My ETF Portfolio, Chapter 6: Switching Into Energy and Taiwan, Out of Turkey and Hong Kong

Includes: EWH, EWT, EWW, IXC, TUR
by: John Crossman

Before we talk about the energy sector, we need to recap the surprisingly active holiday season. In past years, the holiday season has not seen many changes in the “system”, so this year I felt comfortable enjoying the break.

Switch #3

Right before Christmas, the “system” recommended that we let go of Turkey (NYSEARCA:TUR) and put the money into technology heavy Taiwan (NYSEARCA:EWT). So, on December 27th, we took our lumps on TUR (down 11.9%) and picked up 550 shares of EWT at 15.18 leaving us with net cash in the account of $620.75. So this week, we will concentrate on the changes in the portfolio.

A Different Kind of Stop Loss

As you can see from this less than stellar trade, one of the system’s key benefits is getting you out of losing trades before one gets burned too badly. It is not a hard 10% or 15% but in our experience, that is about the scope of the drawdown before something else interesting takes a positions place in the ranking (note that drawdowns were just over 20% in 2008 but let's hope those times do not return).

In this case, there was no fundamental deterioration in the investment case for Turkey. The worst that could be said is that the country is geographically a bit too close to Greece. The renewed Euro troubles remind us that Turkey has been trying for years to complete its application to the EU clubhouse. But, when the market starts to turn, particularly in Emerging Markets where a few big trades can change the mood, the System will usually find a newcomer to switch into. In this case, it is Taiwan, a market that tells me to start thinking about IT again.

Turkey Out, Taiwan In

What does EWT have to offer? Quite a lot actually if you think that cashed up corporations may start spending money to maintain productivity gains in 2011. Information technology makes up 58% of the ETF (iShare info page here) and that is the primary driver of the market. Although local brokers will occasionally make noise about the number of mainland Chinese tourists that are allowed in Taiwan, for now and the medium term future, the big question is how many Android phones and iPads will move in the marketplace.

However you feel about the PC/laptop vs. mobile devices argument, chances are that Taiwanese companies will be supplying most of the components, and assembling it in factories in China. But Taiwan is not all consumer electronics. TSMC (which makes up 13% of the index) is the world’s largest and probably most advanced fabrication facility for custom made logic chips.

The only “fly in the ointment” could be the CBC’s shot across the bow at Soros, whom it accuses of speculating in the local currency. One is allowed to bring money in and out to invest in local securities but parking money just to play currency appreciation is considered poor form for foreign investors. The local currency has been pushing the 30:1 level, which the Central Bank has previously identified as an important defense line. However, an appreciation of the NT$ is less important than inflation or potential revaluation in Mainland China where many of “Taiwan Inc.’s” key factories (and production costs) are located.

Another tangential issue with Taiwan is the insider trading/expert network investigation that has been rumbling along in the US. Although it does not appear to involve Taiwan directly, there have been a number of participants with ties to Taiwan and tech sector contacts that have been tied up in the investigation.

If you don’t like Taiwan or are worried about investing overseas, there is a very close correlation between the EWT and Nasdaq Composite (ONEQ) which you can see in this 5 year chart from Yahoo. While there is no guarantee that it will track as closely in the future, I would be very surprised if we did not continue to see strong correlation given the tight integration of Taiwanese firms in the global IT supply chain.

Switch #4: Hong Kong Out, Energy In

This week, as you can see from the table, the System is telling us to swap our Hong Kong ETF (NYSEARCA:EWH) for the Global Energy ETF (NYSEARCA:IXC).

With the developed economies growing at better rates (albeit still slow because of deleveraging) and several key emerging markets likely to start overheating, it is not surprising that oil prices are heading back into the 90 dollar range. The US dollar still runs the risk of renewed weakness which will also help to put a floor on energy prices for the medium term. And finally, there is the M&A catalyst as bigger firms decide it is cheaper to buy reserves than explore for new ones. Thompson Reuters is out with a forecast of 30% growth in global M&A for this year which must be relying on a healthy dose of energy company dealflow.

So, while we still see money flowing into Hong Kong’s stratospheric property market, the system is telling us that energy is the better bet right now. If all holds at current prices, we will be getting out of EWH slightly above our entry point 8 weeks ago and buying 250 shares of IXC.

For those who want to look at a more US focused ETF, XLE also starts with a healthy serving of ExxonMobile (NYSE:XOM) and Chevron (NYSE:CVX) but includes more of the exploration and production names that are said to top global M&A shopping lists.


The performance for the week was up 0.9% which leaves us a bit underwater for our 8 week endeavor at -3.88%.

In 20/20 hindsight, I should have started up this portfolio in a less volatile part of the year (August, say). That just proves that even with an emotionless system, emotions will creep into the investment process no matter what one says. But I am still confident that the “system” will keep us invested in the “sweet spot” of my universe.

On the subject of investment universe, as we approach week 12, it is time to indulge in a quarterly review of the universe to see if we need to make any adjustments. I will limit myself to two changes and I will share the thinking behind those changes in the next installment. Note that any change will alter the backtested data that you see in the charts. However, the important issue is the actual portfolio performance, not how pretty we can make a backtest look.

Disclosure: I am long EWT and EWW and am switching out of EWH and into IXC.