Teva Pharmaceutical Industries Ltd. ADRs (TEVA)

Wal-Mart recently announced a plan to offer generic prescriptions for $4 and they are rolling it out. After the announcement, there was an immediate negative impact on stocks of Wal-Mart’s competitors in the pharmacy business, but also a negative impact on the shares of generic drug manufacturers that I thought was overdone. For if generic prescriptions are going to become very affordable, won’t volume of sales increase, and won’t the increase be good for business in the long run? At least it will be for the largest and strongest manufacturers, who are in a position to profit by increased volume and economy of scale: Companies like Teva Pharmaceuticals, the world’s largest manufacturer of generic drugs. Teva has their headquarters in Israel but does most of their business in North America and Europe. They just took over Ivax Corp. last year.

Although TEVA shares are down about 24% from their 52-week high, the long-term chart is just spectacular. The ADRs are now 34 and change, and they would have to drop to somewhere between 15 and 20 next year just to reach the trendline on a log scale chart.

Teva’s dividend yield is only .68% now, but they have increased the cash dividend by an average of 33% a year for at least the last five years, and there have been numerous stock splits. If this trend continues, a small dividend now could grow into a handsome yield on the original investment.

In addition to Teva’s human and animal generic pharmaceutical business, they also seek to develop and patent original drugs, and it is possible they could produce a blockbuster.

Clearly Teva could be an excellent investment if the shares could be purchased at a good low price.

Yesterday it was announced that Chief Executive Officer Israel Makov would retire in 2007 and be replaced by Shlomo Yanai. The stock dropped more than 3% on the news before recovering a bit. Mr. Yanai, a retired Israeli Army general, has experience in agricultural chemicals but he has no experience in the drug business. The stock of his current employer rallied on news he is leaving. It is thought Teva has considerable talent in house and it is mystifying that the board would select this particular person to be their next CEO. Perhaps they know something the market does not. Could this event be the catalyst for Teva to become undervalued? Time will tell.

I do not have a position in any of the companies mentioned at this time, except as a possible holding in mutual funds.

Origin of the Term Alligator Investor and a Critique of Short-Term Trading

A reader added some interesting comments to my post about the NYSE Bullish Percentage Index ($BPNYA) and I wanted to expand on my response.

My parents divorced when I was an infant and I seldom saw my father, since I lived with my mother far away. But when I was ten, my father bought me a plane ticket and I visited him for a week. I noticed that he was living quite well, but he seemed to have no occupation other than planning a trip to Europe, so I asked if he had a job. He said his job was to be an investor. I asked what kind of an investor he was. He said he was an alligator investor. My father explained there are two kinds of investors: alligator investors and crocodile investors. Alligator investors lie at the bottom of the stream waiting for something good to eat to swim by, and crocodile investors charge out of the stream to hunt for their prey. Crocodiles waste energy and expose themselves to risk, but in the end they don’t get any more to eat than alligators. My father said that he invested by waiting for good stocks to go down a lot, then he bought and held them for the long haul. I never saw him look at a stock chart, but when he passed away he left a substantial estate.

Twenty years later I became interested in the financial markets myself. I started investing in a mutual fund regularly, and I also began to trade stocks, options, and commodity futures. I studied technical analysis in depth and tried many mechanical trading systems which I hoped would give me an edge. I bought and sold short constantly for several years. Here is how I happened to give up leveraged trading: I saw that I was up about 20% for the year, but filing my tax return was an absolute nightmare because of all the short-term trading. In the meantime, my mutual fund was also up 20%, but effortlessly! Then I remembered what my father had said about alligator investors and crocodile investors, and vowed to become an alligator investor myself.

We have had a great bull market in this country for many generations. That bull market has been punctuated by corrections of varying magnitude, but using sell signals to bail out of stocks completely is a fool’s pursuit. What works best is buying good securities when they are cheap and holding on to them. If you don’t have the time, the inclination, or the patience to study the market and wait for what you want to go on sale, dollar cost averaging works almost as well; all you really need to do is carefullly select one or two good, low-cost funds which suit your investment goals and invest away, regularly – you should succeed in the end.

This is not to say that technical analysis doesn’t work. You just need to find technical analysis tools that suit your trading style. For an alligator investor, $BPNYA is an excellent tool. He will not be looking for in-and-out trading signals, but when $BPNYA does give a reading below 30%, like it did in 2002, he knows it is time to buy stocks aggressively, even high-beta tech stocks. He will have to overcome his fear. The market will look terrible and the future will look dismal. Years later, when $BPNYA is giving a reading over 70%, he will not be looking to sell his stocks, even though he has big profits. He will know that it is time to weed out his portfolio, selling laggards and the clutter that accumulates after mergers and spinoffs. When $BPNYA is over 70% it will seem foolish to sell anything, because the Dow will be making new highs amidst encouraging predictions about the economy and interest rates.

Of course an alligator investor will use other technical tools as well. For example, he will study the list of new 52 week lows every day. And if he has the time and inclination, he will chart unloved stocks which pay good dividends, using technical studies which may be helpful in determining trend changes, such as moving averages, RSI, and on-balance volume. But these refinements are unnecessary, strictly for entertainment and intellectual stimulation! The main thing is to buy low, accumulate, diversify, and hold.

PowerShares Wilder Clean Energy Portfolio ETF (PBW)

I bought an initial position in PBW yesterday at 18.34. I have no idea whether this is really a good time to buy it or not, but it’s certainly a better time than last May, when the price was 24.07! The ETF has retraced 68% of its rally from the May 05 low to the May 06 high, and it appears to be ready to resume its advance. If PBW does go down from here, it won’t hurt my feelings, because I plan to buy more and I wouldn’t mind getting it at a better price. This is a long-term investment that has a chance to turn into a real home run for my descendants. The use of energy from alternative sources should grow exponentially over the next several decades as oil becomes harder to get. It’s a bonus that PBW happens to be negatively correlated to major portfolio holdings, and should help to hedge them.

This exchange traded fund is based on the WilderHill Clean Energy Index and seeks to deliver capital appreciation. There are about 50 components, including as Pacific Ethanol (PEIX), in which Bill Gates invested $40 million last April just before it peaked near 40, and subsequently dropped below 15; and Evergreen Solar (ESLR), which recently traded below 8 after being as high as 17 last spring.

Industries represented in the portfolio are: Energy 27%, Technology 23%, Industrial 20%, Utilities 9%, Basic materials and Electronics, 8% each. More than 10% of the portfolio is foreign stocks. The fund’s current distribution rate is .23% and the expense ratio is .60. This ETF is volatile.  It has not been trading long enough for accurate figures to be calculated, but I estimate the beta is close to 2.0.

A Comparison of Diversified Emerging Market Equity ETFs

There are three diversified emerging market equity ETFs: BLDRS Emerging Markets 50 ADR Index (ADRE); iShares MSCI Emerging Markets Index (EEM); and Vanguard Emerging Markets Stock ETF (VWO). This is a study of their relative merits. The new Claymore/BNY BRIC ETF (EEB) is not considered diversified enough to be comparable. I do not have a position in any of these securities at this time.

1. Expense Ratio: ADRE, .30; EEM, .77; VWO, .30. The first step will be to eliminate EEM because it has the highest expense ratio. That is too bad, because its average daily trading volume is much greater than the other two. EEM may be the best vehicle for short-term traders but long-term investors should keep looking.

2. Dividend Yield: ADRE has a definite edge at 2.46%. VWO is 1.54%.  Different sites give different results; these are from eftconnect.com.
3. Diversification: VWO is more diversified overall with 18% of assets in their top ten holdings, while ADRE has 44%. My impression is that VWO is more diversified by country and ADRE is more diversified by industry. ADRE has a notably higher concentration in Brazil

4. Market capitalization: Average for ADRE is $30 billion while VWO is $10 billion.

5. Relative strength: ADRE has been trading for 4 years but VWO has only been around for 18 months. Looking at those 18 months, ADRE has consistently outperformed VWO. Year to date, ADRE has gained 20%, VWO 13%.

Conclusion: ADRE looks like the best choice.  VWO’s broader diversification may dampen volatility on the downside, but it has been holding them back on the upside. VWO’s smaller-cap portfolio could work out well in the end.

NYSE Bullish Percentage Index ($BPNYA)

One of my favorite market timing tools is the NYSE bullish percentage index, Stockcharts.com symbol $BPNYA. This indicator shows the percentage of stocks in the NYSE Composite Index (NYA) which are currently exhibiting buy signals on point and figure charts on any given day. It is an objective market barometer. Interpretation is simple: If the index is above 50%, we are in an uptrend; if it is below 50% we are in a downtrend. If it is above 70% the market is overbought and unlikely to go much higher. If it is below 30% the market is oversold and it is feeding time for alligator investors. Like any other technical indicator, $BPNYA can give false signals, but it is usually right. Historical charts and information regarding interpretation and use of the NYSE Bullish Percentage Index are available on the internet.

This chart shows $BPNYA plotted against its underlying index for the last three years. Note that peaks of $BPNYA over 70% have coincided with peaks in the market, and have often preceded them. During this time frame, we have not had a correction of sufficient magnitude to bring the $BPNYA below 30%. However, valleys in the index have coincided with dips in the market. The $BPNYA often trends. It is often possible to identify trend turning points as they occur with the use of technical analysis tools.

The important thing is to recognize major selling opportunities when $BPNYA is above 70% and major buying opportunities when $BPNYA below 30%. This is timely because $BPNYA could reach 70% this week.

Fidelity Personal Retirement Annuity – Fidelity’s Deferred Variable Annuity

I’ve seen investment advisors badmouthing annuities, but according to Jim Schlagheck, deferred variable annuities are worth looking into for several reasons. “Annuities give you the advantage of deferring taxes on your investment income and gains until the annuity income is paid out some time later. So annuities function somewhat like IRA or 401(k) accounts. They give you important tax advantages with one major difference – while there are limits on how much you can put into an IRA or 401(k) each year, there are no limits on the amount of money you can lodge in an annuity. With a deferred variable annuity, you are able to invest some entry amount and then make additional monthly or quarterly payments. You are also able to invest your annuity money in a series of different mutual funds. So if you select high-quality funds and prudently diversify your annuity portfolio, you can achieve significant gains with better compounding because of the tax deferral.” It must also be noted that upon death of the owner, the annuity is not considered part of his estate and the cash value is paid directly to the beneficiaries. This type of annuity is one more way to put money in a tax-sheltered account for the purpose of generating retirement income, and arranging for assets to be transferred directly to beneficiaries upon your death, bypassing estate taxes.

There is no question that Fidelity is the lowest-cost reputable deferred variable annuity provider. Their .25% annual charge compares to an industry average of 1.40%. However, Fidelity’s plan does not have a minimum guaranteed death benefit, whereas the industry average annuity may; and of course, any Fidelity mutual funds in which you invest your annuity will have their own expenses and fees.

Fidelity Personal Retirement Annuity, Fidelity’s deferred variable annuity, has a minimum initial purchase of $5000 and there is no surrender charge. You can allocate your investment among a great number of Fidelity funds as you wish, and you are permitted to change investments occasionally, but there are rules which punish “excessive trading”. The plan offers flexible withdrawal options, including an income annuity option to create your own pension, systematic withdrawals, partial withdrawals, or a lump-sum withdrawal.  The Fidelity representatives are friendly and knowledgeable.

But I learned that my state would impose a 2% annuity premium tax on money I contribute to the annuity. I almost abandoned the plan, but after crunching the numbers it does look like it’s worth it. The state is trying to discourage people from investing in these annuities because they permanently remove money from their sphere of taxation. But after a two year payback on what you would have owed on state income taxes, you are home free.

I have decided to use Fidelity Balanced Fund (FBALX) as the investment vehicle for my personal retirement annuity. This fund has a Morningstar 5 Star Rating, a beta of .89, and an expense ratio of .64. I will also pay .25 to Fidelity for servicing the annuity for a total expense ratio of .89. FBALX’s portfolio is about 65% stocks and 35% bonds and includes 10% foreign securities. The plan will be to accumulate shares via dollar cost averaging over a period of several years until the annuity holds 10% of my assets.

In case this sounds like an advertisement for Fidelity, I will add that I have no financial interest in the firm other than ownership of a mutual fund not mentioned. 

The SPDR Homebuilders ETF (XHB)

Homebuilders is not a sector I would normally invest in, but my interest was piqued by the discovery that the SPDR Homebuilders ETF (XHB) is negatively correlated to major portfolio holdings in energy and utilities, and might be a good hedge.
There has been a lot of chatter about homebuilders lately, how cheap the stocks are, whether or not the low has been seen, and what may be the future prospects of this group.

Most of the news has not been very good. Moody’s forecasts a 3.6% median house price decline in 2007. Realtors expect new house prices to fall for the first time in 15 years. And although mortgage applications may be rebounding, due to the recent decline in mortgage rates, much of the recent increase in mortgage applications may be due to refinancing activity, as some home owners take advantage of slightly lower rates to switch out of variable rate mortgages. However, Greenspan says the worst may already be over in the housing slump.

XHB has been trading for less than a year. According to etfconnect, the current distribution rate is .88% and the expense ratio is .35. This portfolio is 100% domestic consumer discretionary stocks. The top 10 holdings, all at about 5%, are Sherwin Williams, Leggett & Platt, Toll Brothers, Pulte Homes, Centex, D R Horton, Mohawk Inds., Home Depot, Lennar Corp., and Lowes.

We have less than 200 days of data for this security so technical analysis is tentative, but I see that after a sharp decline from spring into summer, there has been a basing process and a rally attempt this fall. XHB has benefited from recent sector rotation and speculation about the “Goldilocks economy”. But XHB is very sensitive to interest rates; in fact it has an awesome negative correlation to the 30 year mortgage rate, and any hint that the Fed may engage in further policy firming should send this security back to the new lows list. That is exactly the scenario I am expecting, so I will be looking for an opportunity to buy XHB cheaper in late fall or early winter.

Hedging Energy, Telecom, and Bonds via ETFs with Negative Correlations

Smartmoney.com is offering free use of their Correlation Tracker for a limited time as a promotion, and I used it to check whether I am doing enough to hedge major portfolio positions in energy, telecommunications, and bonds.

Enter a ticker symbol and the correlation tracker will list the ten ETFs and ten stocks which have the highest and lowest correlation to that security over various time frames from six months to three years. I found it helpful to look for patterns, instead of focusing on individual securities, and to look for issues and sectors that appear in more than one time frame.

I used XOM, a major portfolio holding, as a proxy for energy, and found that the following sectors and representative ETFs have a strong negative correlation: Bonds (LQD); Pharmaceuticals (XPH); European stocks (IEV); DJ Transports (IYT); Internet (FDN); Banks (KBE); Homebuilders (XHB); and PowerShares WilderHill Clean Energy (PBW). This confirms my intuitive analysis in most cases, but it had not occurred to me that the Dow Jones Transports (IYT) would tend to move oppositely to XOM, although on reflection, it is obvious; and I have been avoiding PowerShares WilderHill Clean Energy Portfolio (PBW) because I thought it would be highly correlated with the energy sector.

Next, I used IYZ as a proxy for the telecommunications sector, and found that Internet stocks (HHH), Short-term and inlation-protected bonds (SHY, TIP) and Oil and Commodities (USO, OIH, DBC) exhibit negative correlation. No surprises there.

Finally, I checked the investment grade bond sector as represented by LQD. As expected, Foreign stocks (ITF, EWU, EWA, FXI), Industrials (XLI, VIS), Gold and Natural Resources (GLD, IAU, IGE), and Energy (USO, OIH, IXC) all exhibit negative correlation to bonds. But I was surprised to see that the iShares Dow Jones Transportation Average (IYT) shows up here too.

I’ve never given much thought to the Dow Jones Transports, and I discovered they have handily outperformed the S&P500 for most of the last three years. IYT could be a successful investment in its own right, in addition to serving as a hedge for bonds and energy stocks. However, you won’t get rich on IYT’s dividend yield of .56%, and its beta is a rather high 1.25. The fund’s expense ratio is .60 which also seems rather high, in view of the simplicity of tracking an index with only 20 components.

Nevertheless, I see IYT as a “must have” for the portfolio and will start looking for a good entry point.

Closed-End Emerging Market Debt Funds (ESD and AWF)

David Neubert also picked up on the post about ESD by Where is the Yield?, and compared ESD to six other closed-end emerging market debt funds. I subjected Neubert’s list to a little more screening. My sources gave different information than Neubert’s for yield, expense ratio and discount. There were large discrepancies for the expense ratio, especially for ESD, but I’m not going to let that bother me if it really is the best choice. I have added beta and average trading volume for each security. The results are sorted in descending order of yield, and all data are as they were reflected on my sources’ websites on 10 Oct 2006. My source for beta and yield is http://marketrac.nyse.com/Light/ For discount, expense ratio, and average trading volume, I used http://www.etfconnect.com/

I don’t see a quick way to get this data in a proper table, but each ticker symbol is followed by its beta, yield, discount, expense ratio, and average trading volume.
MSD .20 7.14% 4.63% 1.36% 64000
AWF .40 7.06% 9.22% 1.23% 136200
ESD .32 6.77% 14.45% 1.00% 95200
TEI .26 6.61% 9.03% 1.20% 94200
AWG .39 6.58% 11.82% 1.46% 20200
EFL .10 5.92% 7.07% 3.05% 16200
EDF .20 1.02% 13.66% 1.82 73900

The following chart compares the performance of the three highest yielding funds on an historic basis. This picture makes the choice simple! AWF’s performance has been vastly superior over the long term.

To be entirely fair to ESD, which has only been trading since late 2003, here is a closer look at the last two years of data. Poor ESD has been quite a laggard, and deserves its high discount to net asset value. MSD has performed a little better than AWF over this shorter time frame, but for me at least, AWF looks like the clear winner.

According to etfconnect, The Alliance World Dollar Government Fund II (AWF) “is a closed end Fund which seeks high current income and capital appreciation. The fund invests primarily in high yielding and high risk sovereign debt and US corporate fixed income obligations that are expected to benefit from improving economic and credit fundamentals.” The fund traded at a premium of close to 15% in 98-99, then at a discount of more than 15% in 00-01, and it has been at a 14% discount in Oct. 05 and again in June 06. Rounding a few numbers here, the fund’s primary holdings, in descending order, are listed as “Other” 28%, US 15%, Russia 14%, Brazil 13%, Mexico 12%, Phillipines 6%, Argentina 6%, Venezuela 6%. The credit quality is 81% BBB and below. These investments are not for widows and orphans, but I see debt funds as a good way to balance equity investments in emerging markets, with a maximum portfolio weight of 4% for the whole sector.

AWF may be a better choice than ESD for this purpose. It trends nicely, and it is in a nice uptrend now, but I would prefer to buy at the end of a correction.

Qwest Communications (Q)

I parted company with Qwest yesterday.  The telecommunciations sector has had a good run in the past year, and Q has participated fully, rallying more than 300% from the 2005 low.  But I think the party may be over for now, at least for Qwest.  The company announced a large share buyback plan last week, but the market was disappointed that they did not initiate payment of a cash dividend, and so was I.  It shows that Qwest lacks confidence that their earnings will remain strong in the future.