As regular readers know, every month we post the top dividend stocks from the S&P500. Then, a few days later we send out a newsletter (you can sign up for it free) which takes a deeper look into those stocks in order to get not the highest dividend stock but the one that shows the most promise in terms of long term passive income. That generally implies a healthy company (financially) that is growing its dividend and can afford it. One of the criterias that we also use is the payout ratio which we decided to spend more time looking into today.

What is a payout ratio?

The payout ratio is a fairly simple concept, it represents the portion of earnings that is paid out to shareholders. The calculation is quite simply:

Payout Ratio = Dividend per share / Earnings per share

For example, a company that makes a profit of 2$ per share every year and pays out 1$ of dividends would have a 50% payout ratio.

Why you would want a low ratio

Conventional wisdom implies that you would look for a company with a very low payout ratio. Why? Because as you can imagine, a company that has a high payout ratio could very well be unable to continue offering its high dividends. It is non sustainable for a company to pay more out through dividends than what it actually generates. When that happens there are 2 options. Either diminish the dividend or increase earnings, both of which are challenging.

Because of that we have used the payout ratio in a very simple manner in our search for the top dividend stocks; setting a maximum “acceptable” payout ratio that we apply to take out non qualifying stocks.

Why you actually might want a high ratio

All of that being said, there are corporate finance theories that suggest you might not want to have a very low ratio either. One of the advantages of a high ratio is that its puts more pressure on managers to increase their earnings in order to be able to pay and increase the dividends. Such pressure has often been proved to generate better results in the end. It is psychological but it tends to help managers focus on increasing earnings and dividends.

Think about it for a second.. Do you tend to spend more when you have 10,000$ in your bank account (whenever that happens) or when you have a couple hundred dollars? Chances are that when you go shopping, you are much more inclined to spend with a big balance in your account. It is the same thing with companies that are only accumulating big cash piles. They often are less careful with spending which in the end hurts shareholders. A lot of research has been done over the years to prove this theory.

Another reason would be that a company that pays out most of its earnings will be able to make you profit a lot more when they increase those profits. A 50% increase in profits over the years could very well mean a 30-40% dividend increase as well if the ratio is maintained.

It is all about a balance

Like everything else, it is not black or white. You surely do not want a company that is unable to sustain its dividend payout and payout growth but you also want to look for a company that can be as efficient as possible. I will be trying out a few different numbers in the next few months to see what kind of results it generates. Be sure to sign up for our weekly newsletter if you want to find out more.

Examples

These stocks, all solid, consistent dividend payers all pay between 50% and 75% of their earnings out in dividends:

Pitner Bowes Inc (PBI)
Bemis Co Inc (BMS)
Coca-Cola (KO)
Eli Lilly (LLY)

There are many others…

So which do you prefer?

Would you be looking for a stock that pays a tiny portion out of their revenues or a larger chunk?

In what turned out to be the worst month of August in over a decade, bear ETF’s, funds that are built in order to profit from market downturns were at the top of the ranks. These funds and especially the leveraged short ones dominated the charts with Direxion and Proshares sharing the lead.

The other successful bet was the long treasury (TMF) which is essentially the same bet as a poor performance of the equity markets usually translates into strong performance of the treasuries.

Other bets that did well are:

-Short oil (DTO)
-Long Gold Miners (GDXJ)
-Long Global Carbon (GRN)

The one big surprise for me was not seeing a volatility ETF make the top 50 as they usually perform very well in such difficult environments.

And a few other commoditiy plays also did very well. Will these be winners in September? Difficult to say but most of the winners in August are still down for the year.

Without further wait, here are the top 50 ETF’s in August 2010:

I often get questions when takeover bids are made. “If BHP made an offer to buy Potash for 130$ per share, why would the stock move to $150?”

I think we got the perfect example to explain why. It all started when Dell (DELL) made an offer for a little known company, 3Par (PAR). It offered 18$ per share, a very generous offer considering that PAR’s stock was worth less than 10$. You can imagine what happened. 3Par management accepted the offer and it went through, right? Wrong in fact. They did accept the offer but there was speculation that Oracle would make a bid of its own as tech companies with loads of cash look for growth opportunities. A stock that receives an offer for X dollars might move higher simply because investors expect another, higher bid to be made by either the same company or a competitor.

Turns out that HP (HPQ) was the one to make the move as it made a counter-offer for 24$ per share, a big premium over Dell’s offer. And that is when PAR shareholders understood they had the best position of all… their shares were being auctioned off between two tech giants, Dell and HP.

Since that day, both companies have bids, counter-bids and it is still unclear how things will end. On Friday, Dell made another big raise, making an offer of 27$ per share, which HP raised a couple of hours later when it offered 30$. Where will this all end? Unclear but the stock traded over 32$ on Friday fueling speculation that the bidding is not over just yet.

How high could it go?

It’s difficult to say as both companies are already paying a premium of over 200% at this point and while they do have lots of free cash, at some point you would think that one of them will give up. What is clear is that the big winner here will not be Dell or HP but rather 3Par shareholders with a return of over 200% in a couple of weeks. And if anyone was short 3Par? Well as we discussed last week, shorting a stock that is an acquisition target can be costly, especially when the stock goes up so much. Luckily, on such a small stock, there were probably very very few short sellers!

In the newsletter that we sent last week, we asked readers for suggestions and questions and one recurring theme was that it would be nice to review some more basic concepts so I thought one of the best ones to start with would be the P/E ratio or Price/Earnings. Why? Because it is one and perhaps the criteria that I use most when selecting stocks or to evaluate valuations but I have never given a good explanation of what it is, what it represents, etc.

What is it? Lemonade stand example

Up to this point, I have written assuming that readers are familiar with the P/E ratio but the fact is that it’s not the easiest concept and I think going back to an easier example would be a great way to better understand it.

Is there a lemonade stand or store near your house? Imagine that the workers at the stand are paid on a daily basis and do not get “profits”, for simplicity purposes. If the lemonade stand has been making 100$ per year for 10-20 years, you can probably assume that it will remain the case in the future right? How much would you be willing to pay to own the stand and the profits? If you consider that a 10% return would be good enough, you would be willing to pay 1000$ for the stand.

In this example, the price paid (1000$) is 10 times higher than the annual profits so the P/E ratio would be 10 (1000$/100$). Makes sense?

Different types

In the previous example, the lemonade stand is generating the same profits year after year. But imagine if the stand has been and continues to generate growth of 10%. You could expect profits for next year to 110$. In that case, the 1000$ price for the business would represent a  9.1 P/E ratio. This would be the “Next Year’s P/E ratio“.

How important is growth when comparing P/E’s?

Obviously, growth is crucial when looking at P/E ratios. Why? To go back to our example, it’s easy to see how the stand that can increase its profits by 10% per year will make a huge difference over a few years.. After 5 years, that business would be generating over 160$ of annual profits. Obviously, if you paid 1000$, the return of 160$ per year would be significant. That is why it is critical to consider growth when comparing the P/E ratios of different companies. I spend a lot of time comparing P/E ratios of different companies but if you are not taking into account differences in growth, there really is no sense in even doing the exercise.

Downsides to using P/E

Of course, using a P/E ratio has its flaws, here are a few:

-If the lemonade stand is making no profits or actually losing money, it becomes very tricky to use P/E ratios. The best way to do it is to project profits for next year or two years from now, then compare those ratios but it remains a imprecise science
-Does not consider earnings quality. When companies have “one time” items that can affect the “Earnings Per Share”. If those earnings will not repeat in the future, it can become difficult…
-Does not consider the assets and debt of the company. I’ve been looking into ways to better include this in my stock picking. A company like Yahoo has little earnings and honestly I do not see that changing much in the future. But if the company has billions of dollars in the bank, or if it had huge debt, it should be considered obviously but a P/E ratio would not be able to do that.

Why I still use it so much

I agree, I could never trade only with a P/E ratio but:

1-I still think it’s one of the best ways to compare valuations of companies, which is critical in long/short trading.
2-Once you add growth and assets & debt, you can get a very strong feeling of a company’s valuations and value
3- I think that over time, you can learn which companies are reliable in terms of P/E ratio and which ones are too volatile

Where to find it?

The best place to find P/E ratios is on Google Finance or similar wwebsites. Here is a screenshot:

You will not get “Forward looking P/E’s” easily since they depend on future earnings estimates.

You’ve probably heard it 100 times already, China is now officially the 2nd biggest economy in the world after surpassing Japan earlier in the month. It was a huge milestone of course and China now moves to its next objective; passing the United States as the top world economy. It is of course very far from that goal but few argue that it will succeed even if it takes a few decades to get there. China remains contested by most Westerners for its good and its bad but one thing that is very clear is that many opportunities exist for investors ready to get involved in China either as Long or Short investors.

How could the Chinese economy be a good short? Simply because of all the hype surrounding China which has attracted loads of money into the country and hiked asset (and stock) prices. Did it go too high too fast? Some are betting that it did in particular in the real estate business. The big question of course remains what China’s economy’s fair value is, how fast all of this growth will happen and how will the Chinese economy and political system look 10 or 20 years from now.

Obviously, these are big questions and I could probably spend one year on the question but I’ll try to be brief to be able to present you the top ways to play China right now.

Why China is the next big thing

Some say that China will never rival the US in terms of capital markets even if its economy does evetually surpass America’s. Things are changing fast however and doubters should pay attention. A few days ago, McDonald’s became the first foreign company to issue debt in Hong Kong, in Chinese Yuan. This paves the way to other multinational companies that will want to issue debt and also become listed on Chinese equity markets. “This is going to be a popular trend.” Said Donald Straszheim, a head of China research at International Strategy & Investment Group.

The Chinese government is doing its best by deregulating the industry to help the companies. It will of course give greater exposure and visibility not only to China but to the Yuan.

Maybe it’s not

For all its growth and the fact that it is now the world #2 economy, it’s important to remember just how far China really is right now. It did just pass Japan in total GDP but its GPD per capita (per person) is about 10 times lower than Japan. And you can imagine how far it is from US GDP per capita. China has tons of work left to give its citizens access to basic infrastructure.

Another criticism that we often hear is China’s currency manipulation in refusing to let the Yuan rise. That helps the economy generate higher exports and as the government is gradually moving the Yuan towards a “free floated” currency, some argue that growth might decelerate as that happens.

Many of the economic and financial data points generate a lot of criticism and doubts as the Chinese government is far from transparent leading many to believe that the economic puicture and social problems are much greater than we are led to believe.

Plays on China

Wheather you are a bull or a bear on China, there are many opportunities for investors in what is quickly becomming a new major world financial hub. We decided to take a deeper look into many of the plays that can currently be made on China through ETF’s and a few individual stocks. We concentrated on US listed securities since many of the largest Chinese companies are listed as ADR’s on US exchanges anyway.

Straight up

If you want to play the Chinese markets as a whole, you have a few very good options that have been around for a long time and sustained a solid track record . There are many slight different ETF’s but the biggest by far is FXI. Since the fees are roughly the same on each of them, I would stick to FXI for now.

Currency

The Chinese Yuan is certainly one of the most interesting currencies in the world thanks to speculation about government revaluations. The only persons that actually know what will happen are part of the Chinese government but you can be part of the winners when that happens thanks to these 2 ETF’s.

Sectors

There is speculation about the explosion in economic activity but also bubbles in many different sectors of the Chinese economy. You can now make a very precise investment on a specific sector of the Chinese economy.

Leveraged & Inverse Plays

Going short is always a risky proposition as is going long of course. Yes, in theory, a stock can go to one million and you could be wiped out but in reality, like any other price movement, it will usually happen very gradually and you will be able to adjust. There is one big difference though  and that is the extreme rise that can occur when a company bids for a stock that you have shorted.

Last week was a good reminder of what can happen when BHP Billiton made a hostile offer to buy giant Canadian company Potash for $38 billion, which was well abode Potash’s market value. The worst part for short investors in Potash is that the stock shot up much higher than the 130$ per share that was offered on speculation that it was the first offer by BHP but that there will be at least another one. The result? Potash ended Tuesday over 143$, much much higher than Monday’s $112.15 close, almost 30% higher.  Just take a look at the chart of Potash and you will get a better idea of what happened.

Another example

On Thursday, Intel (INTC) announced it was acquiring software security company McAfee (MFE) for $7.68 Billion, a premium of over 60% from the previous close. That means that short investors in McAfee lost a huge amount on that trade. Having a stop loss is useful and necessary but in cases like this, it offers little protection as the stock moves past the stop loss.

To be honest, the threat is important right now because many companies are sitting on huge cash piles which they often want to use in acquisitions.

How to avoid such situations…

There are no ways to make sure that shorting an acquired company will not happen of course but avoiding companies that are speculated to be for sale is one way to do it. In the case of Potash, I don’t think anyone saw this coming and it would have been difficult. But in the case of McAfee, it was easier to see that possibility given its industry and how powerful players could easily move into software security. Companies like Microsoft (MSFT) had been rumored to look into such acquisitions in the past.

Personally, I have not had the impression that many of the companies that I short are good potential targets. Last year, I was worried that Yahoo would be a good target and that was certainly a major worry when I would short the stock. But after its search deal with Microsoft, it seemed very unlikely and I have not had to worry about it since.

Other Risk to consider…short squeeze

When traders notice a very high concentration of short positions on a stock, they can start to drive up the stock which will cause the short traders to be “forced out” of their positions. Of course, those getting out will be doing so at a higher price, which can create even more short positions to reach their “stop loss” limits. You can imagine the effect it can have on a stock when this cycle begins. Then, once the cycle is advanced, the person who started the cycle can close out his position with a nice profit.

Such a strategy is not executed often because a lot of money is required to move a stock enough to create a short squeeze. To be honest, I do not (yet) consider this possibility when selecting short stock picks at the moment but maybe one day I will get burned and have to look into it.

Still a good idea to go short?

I’ve said it many times, I think the long & short trading model that I’m using is perfect for the type of speculative trading that I am doing. It does have some risk involved but as long as the potential gains are large enough, I’m fine with it. That being said, I think that all traders that use short positions had second thoughts this week seeing how Potash and McAfee took huge leaps….

About 2 months ago, I wrote a post about two stocks that were dropping fast, Research in Motion and BP. Both had very different reasons for dropping and the question was mainly if it was a good idea to consider buying these two companies. At the time, Research in Motion (RIMM) was trading at $52.97 and British Petroleum (BP) was at $27.67 (on US markets). Almost 2 months later, we though it would be a good time to back and see how both of them have performed.

Without further wait… the results:

BP    +30,5%

RIMM    -8,9%

Obviously, they have reacted very differently. I don’t think many of you would have been stunned by the possibility that BP would gain 30% over 2 months.. it was a matter of resolving the situation in the Gulf of Mexico to start putting a stop to the oil leaks but also the cash drain. And that is now on course and BP’s stock has started its recovery as well. It did have to unload many assets which means that the stock will probably not regain it’s pre-leak level for a long time, but it is at least moving in the right direction.

On the other hand, Research in Motion is not looking good at all.Last week, Morgan Stanley updated its stock rating, recommending its clients “SELL” their holdings because of the following:

-Morgan Stanley estimates that RIMM’s smartphone market share globally will drop to 13.1% in 2012 (from 16%)
-Morgan Stanley reduced its estimated number of corporate subscribers in 2013 to 16.9M (from 21.5M)
-Reduced both short and medium term profit estimates

The fact is that Research in Motion is in trouble. I met a friend who works at a large multinational pharmaceutical company and the phones they provide employees with are the Apple Iphone. A few years ago, it was unthinkable for a multinational to not use the Blackberry but that “standard” is changing very quickly,  a very important danger for Research in Motion which depends heavily on these clients because of its struggles in the retail sector.

RIMM did announce a new upcoming phone, the Torch and it has not improved analysts so far or convinced anyone that it could stop the decline.

That being said..we are long RIMM

As we mentionned in the previous post, it is more or less impossible to time an entry into a stock that is tanking. You have to expect a possible 10-15 and maybe even 20% loss from your entry point as the momentum is always difficult to overcomee. That is very much the case for RIMM as analysts around the world continue to downgrade RIMM, telling their clients to sell, which has been triggering further downgrades, etc. It would be very easy for anyone to write a post about RIMM’s downfall right now and how the stock is going into the ground… but I don’t think it is.

The company, despite all of its shortcomings, continues to display growth and it’s P/E ratio should be considered useful. In that regard, seeing Research in Motion trade at a 9.1 ratio screams opportunity for me. The key is very limited downfall. Do you think that ratio will fall to 7 or 8? It might, but some stocks but little to no growth trade at higher P/E’s. Do you think that we will soon live in a world where all phones are either powered by Android or by Apple? I personally doubt it. They will grow much faster but that doesn’t meean that RIMM will cease to exist.

Was I a buyer at the start of 2010? No. But I am now…are you?

Good morning to all of you. Today, I decided to answer to a comment that I recently received because it was very well formulated and also many of those questions have been asked either in private or on this blog, it is related to the stock picks that we make. Here is Nathan’s comment:

Hello, I recently started reading your blog and have found the commentary interesting and engaging.

I was wondering if you could please go into further detail regarding how you go about formulating particular trades.

Specifically, what is your methodology/rationale for pairing up two particular stocks?

That is, I understand why you might be long a particular company. And why you might be short a different company. You then seem to pair the two positions, and I’m not clear on how you came about the pairing.

I am assuming your trades are based on the spread in performance of the two positions — is this correct? Do you take equal positions in both sides of the pairing?

How do you pick the second stock for a paired trade? Is it a competitor in the same space that you think won’t do as well, or is it simply a company in a different space that you believe will perform in a non-correlated/independent fashion from the first company? Or is the ’short’ company selection a method of trying to hedge against possible negative performance of the ‘long’ company?

[I did try to find an explanation in previous posts but was unable to clarify to my satisfaction]

Thank you for your attention and blog postings.

**************************************************************************

That is certainly a loaded comment, I will do my best to answer as well as possible but feel more than free to ask more questions. Initially, I wanted to give more hindsight into how I pair up trades.

The easiest and preferred way is to trade two stocks within the same sector such as going Long Priceline against short Travelzoo. These type of trades become a “bet” on which of the two stocks will perform better which takes out a lot of the external factors. If one stock is mis priced relative to another, doing a pair trade is an attempt to profit when they become back in line. Because of the small number of internet stocks, I often have to look deeper.

The way I generally proceed is to look at my dashboard to find 1 or 2 stocks that either look very attractive or expensive. They would be the stocks that I would be looking to pair. Then, I will look for a stock that is similar in nature. For example, if I am looking to do a trade against Amazon, I would be looking for ecommerce companies that trade at a comparable P/E, has similar growth, etc. Once I find that, one might look very cheap or expensive compared to the other.

In most cases, I am able to find a stock that can be paired off reasonably well but not always. If you look at the trades that we did this year, you will find some trades that are well paired off (Priceline & Travelzoo, Apple & Blue Nile) but also others that are not as clear such as (Research in Motion (RIMM) and Monster WorldWide (MWW)). That would be a case where I was unable to get a good pair trade and decided to simply take what I considered to be an overvalued and an undervalued stock.

Why do I pair trades and how?

I do pair trades because it gives me no net exposure to the market (more or less), which means that a 20% increase or decrease in the market will have a very limited impact on the portfolio. There are positive and negative aspects about pair trading or “delta neutral” trading but personally it’s a type of trading I enjoy because I am not trying to predict the overall direction of the market but rather a small universe of 2 stocks. I would not do only pair trading but as far as speculative trading, it has been a good recipe for us.

When I initiate the trade, I would go long and short the same amount, and thus be market neutral. As soon as the stocks start moving, I start getting a small exposure and that will remain the case until the trade is actually closed. For example, if the stock that is long gains 10% while the other does not move, I will be net long. If the initial bet was 2000$ on each side I would have 2200$ long and 2000$ short. It does remain very limited though.

Traps

Pair trading does have its share of traps however and for me, the Chinese market was one example. Going long a Chinese stock against an American one that is similar in nature was a trade that I enjoyed a lot and worked very well for me. Why? Because the Chinese stock usually displayed higher growth, and a smaller P/E for a comparable size. Seemed like an easy trade. But this year, the Chinese markets have suffered greatly and apart from Baidu (BIDU), most Chinese dot com companies have suffered declines. Which explains why I try to make different types of bets. I would never do 5 trades long of Chinese companies against American ones to avoid such traps.

Bigger bets

If you buy and sell for 2000$ of stock, you will have spent 0$ as you can imagine. However, you do need money to initiate such a trade because your broker will need to protect itself in case I lose money. Generally, they will require about 70% of that value as collateral. In this case, if I have 1400$ in my account, they will let me buy and sell 2000$ worth of stocks which gives me some type of leverage. That is why a 7% movement in the stock actually represents 10% or so for me because of this “leverage”.

No secret recipe

All of this having been said, pair trading has been working for me but like every other method, hard work and discipline are the keys to success in my opinion.

When writing about the single country ETF’s, I had mentioned that I anticipate a lot more ETF’s tracking foreign debt to be released in the upcoming years. This week, WisdomTree launched an ETF that could help gain new exposure to these markets. It is not corporate debt but rather national/sovereign debt but ELD certainly looks like it could fit in nicely in a dividend or a fixed income portfolio

Frankly, I don’t understand why there are not more ETF’s that cover sovereign debt. There is much more sovereign debt outstanding for emerging markets than for the US government and much more opportunities as well.

What is ELD?

ELD is a new ETF that was created by WisdomTree, it invests in sovereign debt that is:

-from emerging economies
-denominated in the local currency
-where foreigners can invest

It invests usually by buying government bonds or possible supra national bonds (IMF for example) or could also do swap trades based on these instruments.

In order to determine which countries should be invested in, WisdomTree uses a variety of criteria’s like the credit rating, inflation. debt ratios, CDS prices (which can be used to determine the default probability). The rebalancings are done quarterly and initially 17 countries are owned by the fund (14 of them are investment grade).  These countries are then ranked into 3 groups that determine how much weight they carry.

While most ETF’s track an index, ELD does not. It will be rebalancing in order to maximize return for limited

Historically, the performance of sovereign debt has been very solid. The return since 2003 has been 12% per year, a return that is very similar to that of US corporate bonds. However, the credit ratings of the sovereign debt is higher than the corporate bonds and they provide better diversification so I don’t see why they would not be included in a diversified portfolio.

Dividend Yield

The current yield in the basket is 6.80%. It is not clear if Wisdom Tree will have the ETF distributions be equal to that yield (as opposed to reinvesting into the fund or other options) but given how Wisdom Tree manages its other ETF’s, we can expect the dividend yield on ELD to be close to 6.80% which is considerable in the current environment and a good way to start building a dividend portfolio or add diversification to the one you currently have.

ELD vs EEM

When discussing asset allocation, I often hear talk about Emerging markets. But investing in emerging market ETF’s in an ETF like EEM or VWO is quite different from investing in sovereign debt through ELD. It’s not that one is superior to the other, they both have their pros and cons but I believe that both in the equity and fixed income portios of a portfolio, emerging markets have their place.

Pros

I have no doubt that a product like ELD will provide much needed diversification in a fixed income portfolio. I probably will not need to give you many numbers to convince you that the correlation between the return of a big financial institution and the government of Poland’s debt is very small. Also, the high yield of 6.80% might move over time but in general it will remain higher simply because many investors severely underweight foreign portions of their portfolios which provides great opportunities for those of us that don’t.

Cons

There is no doubt that a few more factors will influence returns on ELD. The interest rates, inflation rates and exchange rates will all have a significant impact on your return and will bring more volatility. That might cause dividend yields to rise and fall much more often than a domestic fixed income security. It could go in either direction though so you should not necessarily see it as a huge downside.Another con in my opinion is that since the ETF is not tracking an index, it will be more difficult to judge and evaluate the performance

Will I be buying?

I will personally probably be a buyer of this ETF in the near future. I will wait to see how exactly they are redistributing income from the fund but chances are good that you will soon see this ETF in my dividend portfolio. Just a side note, I don’t think that adding ETF’s to a dividend portfolio is that useful in general but in some cases such as this one, it would not be possible to add this type of exposure for an individual investor with this portfolio so I’m more than happy to try it out. How about you?

Watching the news for the past 2 weeks or so has brought some very disturbing images of Russia and of its capital Moscow which has been suffering from two major threats. First off, the worst heat wave in Moscow has been making life very difficult for its citizens. Even more critical have been the large fires that have been going on in the Western part of Russia. They have been so serious as to force the government to advise its citizens to stay home even in the capital because of the poor quality of the air.A major part of the worries has also been the impact of these fires on the agricultural economy in Russia, which is one of the top agricultural exporters in the world. It has had major impacts on prices of many grains such as wheat when the government confirmed that Russia would not be doing any exports this year in order to have sufficient resources for its own citizens which have already suffered too much with between 700 and 100 deaths already.

Every crisis has its opportunities

Like almost any other tragic event, there are opportunities and I wanted to take a look at a few ETF’s that could help profit from these opportunities. We could also go into specific companies but for now, let’s start with ETF’s, which provide an efficient way of playing these trends.

Russian economy

While it remains unclear how much this will end up costing in the short and medium term, estimates have started to be published. Barclays Capital has estimated that it would cost Russia around $15 billion, about 1% of its GDP. Where are these costs coming from? The most obvious origin is agriculture, which represents 4.6% of the Russian economy. A large portion of that will be lost this year. Obviously the effects of that slowdown will be widespread.

Another major factor is retail spending. About 20% of Russia’s retail spending takes place in Moscow, which has been in “shutdown mode” for a few weeks now and could be so for a some more time. A slowdown of the Russian economy, combined with tough conditions on other exports to China, the US and Europe (because of their own slowdowns) could mean a crisis in the BRIC member economy.

The flip side of course is that Russia is becoming less dependent on the oil and agriculture economies as it works on creating its own Silicon Valley. Research also shows that tax revenues from the government are up this year despite a flat oil price which confirms the theory of diminishing dependence on natural resources.

The two obvious plays on the Russian economy are trading its entire stock market or its currency (Ruble). Here are ETF’s that allow you to do just that:

We did mention  that some commodities would not be allowed to be exported from Russia and that has obviously already has signifcant impacts on some grains and by far the most significant is wheat. Just take a look at the wheat price movements in the past few weeks.

Unfortunately, there are no US ETF’s that track what. There is one in London such WEAT LN. But some grain ETF’s in the US do have a significant portion of their holdings in wheat. Here are the main ones to be considered:

And finally, another good way to play Russia has always been and continues to be energy plays. A huge part of the Russian economy depends on oil and natural gas. As goes the price of these two resources, as goes the Russian economy in many regards. You could take a bet that thanks to increasing oil prices, the Russian economy will largely espcae the problems. Here are the main crude oil ETF’s:

And main natural gas ETF’s

So what do you expect from the Russian economy and how would you play it?