Eric Roseman's Eruptions: Stocks, Global Markets and Commodities BLOG

Top Non-U.S. Dollar Money-Managers

It's that time of year again...

Each year at this time, I start to prepare my multiple presentations for the grandest offshore investment conference of the year -- The Sovereign Society's Total Wealth Symposium in Panama City, Panama, from May 2 to May 5.

Without a doubt, Panama is where global investors, international estate planners and privacy advocates converge for a fabulous four-day intensive on everything offshore from A to Z. It's by far one of my favorite events of the year. And this year, we've got a great lineup of global speakers.

As part of my presentation schedule in May, I'll be plugging some of the world's top-performing offshore non-U.S. dollar mutual funds denominated in euro, Swiss francs, Canadian dollars, British sterling and Norwegian krone. Although most of the world's best-performing money-managers are indeed based in dollars, even offshore, there's a growing list of non-dollar advisor's with spectacular track records since the advent of the euro in January 1999. I'll review and recommend several stellar mutual funds that have smashed their benchmarks with ease over the last five and ten years -- and all of them require a minimum investment of just $1,000 or less.

Over the last two years, I've noticed a surge in interest from global investors looking to diversify away from the U.S. dollar. And it's not just Americans, either; many Canadians, Australians and even Brits are looking to park some of their money outside of their base currency for diversification purposes.

The latest data from the International Monetary Fund (IMF) this morning will only fortify this argument, especially for U.S. dollar-based investors.

The U.S. dollar has declined to its lowest share of global foreign-exchange reserves in at least eight years as central banks accelerate their purchases of euro. When the euro began trading in 1999, it accounted for 18.1% of central bank holdings; today that percentage has surged to 25.8%. Meanwhile, the dollar as a percentage of central bank reserves stands at 64.7% versus almost 100% in 1970.

More than ever, going global and investing in multiple currencies for long-term capital growth is vital. In Global Mutual Fund Investor, now in its 15th year, I'll be surveying the best long-term non-U.S. dollar mutual funds in April.

And, of course, I'll tell you which non-dollar offshore mutual funds offer the best upside next month in Panama. Hope to see you there!

Have a great weekend.

U.S. Considers Raising Taxes on Income Trusts

Just when you thought the news on Canadian income trusts couldn't get any worse, the next wave of proposed taxation deals another potential blow to a distressed sector.

This time, it's the United States that's considering raising the tax bar on income trusts.

On October 31, 2006, the Canadian government, a conservative minority in Ottawa, shocked the income trust world by announcing the termination of favored tax status for these high-yielding securities starting in 2011. In the United States, income trusts, especially energy trusts, have been great investments over the last five years on the heels of a rising distribution payout, soaring trust prices as oil went through the roof and a rallying Canadian dollar. Indeed, a good chunk of total Canadian energy trust volume from 2002 to 2006 belonged in the hands of foreign investors, lunging at those fat monthly dividends and long-term capital gains.

Distributions from income trusts are now taxed at a rate of 15% in the United States. But Democrat Congressman, Richard Neal, of Massachusetts, recently filed a bill in the House of Representatives, which was then referred to the Ways and Means Committee, that would revoke the existing special tax treatment on dividends from certain foreign entities such as income trusts and real estate investment trusts or REITs.

Though we're just at the start of this long process, which might or might not result in a new tax ruling, it does bear bad news for Canadian income trusts and REITs. If the proposed changes become law, it would raise income trust taxes from 15% currently to 35%, a significant increase.

Both the Canadian and American governments seem bent on destroying a viable asset class that has provided critical income to retirees in a low interest rate world since 2003. Many of those individuals lost a great slice of their retirement pie last fall when Ottawa announced tax changes. Also, Canada's long-term oil and gas exploration projects are now at risk since tax rates for operations and profits will rise in 2011, further denting the country's most prosperous income generator.

For now, I'd avoid making new Canadian income trust and REIT investments. Governments on both sides of the border are not done rewriting the tax rules.

Don't Be Tempted into Short-Term Equity Trading

One of the very best innovations on the financial markets in recent years are exchange-traded-funds, or ETFs. These securities allow you to access sectors, industries, countries, currencies and regions -- usually with management costs just a fraction of most actively-traded funds. ETFs are the fastest-growing segment of the mutual fund industry since 2003. Currently, over 430 ETFs trade on U.S. exchanges with a combined $430 billion under management.

The idea behind an ETF is that it tracks an index, so there is little or no management decision involved in the strategy and therefore, very low overall fees. And let's not forget than historically, the majority of active money-managers have failed to beat their benchmarks while charging high management fees.

However, remember, even good tools can be used in bad ways. And that is precisely what we've seen lately.

A recent study by The Wall Street Journal paints a sobering picture for investors who aggressively churn or day-trade ETFs.

The global mini-panics on February 27 and again on March 13 resulted in many ETFs trading at lower values than the markets they're supposed to represent. For example, the iShares China FTSE/Xinhua 25 Index or FXI, plunged 9.9% on February 27 even though the benchmark it tracks declined just 2.1% that day. The following day, that same index fell another 3.1% while FXI gained 4.8%.

What this tells investors is that the underlying index the ETF is supposed to represent in China declined far less than the actual ETF in late February. The same disconnect or phenomenon occurred for many other ETFs representing foreign markets, including even U.S. indices.

According to fund-tracker, Morningstar, 89 of the 421 ETFs fell short of their portfolio value by more than 1% on February 27 while 60 of those fell short by more than 2%.

The reasons why an ETF might disconnect from its underlying index is because of incessant volatility in the market it's tracking coupled with excessive trading by short-term traders like hedge funds.

Now, don't get me wrong. ETFs are an excellent low-cost vehicle. In fact, today, they can give you virtually direct access to investments you couldn't previously make without opening special commodities accounts. This includes the grains (corn, soybeans, corn), or DBA, oil futures (USO), silver (SLV) and gold (GLD, IAU), to name only a few. Plus, you can invest in currencies like the Canadian dollar, Euro or Japanese yen and broad-based commodity benchmarks like the Goldman Sachs Commodity Index (GSG). So they're really quite versatile and usually extremely cost-effective. That's why I recommend ETFs in my Commodity Trend Alert service and Global Mutual Fund Investor and will continue to do so when they're the right opportunity for my members.

My colleagues at Sovereign Society also do an excellent job using ETFs to capture big trends in markets ranging from currencies (Jack Crooks with Crooks on Currencies) to equities (Mike Burnick with Global Market Investor). But the best way to trade ETFs is to target undervalued themes trading at discounts and buy with an eye for the medium to long-term...certainly longer than day-to-day trading.

ETFs are excellent investment products and will continue to evolve as a great asset class. But for day-traders, some market anomalies exist and investors should recognize these short-term pitfalls if they intend to churn their ETFs regularly.

I

More Evidence of Yen Strength in 2007

Watch-out global investors!

For the first time in 16 years, Japanese real estate prices posted an increase in 2006. If the trend persists in 2007, it'll provide more fuel to my argument for a stronger Japanese yen versus all major currencies this year. It'll also imply a major unwinding of the infamous yen "carry-trade," which involves borrowing in low-yielding yen and reinvesting those proceeds in appreciating foreign assets. If you thought the last several market declines were ugly, spurred lower by fears of a rising yen since last May, wait until what lies ahead as the yen heads to 110 to the U.S. dollar.

Residential land prices rose an average 0.1% in 2006 while commercial property prices gained an average 2.3%, according to the Ministry of Land, Infrastructure and Transport in Japan. In 2006, residential and commercial property values declined 2.7%. Indeed, for the first time since the great Japanese asset "bubble" peaked in 1990, land prices are appreciating again. And foreign investors are taking notice with Morgan Stanley among the biggest international investors in Japanese real estate the last few years.

The danger for global investors in 2007 remains a recovering Japanese economy. It's a danger because the Japanese are going to raise interest several more times over the next 12-18 months, forcing leveraged traders out of the carry-trade market -- and probably violently.

For the first time in Japan's post-2003 recovery, real estate values are increasing. Though consumer spending, which accounts for 75% of gross domestic product remains fragile, an increase in housing values should catapult consumer spending as household wealth increases. It's a natural progression of circumstances that occurred in the United States and Canada over the last five years as well. Rising home values encourage domestic consumption, forcing central banks to raise rates to quash rising prices or inflation.

The good news is that Japanese inflation isn't about to surge any time soon. The country is still transitioning from a protracted deflationary environment into an era of rising inflation and gradual economic expansion. But this transition will come slowly. The risk, which is real and indeed felt across global markets over the last 30 days as the yen rose in value, reminds investors how delicate this transition must be in order to avoid a systemic panic.

Private Equity: Hype or the Real Deal?

The biggest buzz in investment circles lately is the private equity blitz. These companies, which typically buy established enterprises and then sell-off the profitable constituents for a big profit, are now raising funds to go public.

The most successful of these companies over the years, Blackstone LP, has earned an absolute fortune for its employees over the last 20 years -- much more than the average Goldman Sachs employee. Neither Blackstone or its founders need the additional $4 billion dollars they're raising on Wall Street shortly. So what gives? Why would such a highly-prized private equity outfit seek additional funds from the public?

Blackstone is pretty smart. They realize that this is the ideal time to seek outside financing for additional funds. It's almost free money. The stock market, until recently, has been extremely receptive to new offerings and an IPO now will reap its founders a bundle. Last month, Fortress Investment Group LLC, a large hedge fund, raised close to $1 billion dollars in an offering. Again, these guys didn't need the money. But heading to market when it was hot proved to be great timing.

Is private equity, now clearly going mainstream, for you?

My answer is "maybe."

The time to buy an initial public offering is pre-IPO, if you can get in on the ground floor with the underwriters of the deal. But since most of us can't buy pre-IPO, I suggest waiting several months or for another stock market correction before buying Fortress or Blackstone. Both are extremely profitable companies and I see no reason why they won't continue to remain prized cash-flow generators. So yes, I'm going to buy these companies when prices head much lower, if only temporarily.

But make no mistake about it. Just because a label has a "private equity" bill attached to its name doesn't mean it's a 100% quick-fix, either.

Carl Icahn, the big venture capital corporate raider, recently invested millions in Motorola's common stock; yesterday, the cell-phone manufacturer announced poor earnings and slashed its 2007 earnings guidance, driving the stock down 6% to a 52-week low. Not my idea of a Corporate Raider.

I'll let you know when to scoop-up shares of Blackstone. I have no doubt we'll eventually see a lower share price after this offering hoopla. Stay tuned.

Have a nice weekend. See you Monday.

Fed Closer to Cutting Rates

It's amazing how the Federal Reserve says one thing and actually does another.

The Federal Reserve, created in 1913, is supposed to be an inflation-hawk, protecting the value of the dollar. Well, forget its original mandate, which deserves a big 'F.' Under former Fed Chairman Greenspan alone, the dollar shed more than 45% of its value from 1987 until 2005. The Fed talks a tough game on inflation, when in reality, it usually prints an exorbitant amount of credit, which fuels inflation. The only period when the Fed did not print dollars was to arrest bulging inflation in the 1980-1982 period under Volcker. Otherwise, you can always count on the Fed to print, print and print even more.

With the mortgage-backed market now obviously coming undone and nobody really knowing just how bad a mess this will turn out to be in the end, I'm guessing the Fed is inching closer to lowering short-term lending rates. This really is a crisis. The sub-prime market has been knocked-out of business while the Alt-A market is also under stress. The good news is that hedge funds are coming to the rescue to some distressed lenders and employment growth across the country remains benign. So far, the fallout seems rather well contained. But I've got to believe that with the sub-prime market now in distress and many other higher quality loans under stress, the housing market is not going to recover quickly. After all, about 15-20% of the mortgage market is now in a bear market, unable to participate in the housing refinancing business.

Over the next three months, we'll have a much clearer picture of the economy and housing.

I'm sure we're all relieved that stocks have recovered over the last several sessions, especially following yesterday's FOMC shift to what appears to be a "neutral" interest rate bias. Don't go on any buying spree just yet; we're going to see more selling before first quarter earnings hit the market over the next three weeks.

The Best Value Now in Southeast Asia

One of the best investment strategies I’ve embraced over the years is to purchase cheap assets following a market crises or stock-market crash. Though it’s not advisable to plunge into that distressed market immediately following a plunge in values, it certainly pays in spades to wait a few months and then establish a position. It’s a classic contrarian investment approach employed by value investors like myself since 1992 and it has yet to fail, assuming you’re a patient investor.

Thailand now ranks as one of the most undervalued markets in the world following a military coup last September and a botched attempt at currency and stock-market controls in December. In mid-December, the Thai SET in Bangkok crashed 15% in a single day, erasing its gains for the calendar year; from its low on January 9, 2007, the Thai bourse is just 9% above its worst level and still a considerable 15% off its 52-week high. In fact, Thailand was one of the worst-performing markets last year while just about every stock-exchange surged in a great year for global equities.

Thailand is infamous among global investment circles as the most fickle government, triggering the 1997 Asian financial crisis and subsequently introducing currency controls in December and then curbing those restrictions several days later. The government has a history of issuing policies only to modify or entirely scrap regulations thereafter as it deems appropriate. That’s what happened last December amid a massive stock-market decline.

What makes Thailand incredibly mouth-watering as an investment now is the recent appointment of Chalongphob Sussangkarn as finance minister in February. The new finance minister, who worked at The World Bank, is highly regarded by investment analysts as pro-market friendly. On March 9, Sussangkarn issued a statement claiming that “there will be no policies that will shock the market; government policies must be implemented to boost confidence, not destroy it.” The new finance minister is a liberal economist, criticizing the capital controls, warning they might potentially destroy the Thai bond market. He also recently indicated that he favored a gradual relaxation of restrictions, which have already been eased substantially.

I visited Bangkok in February. This country is one of Southeast Asia’s most dynamic economies, enjoying a strategic location near booming Vietnam and other trading centers close by, including Singapore, Malaysia and Indonesia. It is the largest economy in the region after China and South Korea, and also home to the strongest performing currency in 2007 versus the American dollar, up 7%. The Thai SET is the cheapest-priced market in the region, trading at just 10 times trailing earnings and yielding 4.5% in dividends. Most companies traded on the SET also pay big dividends – in a rising currency. By contrast, the MSCI Emerging Markets Index, which includes Thai stocks, trades at 16 times trailing earnings and yields 2.3%.
To revive the flagging economy, hit by recent botched currency and capital controls, the central bank cut its overnight repurchase rate by 0.25% to 4.5% last month, a much-needed jolt for economic growth.

The way I see it, recent developments in March have set the stage for a recovery in Thai stocks this year. Lower interest rates, deeply discounted stocks, a gradual scrapping of capital controls and the appointment of a pro-market finance minister strongly suggest that Thailand’s military government has begun to appease foreign investors.

In the May issue of The Sovereign Individual, I’ll be plugging the world’s top-performing Thai fund, trading at a 6% discount to net asset value and up a cumulative 200% over the last five years.

It always pays to buy low – and sell high. Thailand is next on my buy-list.

Convertible Arbitrage Poised to Shine in 2007

One of the best risk-adjusted strategies during the 2000 to 2002 bear market, convertible bond arbitrage suffered its own version of bear market in 2004 and 2005 after a boom in new issuance resulting in a saturated market. But now, the sector offers another round of opportunities for investors seeking a hedge against downside stock market volatility in 2007.

Convertible bond arbitrage typically involves owning the underlying bonds or convertible bond of a publicly-traded company while simultaneously shorting the same company's common stock, or sometimes, another company's shares. In text-book market theory, the common stock price declines sharply amid an extended market decline (similar to 2000 to 2002 or a bear market) while the underlying convertible increases in value. It's a "win-win" strategy for the investor or hedge fund trader. 

A study compiled by Nomura, the Japanese securities house, shows convertible abritrage strategies returned 9.8% per annum from 1994 to January 2007 versus 7.2% for stocks and 6.3% for bonds. And through February 2007, the Credit Suisse/First Boston Tremont Convertible Hedge Fund Index has gained 2.8% versus -2.2% for the S&P 500 Index as downside market volatility finally makes a long overdue appearance.

What's great about convertible bond arbitrage is the acute negative correlation to common stocks. It's an asset class offering true diversification at a time when market stress is making a comeback after four years of the lowest volatility on record. 

Offshore, accessing convertible bond hedge funds is much easier than in the United States where investors must be accredited. Overseas, several great convertible arbitrage hedge funds funds are still open, starting at just $25,000 for one of the best multi-manager products in this sector -- up 3% in 2007. I'll be plugging that fund in my upcoming issue of Global Mutual Fund Investor, now in its 15th year.

Stocks Trailing Bonds Over Last 12 Months

Despite puny inflation-adjusted yields and a bear market for Treasury bonds since 2004, government bonds are making a big comeback over the last 12 months -- outpacing many stock indices.

Benchmark 10-year U.S. Treasury bonds have risen a cumulative 5.27% over the last 12 months versus 6.10% for the S&P 500 Index. And riskier bond categories, including emerging market debt has gained 9.17%. Even junk bonds, typically vulnerable to a slowing economy, have rallied 10.51% over the last 12 months.

But the bond rally is not a 12-month phenomenon, either.

As the S&P 500 Index struggles with a 2.2% loss in 2007, ten-year Treasury bonds have gained 2%, emerging market bonds are up 1.8% and junk bonds (high-yield) have risen 2.6%, hardly consistent with fears of a credit-crunch this winter amid the sub-prime loan crisis.

So what's an investor to surmise from this comparative asset-class snapshot?

To start, the market is not worried about a credit-crunch. It that was the case, risky debt like high-yield and emerging market bonds would have declined sharply since February 27. Also, mortgage-backed debt is up 1.5% in 2007, another indicator "supposedly" vulnerable to a credit-crunch.

I don't like emerging market bonds in 2007 because credit spreads remain near their all-time lows, making them a high-risk investment. And I don't care for junk bonds, either. However, I've liked U.S. Treasury bonds since last summer because I still think we're vulnerable to systemic risk, namely in housing, a hedge fund blow-up tied to mortgages or a sovereign borrower defaulting.

High quality bonds might not offer riches this year, but they'll probably match or exceed returns generated from stocks.      

Yen, Prime Mortgages and Employment

If the Japanese yen still has legs, then the global correction we've seen since February 27 is not over. That's the BIG trade in the world right now. We might all be tired hearing about the infamous Japanese yen "carry trade," but it's the biggest threat to the financial system in 2007. It's a threat because the Japanese, in large part, have financed global liquidity over the last four years.

With the Japanese economy expanding at its fastest clip in more than four years, interest rates are heading higher in Tokyo. The Bank of Japan (BOJ) is reluctant to raise rates further, currently at 0.5%, mainly because the consumer is still not spending. However, companies are making good money, employment is low and without a doubt, the Nikkei is undervalued versus most markets in the world.

At some point, the BOJ will raise interest rates again this year and possibly twice, as she attempts to normalize monetary policy in the wake of a solid economic expansion. And Japanese stocks remain among the best values in the world, especially small and mid-sized companies, which unlike large stocks, won't feel the heat from a stronger yen this year.

At 116 to the dollar now, the yen will break through 110 during this rally. At that point, I'll bet global equities will trade about 7-10% lower compared to current levels, defined as a classic correction. Again, like I've been emphasizing in these pages for weeks, this is not the end of the bull market for stocks. Yes, I expect the returns to be less this year compared to the last four years; but I don't see evidence of a monetary squeeze in the United States or even in Japan where rates are rising from a very low level. Global inflation rates are low, bank credit is expanding in the high single digits and employment is fairly strong. A correction is actually a good thing because over the last four years market volatility has been largely absent, encouraging all sorts of financial leverage among participants. Corrections are perfectly normal in a bull market and usually don't become bear markets unless central banks are cutting-off liquidity as inflation rises. That's just not the case right now.

As for the mortgage market, thus far it's still pretty much contained to the sub-prime sector. But if defaults rise in the prime market along with rising unemployment over the next several months, then I'll change my tune to a bear. Rising unemployment in the United States combined with falling real estate values and growing defaults don't encourage consumers to spend.  In this scenario, it'll be "good-bye" bull market -- and fast.

Watch the yen, U.S. employment and the prime mortgage market. These three variables will determine whether the United States is at the cusp of a recession or a mid-cycle growth slowdown in 2007.

Have a good weekend.