss of $6bn
• Yet another bail out: $20bn goes to Bank of America, how much more to Citi?
• Ireland nationalizes Anglo Irish Bank, the third largest lender in Ireland
• Steve Jobs (CEO of Apple) takes a 6-month medical leave of absence
• We’ve all missed it: Volatility was back this week. The VIX Index went to 55.16 on Thursday.
• Kuwait Stock Exchange hit a 52 week low on Thursday
• S&P downgrades Greek government debt
• Nice graph for chart enthusiasts: “Four Bad Bears" http://dshort.com/charts/bears/four-bears-extended-large.gif

Predictions for 2009
We don’t have to consult with oracles nor do we need to ask the brightest economists to figure out that 2009 will be a difficult year. You may have already read numerous predictions as to how the S&P, Oil, US$ and other markets will fair in 2009. I'm taking a stab at the near future as well and below are a few of my own predictions for 2009. Please note that these predictions are not based on detailed economic or financial markets analyses, just pure instinct, a bit of common sense and observations from developments in various international markets.

• U.S. Housing will hit bottom during summer/fall 2009.
• U.S. 30 year mortgage rates as low as 4.5% - 4.75% sometime in 2009.
• Continued volatility in energy markets. Oil will eventually trend higher above $50 per barrel at year end.
• Continued volatility in equity markets. S&P will close above 1,000 at year end.
• U.S. budget deficit is a major concern – I predict a deficit of $2 trillion in 2009.
• Onset of a decline in the value of the US Dollar against other major currencies

CBO Economic Outlook 2009-2019
Having real inside information and access to some of the brightest people in the country, the U.S. Congressional Budget Office (CBO) published their outlook for the next 10 years.


I’ll let you decide how realistic these forecasts are but keep in mind that after a tumultuous 2008, any sensible long-term projection of economic trends has become increasingly difficult.

Caveat Emptor
In the past, we have been making the case for using Exchange Traded Funds (ETFs) in favor of investing in Mutual Funds. And indeed, ETFs have become increasingly popular in recent years. The first ones to arrive were simply constructed as efficient instruments to mirror the performance of an index such as the S&P 500 or the Dow. In terms of expense ratios, these traditional Stock Index ETFs beat the typical Mutual Funds by a huge margin. The Vanguard Group of Index Funds along with the first ever ETF "SPY" (aka Spyder) are the most cost effective in terms of simply matching the returns of the general market. These traditional ETFs make a lot of sense, especially for the small investor because it is possible to generate a relatively broad and balanced portfolio from the start without the need for a huge initial investment.

But buyer beware…not all ETFs are exactly low cost. There are currently over 800 listed ETFs that track anything from very broad market indices to highly selective industries and market segments. With higher complexity and more specialization also comes a much higher cost and many of the recently established ETFs are nowhere near low cost. In fact, of the 844 ETFs (available by review at Yahoo Finance) 76 have an expense ratio of 0.95% or higher – clearly no longer ETFs in the traditional sense but more like the typical fees of mutual funds. Top of the list is the Claymore/Ocean Tomo Growth (OTR) which an expense ratio of 2.03%. And as you might have guessed, this ETF didn’t exactly live up to its expectation warranting the highest expense ratio. OTR had an abysmal return of -45.20% in 2008. Bad by any standard, but infuriatingly more so when the Dow was “only” down -33.84% for the year. That’s underperforming the Dow by over 10% in a down market; so why pay the extra fees? As with traditional Mutual Funds, the same argument applies increasingly for some of these recent and more obscure ETFs: “Why pay managers these fees to try and beat the market when most of them don’t”.

Another aspect of considering ETFs is their tax treatment. Yahoo Finance has an easy to understand overview of the tax advantages of some ETFs: http://finance.yahoo.com/etf/education/06

As noted in this article: “ETFs are considered to be created by trading equivalent certificates (the ETF for the many stocks that make up the basket) in what is called an in-kind trade. This exchange of essentially identical items does not trigger capital gains, according to the IRS. Traditional mutual funds must go into the open market and exchange cash for stocks and vice versa, which trigger realization of gains. It's a subtle difference, admittedly, but which results in an advantage for the ETF investor. “

But again, beware here too. Not all ETFs fall into this advantageous position from a tax perspective. Particularly the more complex ETFs e.g. bear market, commodity and highly specialized ETFs which often use derivatives such as futures and options to implement their trading strategies do not fit the bill. One of these ETFs would be the U.S. OIL FUND ETF (USO) which is trying to reflect the performance of the oil price by using options, futures and other derivatives. These futures and other derivative contracts do not fall into the category of “in-kind trade”. US Investors in this ETF are subject to reporting under IRS Form K-1 (Note: I am not a CPA, you should consult your personal tax advisor or CPA to get advice on your personal tax situation).

In summary, it pays to know what you’re buying. Not all ETFs are what they promise to be from the outset. You should always read the disclosures and prospectus especially when you plan on making sizeable investments in any fund or ETF. One of the fastest ways to get an overall idea of a fund or ETF is to look at their holdings. Most ETF’s publish their holdings on their website but if in doubt, call them up directly. Lastly, we have a nice summary spreadsheet of the most cost-effective and least cost-effective ETFs. For a free copy please email: info@fxistrategies.com

Central Bank Rates
NZD 5.00%
AUD 4.25%
EUR 2.00%
GBP 1.50%
CAD 1.50%
CHF 0.50%
USD 0.25%
JPY 0.10%

Good luck & good trading - Clemens Kownatzki

Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this email be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance.

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