The global financial system is in a state of bedlam – just ask anyone whose 401k had WM, BSC, LEH, AIG, GM, or Citi in it. And then there is the US, which has run historically large current account, trade and budget deficits over the last decade. One would think that the US with an est. 2007 current account deficit of 731 billion, a trade deficit this year of about 700 billion and perhaps the first ever 1 trillion dollar government deficit next year, should be facing a run on its currency in the wake of this credit crunch. But in reality, quite the opposite is happening.

Why?
Despite all of the fundamental problems with the US dollar, people around the world still want to hold greenbacks. Why? Firstly, and in my opinion most importantly, the US has an unbeatable military. I don’t think this factor can be underestimated when considering why a group of people chooses the currency it denominates their assets in. Secondly, the dollar has been seen historically as a reserve currency with the best liquidity on the planet. That is, the fact that so many people are trading the dollar makes it a more attractive investment as high liquidity, you guessed it, reduces liquidity risk. Moreover, the recent run-up in the dollar can be largely attributed to an international flight to quality. In And I think this flight should be able to silence any economists out there who are still trying to argue that the rest of the world has decoupled from the US.

In short, the US economy is bad, but it is still seen as one of the safer places to park one’s wealth.

Is the Rally sustainable?
In my opinion- highly unlikely. The fundamentals for the dollar are too bad for it to stay at these unsustainably high levels. Once the world panic subsides, which could be in 6 months, 2 years, or 10 years, then the dollar is going to resume its slump towards a reasonable valuation. In my opinion, after this crisis is over, the rest of the world is going to think twice about holding dollars as their primary reserve currency and diversify into holding a basket of currencies. Right now there are too many dollars out there – the Asian appetite for dollar denominated debt will have to be satiated at some point, it’s an eventuality. What is that point and when will it happen? I don’t know I assume I will see a “run on the dollar” or several decades of dollar positions unwinding, at some point in my lifetime.

The current system is not sustainable. Don’t get me wrong it was great while it lasted – Chinese appetite for debt kept interest rates low and their cheap source of labor kept inflation low. But the day will come when the US debts come due. My advice - keep a short biased on the dollar long term, and make sure you diversify your assets (especially your retirement funds) globally. The home biased is tempting, but it is also very dangerous. I would suggest looking at globally diversified ETF’s from iShares. Also, I would recommend taking advantage of this dollar strength to diversify outside the US if you have not already done so.

Conclusion
In the past the mantra has been “America sneezes and the world catches the flu.” I think today it is more appropriate to say “America catches the flu, and the rest of the world panics (who is going to buy our stuff?) and decides to pay the medical bills.”

Disclosures- None

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There is no doubt about it- Halliburton has taken a beating in the last few months. In late August this oilfield services giant traded for about $45 but due to falling oil prices and an expected fall in North America drilling demand, HAL now trades for only about $19. Now there are tons of reasons to be bearish about the oil services industry right now, the drop in crude will undoubtedly lower demand for HAL’s product as oil exploration companies will spend less money on drilling. The global slowdown and OPEC’s inability to stop falling oil prices are also worrisome for HAL. But I think this all has been priced into HAL and despite these risks I still see upside to old uncle HAL, especially if you have a long enough investment horizon.

Overview
Halliburton is headquartered in Dubai and has operations in over 70 countries. In 2007, HAL had revenues of $15.3 billion and operating income of $ 3.5 billion. According to its 2007 report, the company generates 45% of its revenue (40% of its profit) from Drilling and Evaluation and 55% of its revenue (60%of its profit) from Completion and Production. Also it is important to note that 45% of overall revenue comes from the US

The Bullish Case for HAL
It’s cheap, granted for a reason, but it’s still cheap. Falling oil prices, less drilling, potential terrorist threat, low capital expenditures from US oil companies, yes – But HAL is still trading for about 6.5 times next year’s earnings (18.6/2.85). Halliburton also has $1.2 billion of credit it can draw upon until July 2012. With a ROE for 35 % and a safe LTD/cap of 27 %, I think HAL is in a good position to benefit from the long term oil demand.  The recession will not last forever, China, India, and the rest of the world are going to come back thirstier than ever for the black crack.

Conclusion
In conclusion, I think HAL is a great 401 K stock. The world is not going to stop needing new sources of oil, especially since 70% of current production comes from mature fields. I would take this drop in HAL’s price and add some HAL to your portfolio at bargain basement prices (6.5 times next year’s earnings).

Disclosures - None.

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No One Ever Made a Dime by Panicking

With the financial markets in ruin, a lot of people today seem to be asking the same question -should I take my money out of the market? My answer - not unless you have some proprietary information as to why the market is currently overvalued (which you probably don’t). For the vast majority of people I would recommend staying in the market, but being defensive with your investments. If you pull your money out of the market, you are going to miss on the potential rally. In addition to that, the stock market has historically been a great place to combat inflation (when compares to the fixed income market).  So my advice is simple - don’t pull out, diversify into uncorrelated assets.

It’s all about correlation

Diversification is not about slapping together a bunch of random stock and assets classes into a portfolio, it’s about constructing a portfolio of assets with little or, better yet, negative correlation to each other. In fact, if you are able to construct a portfolio of perfectly negative correlated assets you can technically construct a risk free portfolio with guaranteed returns. In practice however this does not work because it is very difficult to predict correlations in the future.

So how do you know what assets are correlated and which ones are not? Lucky for you there are number of site that provide such information- my favorite is www.assetcorrelation.com.

For example, the correlation matrix for US stocks over the last 182 days is:

So by way of the above graph if you are heavily invested in Energy sector, then you are going to want to diversify into the Healthcare sector because of the negative correlation there between those two sectors. For passive investors who don’t want to see their gains eaten up by unnecessary fees I recommend ETF’s, which have a favorable tax structure, low expense ratio and trade like stocks.

If you want to get even more defensive with your money, which I think you should, I would recommend you diversify outside of just the US stock market into all the major asset classes.

Below is the correlation matrix for all major asset classes over the last 182 days:

So by way of the above graph, if you only have investments in US stocks, you would want to diversify into some TIPS, US bonds or commodities.

In short, don’t pull out - uncorrelate.

TransGlobe Energy ( TGA), Uncategorized - 1 Comment »