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What Asset Allocation Today?

Thursday, Jul 09 2009 by
3


This thread discusses the most appropriate asset allocation for today’s market. Over time it is hoped that ongoing debate will guide “Stockopedes” to continuously re-position their portfolios into the most advantageous current sectors.

If we can select the up-and-coming sectors and, as importantly, avoid the losers our portfolios have a good chance of outperforming. No one disputes the importance of “stock picking” but it’s difficult compared to choosing appropriate sectors; it can be avoided entirely by the selection of appropriate ETFs.

To kick of the discussion here some thoughts.

I consider there is a high risk of the market revisiting its lows and indeed going lower in the next 18 months. The normal place to hide in this circumstance would be bonds but with massive projected, worldwide debt issuance (the US alone is forecast to borrow $1,840bn this year and $10,000bn in the next decade Congressional Budget Office), there is a clear risk of rising interest rates.

In developed economies both unemployment and the savings ratio are rising, which spells gloom for consumer spending, property and the major exporting nations. If China suffers then miners and metals will suffer alongside.

Global oil demand has shrunk, only a little, so existing well depletion and reduced capital expenditure mean that oil and oil stocks will do well in the next three years. (US natural gas is very cheap relative to oil and coal and should be on every ones watch).

Agriculture and food could do well given the low world stocks of most feed grains.

Currencies are a parade of ugly sisters; Obama’s spending may well do for the US $, as Gordon Brown’s has already done for the £ and Eastern European debt may do for the Euro, which leaves Gold as an obvious safe haven.

I look forward to hearing counter views and what about other sectors: Banks, Healthcare, Defense, Utilities, etc?


Filed Under: Strategies,

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7 Posts on this Thread show/hide all

lfc 9th Jul '09 1 of 7
2

Hi Hugoc

I would offer one thought which for me is something of a rule of thumb;

The greater the uncertainty an individual investor has about the future then the greater should his/her diversification be. At the moment I am hugely uncertain about the future and have obeyed my own rule by splitting my investments;

60% equities - approx. 50/50 between a diversified high yield basket and oilies.

30% cash - actual cash rather than bonds/gilts as I cannot bring myself to buy the latter at what to me looks like the top of the market (accepting I could be wrong and that this compromises true diversification)

10% gold

I own my house outright but do not consider it an investment as I'll always need a roof over my head!

How about your own investment split - I'm guessing E&P's and perhaps some gold?

rgds

lfc

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Gradders73 9th Jul '09 2 of 7
2

I've placed a healthy portion of my funds in a Norwegian ETF that tracks the OBX, OBXEDNBN NO is the ticker.  I like the Nrowegian economy and I also like the currency a great deal.  They have huge reserves, both mineral and currency, a massive state pension fund, unemployment at under 3% and the manufacturing sector is going strong.  They don't have the exposure to the Baltic states that Sweden does. Currency is very low in my view relative to USD and Euro, it's still about 30% weaker than the highest vs USD of 12 months ago (before they started to unwind the quanto trades) and about 12% lower than the 10 yr average vs Euro, but frustratingly, funds trade it as a proxy to oil, so it's pretty volatile right now.  Also, when there is the "risk aversion" trade, people sell NOK vs USD.  So bizarrely, bad US data causes USD to rally vs Euro - go figure!

Have a few individual positions in Norwary, one being Yara, an agri chemical business.  Norwegian stocks will soon have dual listing in Singapore, which will help liquidity.

Further point, as the Norwegian oil runs out, the natural gas will become more significant, but as and when the troubles between Europe and Russia (or more likely Russia and Ukraine) start again, this is v positive for Norway.

My general view is to expect a global rebound much more strongly than the US or UK and will be positioning accordingly.

 

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lfc 9th Jul '09 3 of 7

Hi Gradders

I agree Norway looks a good investment, ticks so many boxes it almost looks too good to be true! My main question would be how to assess whether or not the etf represents value - plenty of investments in the past have come unstuck not because of underlying performance but because they were overpriced when purchased. And Norways wealth is not exactly a secret.

What metrics do you look at when assessing the value inherent in the etf? Do you know how much Norway is valued (total currency) compared to its gdp? Also are there any weaknesses/vulnerabilities for the economy. The only one I can see is the relatively small size but this need not be a problem so long as they don't do an Iceland! At first glance they appear not to have become over-reliant on oil/gas exports which is a danger for such countries and one that bedevils some gulf states.

thx

lfc

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Gradders73 9th Jul '09 4 of 7

The ETF is basically a index tracker in ETF form, there is no premium.  It's quite clever as there are several tracker funds out there, but this undercuts on fees etc, but you are taking DnB risk on the principal (AA rated 120 bps 5 yr CDS spread, so for a bank, pretty good.)

OBX is 50% oil and gas, in fact 28% Statoil, which is majority state owned.  They are moving into other regions as local reserves become depleted and there is a risk it all goes wrong.

Norway itself is rated no 1 safest sovereign credit by spread

Here's a bunch of Norway stats, makes pretty amazing reading.  What is interesting is that the balance of trade surplus is basically the oil and gas exports, so this is far from the only source of income.

http://www.ssb.no/ur_okonomi_en/

The Government Pension Fund of Norway is predicted to have $400 billion in assets by the end of 2009.

The central bank has stated it will take steps to ensure the currency doesn't become overvalued and like I said there are plenty of traders who consider it to be a risky currency, so it tends to fall against Dollar and Yen when there is bad economic data.

Goldman said they expect a 10% rally versus the USD this year.

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lfc 10th Jul '09 5 of 7

Thx for the link Gradders.

I've had a rummage around and it's interesting that the Norwegian stock market trades on a P/E of 9.6 (May FT data) which is almost exactly the same as the Brazilian SM. Both are a point or so higher than the UK market. And both countries have a decent trade surplus. In a previous thread on here I considered investment in Norway, Russia and Brazil as energy plays and came down on the side of Brazil - hence my (relatively small) holding in the etf IBZL. Whilst I agree norway is tempting I'm going to stick with brazil because;

1. O&G production is on a rising curve compared to a falling one for Norway.

2. Brazil is perhaps the only country in the World to have large scale and significantly +ve EROEI sustainable liquid fuel (biofuel) production. The US will be an increasingly thirsty market for this in the years to come.

3. Huge young labour force compared to Norways ageing demographics (issue for many developed economies). But taking your point about the pension fund surplus which ameliorates this to some extent.

4. Brazil have a far better football team than Norway.

Obviously there are risks with Brazil (still developing, beurocracy etc) but on balance I prefer the risk/reward balance and will stick with IBZL for now. But will watch if valuations change significantly.

rgds

lfc

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Gradders73 10th Jul '09 6 of 7

You seem to be with the market on seeing Norway as a pure energy play, but I would reiterate that Norway is the safest sovereign credit by price and the other two are sub-investment grade.  For me, I would argue that the additional risk you take on Brazil is not compensated for by the returns - yes, the potential growth is higher, but this seems priced into the P/E ratios in my view.  Political and corruption risk is so much higher in Brazil, esp the chances of a Chavez like person being elected and choosing to share the wealth.  Maybe I am scarred because I have seen so many blow-outs in LatAm.  Yes, O&G is declining in Norway, but it is has approx 30 yrs of gas left and is about the same as Brazil, slightly less oil than Brazil, but it's got a population of 5 million compared to 200mm in Brazil.

Anyway, I view Norway as a defensive investment with an upside linked to commodity prices, which I think has proven true for many years.  Brazil has been a super hot EM investment for a decade, and rode out the recent global chaos pretty well, but it is still EM and plenty of risk.

I am interested in your point about biofuels as I think this a menace to the world, a waste of resources, harmful to the environment and likely to lead to famine for poorer countries as food prices rise.

Not going to argue about the football team though...

 

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lfc 10th Jul '09 7 of 7

Just on the biofuels subject, I completely agree with you wrt temperate zone production - even setting the ethical/environmental issues to one side the EROEI is barely above 1. Factor in all the other post-production costs and EROI is probably negative which is hardly the basis for a sustainable replacement for oil.

But Brazilian biofuel is different and has an EROEI estimated at 8:1 (although these estimates vary) making it far more efficient than temperate zone stuff. There have been arguments that even the Brazilian biofuel production compromises food production and has environmental implications, esp for the rain forest, but these arguments seem more balanced than elsewhere;

http://news.bbc.co.uk/1/hi/sci/tech/7420770.stm

Also the Brazilians have been doing biofuels for a long time and have established production as a viable ongoing process. Expansion of course raises issues.

I don't see either brazil or Norway as pure energy plays but it is worth noting that if you strip out O&G revenue then Norway would have a significant trade deficit. This is something they will need to address well within the next 30 years - the gas may last that long but it will be well down the depletion curve by then. The likelyhood is that gas production for the whole world will be in decline by then - last time I performed the calculation I came up with peak gas around 2020.

lfc

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