February 2008 Investing Strategy Update

In an article dated December 30^th, I offered two perspectives for investing in 2008 and beyond. The first view included suggestions for long term positions in commodities (DBA, up 12.1%, CUT, down 7.5%, and RJA, up 4.46%), emerging markets (RSX, down 10.8%, EWW, up 0.26%, and TAO, down 10.6%), and currencies (FXM, up 0.25% and FXA, up 2.66%).

Obviously, my call for investing in Russia (RSX) was premature, and although I believe international real estate in the form of the Chinese offering from Claymore, TAO, continues to be a valuable diversifying play, I'm disinclined to open a position now with China in a short term bear market. Instead, a better international play would have been another diversifier I mentioned, RWX, which is down only 1.6%. (Please note, other options based on international earnings growth as a principle driving element, including McDonald's (MCD) and Unilever (UN) were hard hit as the decoupling argument – considered below – unraveled, though we sold the latter into strength for an overall gain on the position; Berkshire Hathaway (BRK.B), a long term hold, was down substantially less than the Vanguard total market etf (VTI): 1.1% vs. 5.5%.)

The second view, and one for which I took some flack for being "overly complicated" in the words of some readers, turned out to be rather successful, save one component. Let's review some of my thoughts and consider why things developed as they did…

With respect to other ideas we were considering, I said we'd be…
Exchanging our Chinese equities holdings for iShares' Chinese etf, FXI, with a 60% short position in ProShares' double-leveraged short Chinese etf, FXP.

Considering the Chinese markets substantially overbought and due for a correction, this strategy was timely: We ultimately sold China Life (LFC) for a 53% long term gain on January 10^th (afterward, it promptly fell 24.3% compared to flat performance for VTI through February 1^st), though with proceeds from the sale, and our previous 74% long term gains from Sinopec (SNP), we did not purchase FXI. Instead, since December 28^th we saw the China ProShares short double inverse gain 19.50%.

In times past, the story goes, when the American economy suffered, the world was similarly so affected. Then, to the chagrin of etymologists everywhere, a "new" global economy once again took hold and decoupling – the divergent performance between emerging and emerged global economies – was born, promising continued gains in those prosperous markets of '06 and '07 while North America and Europe floundered in some backwater morass. Unfortunately (for longs), just as some investors were too quick to signal the triumph of silicon over bricks and mortar in 1999, so too were they again in 2007: there was a partial decoupling, in terms of R^2, but those in the know forgot to pound into the heads of stalwart, deaf decoupling adherents that outperformance of some (international/emerging/frontier) holdings could still mean negative performance. Truly diversified portfolios holding, say, VTI and Vanguard's emerging market etf (VWO), saw monthly results boasting lesser losses for VTI (down 5.5%) than VWO (down 7.5%). Hey: did I ever tell you that R^2 would only increase the value of your portfolio?

Hedging some of our emerging markets exposure (VWO + equities) with a 20% position in ProShares' UltraShort MSCI Emerging Markets etf, EEV.

This story is very much similar to the previously mentioned Chinese/decoupling example. With the VWO down 7.5%, ProShares short double inverse offering (EEV) was up 14.26%. Of course, the prudent move here was realizing that better R^2 performance in the short term was offered not by VWO, but by its (double) inverse short equivalent, EEV: ProShares offered the true decoupler.

Taking a long position in Japan with iShares' EWJ, but hedging it with a 40% short using ProShares' EWV.

Japan, the perennial "almost, almost" player in the game of "when will we emerge from years of underperformance?", largely stagnated, although both the long and short positions in our January strategy outperformed EWJ's 2007 gloomy showing (down 6.5%), with a long position in EWJ losing 2.2%, and a double inverse short in EWV gaining 4.25%.

Shorting the Russell 2000 index – using either ProShares' RWM or SJH (or openly shorting ProShares' Ultra Russell 2000 Value Index – UVT) – and going long the Nasdaq (as a tech hedge) – using ProShares' QLD, as opposed to Powershares' QQQ.

While our RWM and SJH picks fared well (up 5.8% and 5.5%, respectively), my call on the continued outperformance of technology was sub par. Not only was QLD – a ProShares Ultra (2x) non-short etf – down 23.53%, but many adherents of the "technology decoupling" camp were awakened by a torrent of cold water when companies including Motorola, Yahoo! (the takeover bid by Microsoft notwithstanding), Apple, and Google (GOOG) failed to sing the lyrics of "everything's going to be alright". As long term holders of GOOG from a price point far below Friday's close, we nevertheless bled during GOOG's ~$49 fall to ~$515.90. My view looking forward is that tech will not substantially underperform the markets, but I believe that continued cries for its outperformance will be unsubstantiated. (Note: We ultimately did not short UVT.)

Performance Summary:

DBA - 12.1%

CUT - (7.5%)

RJA - (4.5%)

RSX - (10.8%)

EWW - 0.3%

TAO - (10.6%)

FXM - 0.3%

FXA - 2.7%

RWX - (1.6%)

FXP - 19.5%

EEV - 14.3%

EWJ - (2.2%)

EWV - 4.3%

RWM - 5.8%

SJH - 5.5%

QLD - (23.5%)

Sources:

http://www.proshares.com/funds

http://www.claymoresecurities.com/etf/etfhome.aspx

http://www.elementsetn.com/ProductsPage.aspx

http://www.ishares.com/home.htm

http://www.powershares.com/products/default.aspx

http://www.currencyshares.com/

Yahoo! Finance

Google Finance

Disclosure: author is long CUT MCD BRK.B VTI VWO GOOG