Judge Rules Against Schwab in YieldPlus Fund Case

Last week a judge ruled that Charles Schwab (NYSE: SCHW) violated the law with its YieldPlus Mutual Fund (SWYSX) when it held upwards of 50% mortgage-backed securities without shareholder approval. (See "Angry Schwab bond-fund customers win in court" and "Judge Rules Charles Schwab Violated Law in YieldPlus Mutual-Fund Case.") This case, somewhat surprisingly, has not been publicized much.  With the fund seeking to increase its appeal to the masses, its managers loaded up on risky mortgage-related structured debt to increase its yield, and consequently its assets ballooned to $13 billion in 2007.  In other words, the strategy worked.  The collapse of the mortgage market in 2008, however, led the fund to lose a whopping 36% of its value, a far cry from the advertised description of the fund as a low-risk alternative to money market and cash accounts.  The fund is currently described as seeking "high current income with minimal changes in share price."  This lawsuit reminds me of the one filed against Schwab's total bond fund for the same reason, which I reported in my Lazy Portfolios post.

In 2001, Schwab apparently stated that the fund would hold a maximum of 25% of its assets in any one particular industry, but amended it in 2006 stating that its fund managers reserved the right to make investment decisions at its own discretion without shareholder approval.  The judge ruled that this went against the Investment Company Act of 1940 that states that once a mutual fund proposes a policy (as Schwab did in 2001), it can only modify the asset allocations after an okay from the majority of the shareholders.  While Schwab publicly disclosed its holdings at all times and was transparent in its investments (this certainly wasn't a hedge fund-like case wherein the fund was not clear with its investments), it neglected to seek approval from its investors when changing investment philosophy in an attempt to increase the funds yield and attract additional monies.

Lead attorney for the plaintiff, Steve Berman, explained:

Plaintiffs contend that Schwab wanted complete, unfettered control of the fund so the managers could drive up yields, to in turn attract more investors as YieldPlus grew into the largest ultra-short fund in the country.  Schwab's money managers did, indeed, jump in and gamble, but with other people's money.

This case does not signal to me that Schwab has a wider corporate issue and that you should no longer trust them with your money.  Personally, I think Schwab has some really great low-cost offerings and is a customer-friendly discount brokerage with ample resources and insightful research reports.  In this isolated incident, though, specific fund managers made a particularly egregious judgment in an effort to get more investors into the fund.  This could have easily happened at a variety of different mutual fund families and I still trust Schwab as much as I would any other highly-respected brokerage firm.

There are two important lessons to learn from this debacle, though.  First, monitor your investments regularly and look closely at the holdings of every fund you own to ensure that it meets your standards and risk tolerance.  In this case, simply reading the prospectus or using a fund analyzer tool online for the YieldPlus fund would indicate to any investor that it held greater than 50% of its holdings in privatized mortgage-backed securities.  That would be a red flag to any educated investor as this clearly is at odds with the funds intended risk/reward profile.  Schwab did not try to cover this up and the managers disclosed the funds holdings at regular intervals as required by the SEC.  On the other hand, their general description of the fund was misleading and thus, as an investor, you should learn to delve deeper by reading the prospectus and holdings in detail.  This applies to all sorts of funds, especially "closet-index funds" - that is, actively managed funds that charge you a hefty expense ratio, but when you breakdown the holdings, it is essentially tied to an index benchmark and could be held in a more cost effective manner.  The second lesson from this case is that you must resist the urge to chase yield.  Money managers knew that loading up on MBSs would help sell the fund as the yield surged, but this certainly backfired.  Legendary Vanguard founder Jack Bogle explained that this was a classic example of a firm "reaching for yield" to attract new investors, and a typical action many mutual fund companies cannot resist.  "The message over and over again," Bogle says, "is, 'Go the straight and narrow.'"

The amount of damages will be determined in a trial beginning May 10.

Update 4/20/10: Schwab has decided to settle for $200 million rather than go to trial.   Schwab's statement indicated that settling "allows the company to avoid the distraction and uncertainty of a trial, and the further possibility of a protracted appeals process."  They admit no liability under the settlement, which is still awaiting final court approval.

Book Review: The New Coffeehouse Investor

Bill Schultheis' The New Coffeehouse Investor (Portfolio, rev ed. 2009, 224 pp) builds upon his 11-year old original to devise a simple and common sense approach to long-term saving and investing.  This certainly is not a dense book of tactical investing strategies and terms, so if you're looking for that, this is not where to find it.  Rather, Schultheis essentially writes a "life book" that happens to be primarily focused on investing by saving well, approximating the stock market average, lowering costs, and diversifying with an appropriate asset allocation plan.  The author intersperses his own personal stories throughout, which I found made the book more enjoyable and an easy read.  Not only does he have wisdom in the investment realm, but Schultheis really attempts to give larger "living life advice" and parallels his life experiences with that of investing.  

First, Schultheis begins the book speaking about his interactions with other "coffehouse investors" - that is, friends whom he'd discuss investing ideas at a coffehouse in Seattle with.  Building on his 13-year Wall Street career mostly with Smith Barney, Schultheis argues that listening to stock brokers is a fool's gold and arguments for individual securities such as "I own world-class companies" doesn't hold water, especially if your age and risk tolerance suggests a certain allocation to bonds is more appropriate.  The author really talks about living life (and retirement) to the fullest, rather than constantly worrying about stock picks and your broker.  There are several side stories about his mountain climbing experiences as well as stories from his youth such as building an airplane with his brother.  They serve a couple purposes - first, to make the book interesting and relay these lessons to investing by using various analogies and metaphors, and also to stress what's really important in life - and that's living it.

Schultheis espouses three main principles that guide his philosophy: 1.) Don't put all your eggs in one basket; 2.) There is no such thing a free lunch; and 3.) Save for a rainy day.  In particular, he takes a fairly significant chunk of the book talking about the importance of saving early and the power of compounding; certainly not to the level of not being able to enjoy life, but making certain sacrifices in order to have the retirement you want.  He outlines in details the effects of high expense ratios in mutual funds can have on your bottom line as well as inflation risk, holding small company funds, and the significance of re-balancing.  While Wall Street likes you to believe that stock market risk is huge when compared to inflation risk in the long-term, when looking at 10-year returns on the market, you'll notice that rarely does it go down for a significant period.  Of course there are no guarantees, but for long-term investing, taking a chance on stocks is the way to go and really the ultimate risk is inflationary in nature.  Schultheis urges individuals to ignore the short-term Wall Street stuff and to focus on the big picture.  We know the stock market is volatile in the short-term, but if your investment horizon is significantly longer, this should not be terribly concerning to you.

The author goes on to explain while certain funds will outperform in the index at large for certain periods/categories, sustaining such an outperformance is unheard of and underperfoming by even a seemingly small amount over the course of a long period can lead to a huge reduction in assets.  So, while a fund may be the #1 performing large-cap for the last three-month period, this really is meaningless in the long-run and chasing such returns ends up biting you in the butt.  It's better to have a plan to match the market return with the lowest fees possible, Schultheis argues.  Even large state pension funds follow this strategy, with California indexing 85% and New York 75% (although the author doesn't mention that university endowments typically employ hedge-fund like strategies unlike state funds counterparts).

Schultheis proposing a hypothetical situation and game that he calls "Outfox the Box" that illustrates the index fund versus actively managed fund (or individually picking securities) quite well, so I thought I'd mention it here.  There are ten boxes with money in them, ranging from $1,000 to $10,000 in $1,000 increments:

 

$1,000	$2,000	$3,000	$4,000	$5,000
$6,000	$7,000	$8,000	$9,000	$10,000

You are told to choose one.  When the boxes show the amounts, it's obvious you'll choose the $10,000 one.  But let's say it looks like this:

$8,000	?	?	?	?
?	?	?	?	?

In that case, you should choose the $8,000 since it's not worth the risk as chances are you'll get much less than $8,000 if you choose a "question" box.  Picking a "question" box is essentially gambling, and investing should be going with the percentages.  Most likely, you'll choose a box with less than $8,000, and this is equivalent to choosing an actively managed fund as they typically lag the market on top of having higher fees.  A fund that has outperformed in the past is unlikely to do so in the future, and over a 10-year span, something like 85% of actively managed funds lag their benchmark.  Schultheis explains that Wall Street is essentially trying to convince you to give them your money so that their experts can "outfox the box" even though the odds are quite grim that they can do so.  On top of that, they charge much more so the chances of your total return improving is even slimmer.

In the end, this book provides some great analogies and sound advice for simple, long-term investing.  It is not a detail oriented analysis on various strategies and securities, but rather a "life book" that uses life lessons and the author's personal experiences in order to give you a clear picture of how to apply such fundamentals to your own life to ensure financial well-being.   The book is an easy read and provides many examples and supporting figures for his philosophy, and, as such, I think it's a great read for somebody formulating an investing plan.  It isn't, however, revolutionary in nature with its research findings (not that it needs to be) and some may find the tangents distracting rather than enriching.  I found it an enjoyable read that looked at a few topics from a new angle, while reinforcing the guiding principles of my own investing philosophy.

Rating: 4 out of 5 stars

Book Review: All About Asset Allocation

All About Asset Allocation (McGraw-Hill, Sept 2005, 256 pp), written by Rick Ferri, CFA, seeks to educate individuals about the fundamentals of asset allocation and why implementing a sound strategy is key to long-term success.  Ferri first covers the basics of asset allocation, risk, and diversification, explaining why asset allocation accounts for largely 90% of one's portfolio performance (that is, market timing and security selection aren't nearly as significant).  He then goes on to break down each asset class and specific index funds to choose to represent such classes.  Ferri highly recommends low-cost index funds and explores US equity, international equity, fixed-income, real estate, and alternative investments (e.g. stamps, artwork, collectibles, commodities).  Finally, he speaks to managing and building a sound portfolio, realistic expectations, behavioral psychology and its influence on investment decisions, and fund and financial advisor expenses.

In the end, Ferri succeeds in his core mission to convince individual investors to ignore most of the "advice" spewed by Wall Street and CNBC and instead rely on a sound systematic and non-emotional portfolio of diversified index funds that explore all asset classes held in appropriate proportions based on age, goals, and risk tolerance.  He also provides a list of funds to look at near the end of each chapter.  Having said that, frankly, I found the book a bit boring as it is probably more well-suited for a novice investor.  He explains concepts in layman terms so that anybody can understand - a positive for most, but I found that it almost too simplistic and not terribly interesting.  Ferri simply stated things I already knew and didn't really add to my knowledge; it simply served as reinforcement (which certainly isn't a bad thing).   One portion where he did go above and beyond a typical book, however, is describing the asset allocation of fixed-income in quite some detail.  That certainly is a welcome addition.  Ferri stresses the importance of holding asset classes that have little correlation and then re-balancing; backing up these assertions with illustrations as to how this strategy increases overall long-term returns.

For an individual investor who wants an easy to read guide on how to develop and stick with a sound asset allocation, All About Asset Allocation is a great choice.  While I found it generally elementary in nature and simply reinforcing concepts I already knew, it certainly is a nice change of pace to read an author who holds a similar investing philosophy as I do.  I'd certainly recommend reading the book for those just starting out, individuals who want to simplify their investment approach and lower costs, or those who want confirmation that their portfolio currently covers all appropriate asset classes in reasonable percentages.

Rating: 4 out of 5 stars

Market Timing using Exponential Moving Averages

Chartists and momentum investors typically look to moving averages (MA) as signals of market movement trends.  As such, even if you don't use such indicators, it is helpful to understand them as other traders certainly do pay attention to them and act on their signals.   Moving averages are lagging indicators, meaning they are used to identify pre-existing trends rather than predict future movements.  For example, when a stock price is above its 50-day MA, it is seen as being in a uptrend and many investors choose to go long in such circumstances.  On the other hand, once a price is below its MA, it is seen as being in a downtrend.

While one MA alone gives a generic sense of a price's trend, more commonly two are used in tandem.  As a short-term momentum indicator, the 12- and 26-day MAs are frequently used.  When the 12-day average is above the 26-day it is seen as a bullish phase with positive momentum going forward.  Conversely, when the 12-day passes below the 26-day, it indicates negative momentum.  These two are also used to create more complex indicators such as the Moving Average Convergence Divergence (MACD).

(Source: StockCharts.com)

For example, in the above chart for Google (GOOG), the crossover of the 12-day indicator below the 26-day signals a negative trend and potential sell signal.  On the other hand, the MACD signals a slight buy (although it being in negative territory is usually seen as slightly bearish).  As you can see, different indicators can say opposite things about the same stock at the same time.  Thus, looking at just one in a vacuum doesn't seem wise as it's best to have a complete picture.  Volume is another key aspect that chartists tend to look at to see if a movement is legitimate or not.  (Note that I do not consider myself a chartist or technical analyzer.  I find it interesting and appreciate the sentiments learned by such analyses, but prefer to generally rely on fundamentals).

For long term trends, it is more appropriate to use the 50 and 200-day moving averages.  The same logic applies as the above, but these signals are much less frequent and are used to identify significant bear and bull markets.  There are two types of moving averages - simple and exponential.  While the SMA gives the same weight to all the data within the range, the EMA gives more weight to the latest data.  Thus, EMAs reacts slightly faster to price changes than their SMA counterparts.

The Strategy

An interesting market timing strategy is to use the long-term EMAs as signals to enter and exit the market as key points.  Since they're so long-term, the signals are not very frequent and it's quite simple to follow.   The purpose of such a strategy is to avoid the worst downturns while being able to maintain market positions during bullish phases.

I tested a strategy that uses the 50-, 100-, and 200-day exponential moving averages.  Using a $10,000 investment in an S&P 500 ETF (SPY), I went back to 1993 to start the backtest and went through the open on 2/16/10.  My strategy was quite simple: sell when the 50-day EMA moves below the 200-day EMA and buy when the 50-day EMA moves above the 100- or 200-day EMA.  The reason I added the 100-day for the buy signals instead of simply using the 200-day is that in extreme bear markets, the 200-day is far too long of a laggard.  Investors would then miss most of the upswing (as what would have occurred in 2009).  Plus, I think being in the market more often than not is a reasonable strategy and selling only when downward trends are clear is advisable. 

Using the above strategy, there were only six roundtrip transactions in 17 years.  That is about one buy and sell every three years.  As you can see, this doesn't require that much monitoring and keeps you in the market for the majority of the time.  I didn't calculate T-bill rates or cash equivalents when the strategy called for being out of the market, so it is inherently at a disadvantage.

Results

Of the seven transactions (one more than previously indicated since I'm including the start and end points), two were marginal losers in the amounts of 3% and 5%.  The other five accounted for gains of 1%, 110%, 22%, 58%, and 14%.  

EMA Timing

Buy Date	Buy Price	Shares	Cost Basis	Sell Date
1/29/1993	43.94	227.58	$10,000.00	4/13/1994
8/18/1994	46.45	218.42	$10,145.65	12/9/1994
1/17/1995	47.03	209.23	$9,839.86	10/5/1998
10/30/1998	110	187.71	$20,648.43	10/18/2000
3/18/2002	116.67	216.00	$25,200.48	4/11/2002
5/1/2003	91.9	259.93	$23,887.21	1/2/2008
6/1/2009	94.77	397.50	$37,671.09	2/15/2010

Sell Price	Sell Value	Difference	% Net Change	Cumulative
44.58	$10,145.65	$145.65	1.46%	1.46%
45.05	$9,839.86	-$305.79	-3.01%	-1.60%
98.69	$20,648.43	$10,808.57	109.84%	106.48%
134.25	$25,200.48	$4,552.04	22.05%	152.00%
110.59	$23,887.21	-$1,313.27	-5.21%	138.87%
144.93	$37,671.09	$13,783.88	57.70%	276.71%
108.04	$42,945.92	$5,274.83	14.00%	329.46%

Cumulative: +329% 

The S&P 500 was up 146% over the same period.  If you had invested $10,000 in 1993 and used the EMA strategy, you'd have $42,946 today, while buy-and-hold would have left you with $24,600.  Note that the above only captures capital appreciation and excludes dividends.  Thus, the gains are actually greater than stated in both circumstances.  As you can see, this timing strategy had some impressive outperformance over this period which encompassed one of the greatest bull markets of all time and two large bear markets in 2000-2002 and 2008.

Source: investingguy.blogspot.com

Red = S&P 500 buy and hold

Blue = EMA Timing

Similar to other market timing strategies, one can plainly see that it trails buy and hold in continuous bull markets (1993 - 2000).  This is no surprise since being out of the market when it's up virtually every month never helps performance.  Despite this, since EMAs indicate past trends, there were only thee very short periods through 2000 that it indicated to be out of the market, and thus the strategy captured the majority of the gains.

Another performance figure that I like to examine to measure volatility and risk is the year-by-year values.  Of the five years in this sample range wherein the market had a negative return, the EMA strategy outperformed in four of them.  In the two worst years, the EMA considerably outperformed.  In 2002, the S&P was down 21%, while the EMA strategy called for being in the market only about a month the entire year and thus was down a mere 5%.  In the disastrous 2008, the S&P sunk 34%.  The EMA strategy signals a sell right at the beginning of the year and never got into buy territory, so it remained unchanged.  See below for the year-by-year performance with the better performing strategy in green, if applicable.

Year	Buy and Hold	EMA     Strategy
1993	6.03%	6.03%
1994	-5.11%	-10.22%
1995	30.22%	30.22%
1996	16.92%	16.92%
1997	23.62%	23.62%
1998	23.48%	12.29%
1999	15.20%	15.20%
2000	-5.55%	-3.94%
2001	-16.04%	0%
2002	-21.43%	-5.21%
2003	29.73%	21.60%
2004	6.91%	6.16%
2005	5.87%	5.87%
2006	11.29%	11.29%
2007	1.65%	1.65%
2008	-34.44%	0%
2009	37.76%	18.57%
2010	-3.85%	-3.85%

_______________________

  Total       +146%         +329%

On the other hand, during years the market performed very well, the EMA strategy sometimes underperformed.  There were five years of greater than 20% gains: 1995, 1997, 1998, 2003, 2009.  The EMA strategy got all the gains of '95 and '97.  It captured about half of that in '98, 2/3 of it in 2003, and half in 2009.  Since the strategy is a laggard, if the market was up in a year following a bull market, the EMA never signaled a sell and then captured all the gains.  If, however, the run-up was after a large correction as those that happened in 2000-2002 and 2008, then it took some time for the buy signal to be initiated and the EMA strategy missed some of the uptick.

Conclusion

As a long-term trend indicator, the 50-, 100-, and 200-day exponential moving averages do signal momentum shifts in the market.  This simple strategy had an impressive outperformance of the market during this time period, but there is certainly no guarantee that such a pattern will continue to exist.  Having said that, I think this strategy actually makes more intuitive sense than Sy Harding's Seasonal Timing Strategy (that I explored in this post) and requires very few transactions over a long period.  Its key to success is exiting the market near the relative beginning of huge downturns.  

Furthermore, this strategy is successful during periods of high volatility, while during a sideways market, it would simply signal nothing and thus is the same as buy-and-hold.  It is for that reason, that I like it more than many other timing tactics.  Instead of trying to enter and exit the market frequently at opportune times, this approach only acts when trends have been clearly established.  

Rather than taking these signals without reservation and having them dictate the complete selling of your equity position, I personally could see risking a bit less and selling about half of your equity position and investing in bonds with that half.  That way, it's a combination of a buy-and-hold and market timing strategy.  While no market timing strategy has really shown to outperform the market in all conditions over a lengthy period of time, those risk averse investors who cannot stomach large downturns might consider this simple EMA timing strategy (or simply reduce their equity percentage).

2010 Sector Outlook: XLK, XLV, XLU, and XLE

Technology, health care, utilities, and energy appear to be the sectors most poised for outperformance of the market at large in 2010. Although nobody can effectively and reliably predict the sector movements at any given time (and sector rotation strategies are a high-risk, high-reward proposition), the current macroeconomic factors at play lead me to believe that these four areas will perform well in 2010. The corresponding Select Sector SPDR ETFs are XLK, XLV, XLU, and XLE. Here is a breakdown of these four industries.

Technology

Although technology had a huge upswing in 2009 (up 54%), I still think there is room for continued upside as the valuation on a forward P/E basis is still reasonable. The close of XLK today was 20.84 - a level in the trading range of 18.3 -22 that XLK was in from the beginning of 2004 until September 2006. XLK is down about 9% YTD, making it a good entry point at this time in my mind. Although this move has been on some considerable volume, which causes me some concern as high volume often indicates that a move is legitimate. Nevertheless, I see technology as the single most important catalyst in the worldwide economy for continued recovery and growth. And I'm cautiously optimistic that we will see that growth this year. On top of that, technology typically performs well in inflationary periods, which is what many expect us to see in the next year or two. With its top holdings as Microsoft (MSFT), Apple (AAPL), IBM, AT&T (T), Cisco (CSCO), and Google (GOOG), technology has some major innovators and stalwarts that are key for our economic well-being. And with forward P/Es averaging about 13.5 versus a current P/E for the market at large at 16.2, they seem to be a bit undervalued.

The are, however, many negatives. For one, it seems like most pundits and investors are extremely bullish on tech and this oftentimes serves as a contrarian indicator. Likewise, in typical stock market cycles, technology leads the way at the beginning of the bull market, but only modestly outperforms six months after the recession. From a technical perspective, as you can see in the chart below, the MACD signal is showing "sell" with both the EMA-26 and EMA-9 in negative territory, often also seen as a bearish sign. In addition, the 20-day moving average just pierced through the 50-day moving average from the top (on fairly high volume as I stated earlier), which also signals a "sell." If I was going only by the technical analysis, I would be a complete bear on tech. However, I prefer to analyze the fundamentals and use that to dictate my investment choices. I am certainly not a chartist or momentum trader, although I like to point the technicals out to those who find it intriguing. Ned Davis research also points to the fact that the breadth is weakening, the seasonality trade has ended, and that production from a factory perspective for high-tech machinery remains quite weak.

Despite all these negatives, the valuation of the sector and ability of the aforementioned companies to spark an economic rally and innovation war with one another, leads me to think that XLK will be a good sector to own during 2010. Tech is always a fairly volatile industry, though, so it's certainly not for the faint of heart and is a bit riskier of a proposition than perhaps other options. (Disclosure: I picked up some XLK today, 2/4/10 with a limit order at 20.94.  Sold it on 5/11/10 at 22.93 for about a 10% gain in a bit over two months).

(Source: StockCharts.com)

Health Care

This sector will benefit from increased inflation and an aging population in the upcoming year. Although the one trump card in this sector is certainly any changes coming out of Washington, which may affect the profitability of certain areas. But such a proposal out of Congress seems unlikely at this point based on what has been passed and the proposals currently floating around that have ample support. Another pause for concern is the ending of patents for several major blockbuster drugs in the next couple years. The points that make this sector really attractive to me is its defensive nature in times of economic uncertainty, its undervaluation on an absolute basis compared to all other nine sectors (per Ned Davis Research), its ability to deliver sizable dividend yields, and the amount of cash on hand. XLV's top holdings include Johnson and Johnson (JNJ), Pfizer (PFE), Abbott Labs (ABT), Merck (MRK), Amgen (AMGN), and Bristol-Myers Squibb (BMY).

XLV is flat YTD and was up about 20% in 2009. It's 20-day MA is still above the 50-day MA signaling a bullish phase (although it's teetering), while the MACD that is a shorter-term indicator is in a slightly bearish. Not too much to glean from the technical chart, but the fundamentals to me signal a buy. XLV closed at 30.88 today.

(Source: StockCharts.com)

Utilities

Utilities as a sector is quite often defensive and boring; but that is why I like it. Its volatility isn't that great and many of the companies offer solid dividends. The demand for utilities will probably remain relatively weak given the state of the housing market, but with energy prices likely increasing and investors seeking undervalued, dividend-oriented plays, I think utilities and XLU is a solid bet for 2010. They only returned about 10% in 2009 and are down about 7% YTD, but I really expect them to be an attractive place for many risk-averse investors.

Standard & Poor's and Ned Davis Research appear to be more negative on this sector that I am, though, so I certainly will admit it if I made a wrong call. S&P argues that "an ongoing domestic economic recovery will continue to fuel cyclical outperformance at the expense of this counter-cyclical sector" which is certainly a valid stance. Utilities tend to perform best in the middle of a stock market bear, certainly not after a large upswing in the market. However, going by this same logic one would be inclined to snatch up consumer discretionary names, and I think our economic experiences in the past two years and the continued poor employment market are going to lead to a scared consumers. They certainly can sacrifice luxuries, but will continue to live and pay utility costs. Similar to S&P, NDR has a list of sector negatives such as "long-term overbought conditions," "excess capacity," "low beta," and "weaker pricing becoming a concern." However, they still have it at marketweight based on shrinking credit spreads despite the fact that valuations suggest they're not at bargain prices anymore. From a technical perspective, the signals and money flow are in a bearish phase. This sector, along with tech, are my two riskier picks.

(Source: StockCharts.com)

Energy

Commodities, and oil in particular, have had a rough couple weeks, but since I believe the global bull market will continue, I have to think that oil has some upside. Crude oil supplies are relatively high from a historical perspective, but it appears that energy is going to prove vital in many of the infrastructure projects being targeted by various governments. Emerging markets certainly will have increased demand for energy in the upcoming years (and demand in the US should have an uptick with the improved economy) and as a group, the names in the energy field are trading a bit under their valuation. The MA indicators are in the bullish phase, while the MACD is bearing as is the 3-day cash flow. XLE's largest holdings include ExxonMobil (XOM), Chevron (CVX), Schlumberger (SLB), ConocoPhillips (COP), and Occidental (OXY).

(Update 4/27/10: I would no longer own the energy sector as a result of the BP oil spill that was reported in the last few days.  As new information comes and situations change, it's important to be flexible with your investments.  You can't marry any particular position and when something disastrous like an oil spill occurs, that certainly makes the sector a huge question mark in the short-term.  I personally don't feel that the risk is appropriate to take on and would close my position.   This could be bad...really bad.  So, I'd get out personally.)

(Source: StockCharts.com)

Conclusion

In the end, we'll see at the end of this year if these were good picks or not. Certainly, I re-assess as market conditions and macroeconomic factors at play change (as they undoubtedly will), but I think these four are a good starting point and I will happily admit it if I am off-base. It will be interesting to see how these perform. On a separate note, what would I avoid in 2010? Treasuries. Gold also seems set for a pull-back after a monstrous 2009, even if that's contradictory to my above statements regarding inflation.

As I have said in previous posts, I don't think market/sector speculation and investing in non-diversified offerings is the way to go for the vast majority of investors. However, I think it's reasonable to make some gambles (and yes, they're educated gambles) with 5-10% of your assets if you have the necessary time and knowledge, and enjoy performing such trades.

Here are the closing prices as of 2/4/10 for the four aforementioned ETFs as well as a S&P 500 Index Fund. Performance will be updated sporadically and compared to the return of the S&P at large:

XLK: 20.84

XLV: 30.88

XLU: 28.99

XLE: 54.29

SPY: 106.44

Updated Performance:

 

Sector	Start Price	Current Price	Change	Through
XLK	20.84	25.19	+20.9%	Year end
XLV	30.88	31.50	+2.0%	Year end
XLU	28.99	31.34	+8.1%	Year end
XLE	54.29	68.25	+25.7%	Year end
S&P 500	106.44	125.75	+18.1%	Year end

This further illustrates how hard it is to predict sectors.  The cumulative average of the four sectors was +14.2%.  However, this doesn't include dividends.  I really should like them up to make the comparison truly valid but don't have time right now.