Global Stock Market BLOG - Mike Burnick

Japan Posts an Economic Surprise

"Japan's economy grew faster than economists estimated last quarter as exports to Asia and emerging markets helped the nation weather the U.S. slowdown" – Bloomberg

I did a major double-take when I read this lead-sentence from Bloomberg news last night.

I had just returned to my hotel room after a full day of exciting and very informative presentations at the Total Wealth Symposium here in Panama. Browsing online through my usual news sources – I couldn’t believe my eyes when I ran across this story.

That’s because just a few hours before this story was published online by Bloomberg, I spoke pretty much these same exact words in my afternoon workshop presentation here in Panama. So, was there a Bloomberg reporter sitting in the back of the conference room? I guess not, just one of those eerie coincidences… if you believe in that sort of thing.

As long-time readers of this blog know all too well, I’ve been very bullish on Japan since I first began buying this undervalued market (too early) last year. So the news of Japan’s better than expected first quarter GDP report was good-reading indeed!

Jason Clenfield, who actually DID write this story for Bloomberg (not me), does a great job (using some very familiar words), so I’ll let his words do some more talking…

“Gross domestic product expanded an annualized 3.3 percent in the three months ended March 31” – that was far better than economists had forecast but didn’t surprise me. The reason for this positive growth surprise: “A surge in shipments to emerging markets kept last quarter's growth above the average 2.1 percent of the past five years, even as exports to the U.S. fell for the quarter.”

As I have been pointing out for quite some time – and repeated again today for conference attendees here in Panama – Japan’s patterns of trade have changed – for the better. This is leading to much faster growth for Japan’s economy in the face of a sharp slowdown in the U.S. and Eurozone.

For the benefit of those of you keeping score at home, the U.S. economy expanded just 0.6% last quarter. Europe actually “beat” expectations… with growth of 0.7% last quarter… wow, that’s some “surprise”!

This graph clearly shows that Japan’s “best customers” in terms of export trade also happen to be among the world’s fastest growing economies – right in Japan’s back-yard – namely emerging Asia.

This trend goes back further, but just since 2000, Japan’s exports to the U.S. (as a % of total exports) have fallen from above 30% then… to just over 20% today. Exports to Europe have also declined as a share of Japan’s total.

So who’s picking up the slack?  Emerging Asia is importing more goods from Japan than ever before, led by China. Japan’s exports to China since 2000 have jumped from mid-single digits then, to about 15% now. Emerging Asia as a whole (including China) now accounts for nearly HALF of Japan’s total overseas shipments.

The entire Asia-Pacific region is becoming a fast-growing – and importantly – self-sustaining economic block… and Japan is benefiting in a very big way. Oh, and it just happens to be the world’s MOST undervalued major market too!

These are two very key factors in favor of higher Japanese share prices… at last.

Even in Panama, China is on My Mind

In Panama yesterday where I’m attending the Total Wealth Symposium, I got my first chance to rub elbows with Sovereign Society members from all over the world. The subject of China was on many people’s minds, judging from the number of questions I got.

Of course China just got thrust back into the headlines due to the tragic earthquake that hit the country recently, but the big issue on everyone’s mind is the future for China’s booming economy.

The contrast between China’s growth and stagnation in the U.S. is striking. I could go through mountains of economic data to prove the point, but two items in particular stand out…

1. China’s economy grew 10.6% last quarter – the fastest growth rate in the world. The U.S. economy grew 0.6% last quarter – the slowest growth rate in the world.

2. Retail sales figures were just released for both countries too. Last month U.S. consumer purchases declined -0.2%. In China, retail sales soared 24%

China’s output is growing nearly 10-times faster than in America. Due to the ongoing impact of the credit crunch, the U.S. economy faces the prospect of long-term stagnation. To be sure, China has its share of problems too.

The rate of inflation is close to 9% due to soaring food and energy costs. That’s a much bigger problem for China and other emerging markets than it is in the U.S. That’s because the average Chinese family spends a much higher share of their disposable income on the necessities of life – including food and fuel.

China is taking steps to try and reign in soaring inflation. Beijing has raised interest rates several times in the last year and has tightened bank lending. So far these measures don’t seem to be having much of an impact, judging by China’s 10.6% growth rate.

Of course economic growth doesn’t always correlate with stock market performance. In fact, China’s mainland markets in Shanghai and Shenzhen are down about 30% on a year to date basis – the world’s worst performing stock markets.

In my view, a better way to enter China now is through its neighbor Taiwan. Recent election results should lead to friendlier relations between the two Chinas – and that’s good for business. Taiwan is already very big investor in mainland China.

Profit opportunities in the mainland look a lot more attractive now, and are becoming easier for Taiwan investors to tap into.

Natural Gas Goes Global

I’m writing to you from Panama today where I’m attending the Sovereign Society’s Total Wealth Symposium. I’ll be here all week, and look forward to catching-up with many of our council of experts who traveled here from Europe, Asia, and elsewhere to bring their best investment and asset protection ideas to this conference.

Driving in from the airport yesterday it didn’t take long to see that the global energy crisis is hitting Panamanians pretty hard too. Gasoline here is over $4 per gallon, and according to our Panamanian cab driver – that’s producing intense sticker-shock at the pumps for consumers here.

Remember, Panama’s per-capita income isn’t on par with the U.S. so the average Panamanian is shelling out a lot more of his or her disposable income on fuel these days. As a consequence you don’t see many SUVs on Panama’s roads these days.

Crude Oil Isn’t the Only Energy Source Poised to Soar

I noticed that crude oil hit yet another record high overnight above $127 a barrel. With Sumer driving season getting ready to kick into high gear in a few weeks, we will soon be dealing with gas prices north of four bucks a gallon in the States too. It’s just a matter of time.

Another energy sector investment that’s been steadily climbing in price is natural gas, which I’ve written about before.

In addition to higher prices at the pump, there are good reasons to believe that natural gas will keep climbing too, even though prices in the U.S. have about doubled since last August. The problem here seems to be a familiar one: increased global competition for a scarce resource.

Up until the past few years, natural gas was a regional commodity. Most gas was consumed close to where it was produced. But now the market for natural gas is going global.

Asian Importers Have a Big Appetite for LNG

This increased global trade is made possible thanks to investment in high-tech liquefied natural gas terminals (LNG), that chills the gas to -260 degrees Fahrenheit, converting it to a liquid form. That makes it much more cost-effective for LNG tankers to transport gas across the world’s oceans.

Energy hungry countries in Asia, especially South Korea and Japan, have stepped up LNG imports in a big way, and they’re willing to pay-up for it. In fact, U.S. natural gas prices are pretty low by global standards, averaging about $10 per million BTUs in New York. In Japan and Korea, they’re willing to pay $14 for the same amount of gas. India is bidding $13.70 for LNG imports.

The inevitable result is that more U.S. gas is getting shipped overseas. LNG imports to the U.S. are also declining rapidly, as global producers prefer to sell to the highest bidders in Asia and elsewhere. Monthly imports of LNG to the U.S. have fallen 60% to 70% from peak levels of nearly 100 billion cubic feet in mid-2007.

With imported supplies falling this fast, and domestic natural gas producers able to sell at such a premium overseas, it’s just a matter of time before natural gas shoots higher in price too.

Another Not-So-Hot Earnings Season Comes to a Close

The vast majority of U.S. public companies have announced earnings for the first quarter of 2008, with just a few high-profile companies – such as retailer Wal-Mart (WMT) yet to report. With most of the numbers in, the results still don’t look pretty.

Overall, S&P 500 profits sank nearly 13% from a year ago. That’s quite a negative reversal of fortune, especially considering that back in January when the first quarter began, analysts were looking for an earning rebound from dismal fourth quarter results. That didn’t happen.

Once again the financial sector is largely to blame, with earnings plunging -67% in the quarter. It’s hard to believe, but that was even worse than analysts expected (-59%). This indicates that Wall Street’s rosy forecasts still haven’t caught up with reality.

There were a few bright spots however. Earnings in the technology sector (which I’m bullish on right now) rose 22% as did energy sector profits – the two strongest groups. Telecom sector shares surprised on the upside with a profit gain of nearly 11% vs. expectations of just 1.5% growth. Basic materials and consumer staples also performed well compared to forecasts.

According to some analysis I’ve read, if you exclude financials, first-quarter earnings rose 11% in the quarter over a year ago. Of course, you can’t really exclude financials, since this sector has a nearly 20% weighting in the S&P 500 Index. This reminds me of the tech-wreck early this decade when it became convenient for Wall Street to “exclude” plunging profits in the tech sector from the calculation.

The problem was that eventually other sectors caught up with the falling profits in the tech sector. Could 2008 be a repeat? Another troubling indicator is the fact that analyst estimates for the rest of this year still look too rosy. When earnings expectations are constantly being cut, it makes for a difficult environment for stocks.

This same trend is playing out – to a lesser degree so far – with earnings reports in Europe. Asian companies by contrast have continued to report very strong profit growth by and large, including the financial sector.

This week I’ll be traveling to Panama for the Sovereign Society’s Total Wealth Symposium. I’ll be eager to catch up with the European and Asian analysts who will be attending this conference. Stay tuned.

Don’t Look Now… But Mark-to-Make-Believe is On the Rise

Here's a little credit-crunch update for your consideration over the weekend...

Last year as the credit crunch market shock was just getting started, I wrote about accounting rule changes that signaled more trouble ahead for Wall Street’s big banks and brokers.

These troubles are now ballooning in value on the balance sheets of these firms. Watch out!

Here’s a quick refresher course on changes in the ground rules for this accounting shell-game. Last November a new accounting regulation from the Financial Accounting Standards Board took effect (FAS 157) that changes the way firms account for balance sheet assets. This new rule forces companies to “mark-to-market” their assets at the end of each quarter.

But it also allows firms to divide these assets into one of three categories. This change has had perhaps the biggest impact in the financial sector. Here’s how it works:

Level 1 assets have easily “observable market prices. Think of a company like Berkshire Hathaway (BRKA) for instance, which owns lots of Coca-Cola (KO) shares. That’s easy to value, just look up the quote on the NYSE. These assets have legitimate values.

Level 2 assets don’t have an easily “observable” price. These might be credit-default swaps or other derivatives, where you can have to “guess-timate” the value based on other market data such as Treasury yields. This is “mark-to-maybe” accounting; as in, maybe the value is right, and then again maybe it’s not.

Level 3 assets are the most opaque – if not totally fantasized. Here there are NO “observable prices”. Think of say, sub-prime mortgage backed securities, or leveraged loan securities – that don’t trade at all in this credit-challenged market.

Since there’s no market price available, the firm’s management and its bean counters have lots of leeway in making an “estimate”. This is what I call “mark-to-make-believe” accounting!

As in: I believe this Level 3 asset is worth a billion dollars today; maybe it’s only worth half-that (or even less), but let’s say it’s $1 billion this quarter and call it a day…

First Quarter Disclosures Show Soaring L-3 Assets on Wall Street

Now, if you fast-forward to the present, and look at some of the recent first-quarter financial statements from leading banks and brokers, guess what you’ll find?

Yep, Level 3 Assets are expanding fast! In spite of more than $320 billion in collective losses and asset write-offs (and still counting) taken by global financial firms so far, there’s still far too much mark-to-make-believe going on down on Wall Street.

Merrill Lynch (MER) has already written off nearly $32 billion in assets since the credit crunch began. But in the first quarter of 2008, Merrill’s hard to value Level 3 assets soared 70% to $82 billion, up from $48 billion in December.

Citigroup (C) has reported credit write-offs and losses of more than $40 billion so far. That didn’t stop Citi from reporting its Level 3 assets still climbed 20% last quarter to $160 billion!

Morgan Stanley’s (MS) illiquid assets jumped to $78 billion at the end of March. That's in addition to the $12.6 billion the firm has already written-off. At Goldman Sachs (GS), assets classified as Level-3 surged 39% to $96 billion last quarter.

How much, if any, of these illiquid asset values will ever be realized in cold hard cash is the multi-billion dollar question. Investors are right to be afraid (very afraid) of the day when Wall Street’s finest can no longer get away with this fantasyland asset pricing, and are forced to admit the ugly truth, there could be hundreds of billions more in losses.

That particular market shock is still lurking out there, cleverly hidden for the moment by Wall Street’s shell-game accounting rules. Stay tuned.

Is Gold Really Cheap, Or is Oil Just Expensive?

A feeding frenzy is taking place in the financial media about the prospects for oil prices reaching $200 per barrel.

Based on the sheer number of outlets who have picked up this story – and the volume with which they’re repeating it – you would think, perhaps crude will reach this forecast “target” sometime next week, if not sooner.

Yesterday’s Financial Times ran a short story and interesting graph that compares the price of gold to that of crude oil over time (a similar graph from the folks at www.zeal.com is below).

The upshot of the story is that commodity investors, eager to seize on any opportunity to reinforce their bullish long positions, are now focusing on the historic gold-oil ratio.

This ratio is said to be a good measure of the relative value between these two “headline” commodities. The article points out that “a common refrain of goldbugs is that an ounce of gold now buys less than eight barrels of oil, against a long-run average of just under 16. On that basis, gold is cheap and ought to rise as it reverts back to its ‘mean’.”

Of course this “long-run" ratio of 16 has often strayed far and wide from that mean. In fact the ratio has been over 30 and below 10 at extremes. It’s said that historically, whenever the ratio rises above 25, oil is cheap relative to gold. Likewise, whenever the ratio falls below 10, gold is a bargain compared to oil.

The article correctly points out that “making judgments on the future through a backward-looking ratio of market-set prices is nonsensical.” This reminds me of the old rule of thumb on Wall Street in the pre-1990’s era that said stocks aren’t cheap enough to buy until you get a single digit price-earnings ratio.

Investors who religiously followed that ratio “signal” have been on the sidelines – for the past 25 years – still patiently waiting for the next buying opportunity in stocks!

Still, the gold bugs will tell you the yellow metal is a screaming buy at today’s gold-oil ratio reading of about 8, and they may be right on the money. But, what happens if you turn this ratio upside-down and take another look?

Then the ratio may be telling us that instead of gold being dirt cheap at $869 an ounce – perhaps crude oil is too expensive at $122 a barrel!

In fact, both gold and oil have suffered sharp corrections during the extraordinary bull-run they’ve jointly enjoyed this decade.

Nearly every time there has been a break in the uptrend, it was gold that peaked first and started to correct in price ahead of oil.

Gold has declined about 15% from its recent peak above $1,000 an ounce, yet crude oil keeps setting new record highs. Something’s got to give – I’m betting it’s the price of crude. Stay tuned…

Brazil Finally Makes the Grade

Last week Brazilian financial markets got a good reason to celebrate as credit rating agency Standard & Poor’s finally elevated the country to “investment grade” status.

This comes as no surprise to me. In fact it serves as an epilogue to Brazil’s long story of economic success over the past decade. Since the end of 2000 Brazil’s Bovespa Index has been one of the world’s best performers gaining about 500%! So what will Brazil do for an encore?

I’ve been bullish on Brazil for a very long time. Last year I recommended the iShares Latin America Index ETF to Sovereign Society readers, which has a heavy allocation in this dynamic economy. The last time I wrote about Brazil in these pages (Amid Global Credit Crunch, It’s “Business as Usual” in Brazil) I described how the country has largely side-stepped the credit crunch turmoil that has impacted stock markets around the world.

Brazil’s Future is Now

In fact, Brazil’s Bovespa is one of just a handful of global indexes that’s actually posting year to date gains – up about 10% so far in 2008. For years investors derisively said that, Brazil is the country of the future… and it always will be!

The implication being that this vast resource rich nation has lots of potential… if it could only harness it and get its act together.

In recent years, Brazil finally got its fiscal house in order, paying off most of its foreign debts. Inflation, which ran over 1,000% in Brazil just ten years ago, has now been wrung out of the economy allowing interest rates to come down.

Today, Brazil is a creditor nation. It’s once shaky currency appreciated 22% against the U.S. dollar over the past 12 months! Brazil’s stock market is soared as its economy is humming along with robust growth of 6.6% in last year’s final quarter, compared to just 0.6% growth for the U.S. economy.

What a Difference an Extra “B” Makes

Given Brazil’s economic successes, it’s really no surprise that S&P elevated the nation’s credit rating from BB+ (junk bond status) to BBB- (investment grade) last week… what a difference an extra B makes.

The financial press was full of stories about how this ratings upgrade should lower Brazil’s cost of capital (true) and help deepen its financial markets by attracting more global capital flows (also true).

These are all very bullish arguments in favor of Brazil’s long-run growth potential. But 500% later, Brazil is really no secret to global investors anymore. Brazil’s booming economy is of course rich in natural resources. Leading companies such as CVRD and Petrobras come to mind.

The Next Great Buying Opportunity in Brazil

This dependence on resources has been one of Brazil’s greatest strengths in recent years, as commodity prices have soared.

However, it could also prove to be a weakness should commodities correct sharply.

The challenge for Brazil now is to diversify its economy away from such a heavy reliance on resource exports – and more toward internal consumption.

The country’s new investment-grade credit rating will help attract the capital needed to make this transition a reality.

In the meantime, if commodity markets correct more sharply in the months ahead – as I expect – it should provide another excellent long-term buying opportunity in Brazil.

Buffett Loses a Billion Dollars

Shareholders of Berkshire Hathaway (BRKA) got their “fix” this weekend as the Oracle of Omaha held center stage at the company’s annual meeting. One of the more interesting topics NOT covered much by the financial press, was how Berkshire managed to post a $1 billion first quarter investment loss!

In fact, during the run-up to this past weekend’s “Woodstock of capitalism,” I didn’t hear much on CNBC about Berkshire Hathaway’s report Friday that first quarter profits plunged 64% from a year ago

It’s not that people aren’t saving a lot of money anymore by switching to Geico.

In fact, Berkshire’s insurance operation are performing very well, thank you. Buffett’s entire shortfall came not from Berkshire’s operating businesses. The loss came from the investment side of the company, specifically from derivatives contracts.

Financial Weapons of Mass Destruction, Hard to Value in a Credit Crunch

That’s perhaps surprising that Buffett, known for his legendary value investing acumen, could lose a billion on investments.

No, Warren Buffett hasn’t lost his touch either. In fact, Berkshire’s quarterly shortfall shows the one of the pitfalls to investing these days amid the credit crunch, and complying with new accounting rules that can lead to wide valuation swings.

It is perhaps ironic that Berkshire would report a rare quarterly loss as a result of derivates, which Buffett himself has called “financial weapons of mass destruction.” But these losses can befall any financial firm, and they’re becoming much more frequent than ever before.

Berkshire booked a loss of nearly $500 billion on credit default swaps intended to protect against junk bond defaults. The larger share of the hit, at $1.2 billion was recorded for unrealized losses on long term put option contracts Berkshire wrote on the S&P 500, and other stock indexes.

This is a stark illustration of the unpredictability that’s created by new mark-to-market accounting rules. Berkshire’s loss is due to the fact that these derivatives contracts have temporarily moved against Buffett. Rather than ignoring the impact until sold, the new accounting rule compels firms like Berkshire to mark down the current value of these derivatives to reflect today’s market value instead of “cost.”

Mark to Market is Mostly a Good Thing, But Can Lead to Wide Valuation Swings... Just Ask Warren

In explaining this loss Buffett said that he’s not “bothered by these swings even though they could easily amount to $1bn or more in a quarter”.

Many other companies, particularly in the financial sector, have blamed larger than expected losses on the new mark-to-market rules. In fact, this accounting practice also had a hand in General Electric’s (GE) surprising first quarter earnings miss – all of which came from GE’s large financial services business.

Mark to market accounting is generally a good policy for creating more transparency in the financial sector. At the end of each quarter, four times every year, investors get to see exactly what a firm’s various investment contracts are worth... at fair market prices.

Mark-To-Market Can Lead to Negative Accounting Distortions

In an era of “creative” financial products that are very difficult to even understand, much less value, mark-to-market accounting can negatively distort a company’s financial position too. Such was the case with Berkshire’s nearly $1 billion net loss from investments last quarter.

During a credit crunch, financial markets are essentially grid-locked with sharp slowdowns in trading for many securities. Trying to mark-to-market these already illiquid securities can result in assigning a price that’s anything but “fair.”

Fire-sale prices might be a more accurate description. In many cases the unrealized losses that result are much worse than would be necessary in a normally functioning credit market.

Investor’s should keep this potential negative accounting aberration in mind whenever valuing a financial stock. Judging from the turnout of adoring fans at last weekend’s annual meeting, Berkshire Hathaway’s shareholders seem unfazed by Buffett’s billion dollar loss.

Reversal of Fortune: Markets Go From Worst to First in April

Happy May Day!

It’s hard to believe that summer’s heat (and Hurricane season) is almost here. As the calendar turns to another month it’s often quite interesting to take a look back at the month that was... to see which trends may be in for a switch.

One phrase comes to mind that perfectly sums up April’s market action: reversal of fortune! From November through March U.S. stocks (and most global equity markets) suffered a string of five-straight monthly declines. That’s a very rare occurrence that has only been seen on a handful of occasions in the past 40 years.

Sure enough, April saw a sharp reversal of the five-month downtrend. The Dow Jones Industrial Average had fallen over 11% at the March low. But the Dow got up off the mat in April to post a 4.5% gain. The Dow wasn’t alone. In fact, international stock markets pulled off much more dramatic reversals.

Japan is perhaps the most striking turnaround. I’ve been bullish on Japan since last year... and had been proven dead wrong through March. But Japan rallied strongly last month – soaring 11% in April alone – it’s biggest single-month gain since 1995! That’s 13 years ago.

In spite of this rally, Japan remains one of the world’s most undervalued major markets, but now it looks like global investors are catching on.

Honk Kong, another one of my favorite overseas markets, also pulled off a major turnaround in April.

After a drubbing of -18% in the first quarter of 2008, the Hang Seng Index jumped 13% last month.

Taiwan, another favorite, rose 4% in April. Mainland China too bounced back 6.3% last month. But Shanghai shares still have lots of “heavy lifting” ahead – as they’re still down 30% year to date.

Perhaps the biggest surprise was commodities. Gold and crude oil rallied pretty much in tandem through the end of 2007 and early 2008. Oil was up another 12% in April – adding to gains of nearly 20% year to date.

The yellow metal however declined nearly 6% last month. That’s gold’s second consecutive monthly decline; perhaps this precious metal will go for five in a row too!

Of course last month’s market action could prove very fleeting indeed. And I doubt that the ultimate “bottom” of this bear market has yet been reached. However, with such broad-based strength in equity markets around the world, we may be in for a decent rally that has some legs.

Yesterday, the Fed cut rates again as I expected to 2%. The financial media seems convinced that the Fed intends to “pause” sometime soon. That has helped the beleaguered U.S. dollar (talk about a bear market!) to stabilize somewhat.

If the buck can stage a more convincing reversal of fortune at this point, I would expect commodities to correct further, while global stocks (particularly emerging markets) should continue to get a boost. Stay tuned...

“Holy Grail” of ETFs Looks Like a Dead-End to Me

The world’s first actively managed exchange-traded fund (ETF) – the industry’s long sought-after “holy grail” has finally been realized at last, or so the industry would have you believe.

After years of discussion between fund sponsors and regulators, the ETF sector finally has its first actively managed ETFs.  Invesco PowerShares last week launched four new ETFs on the New York Stock Exchange, after being granted regulatory approval.

Since the very first ETF was launched 15 years ago they have quickly become one of the hottest investment vehicles of all time. Assets under management in ETFs soared 30% last year alone to nearly $560 billion. ETFs have proven especially popular among affluent investors.

It’s worth noting here that the very first ETF launched in 1993 was designed to track the S&P 500 Index. That’s been one of the key advantages to ETFs all along. That’s a key advantage that actively managed ETFs don’t have in their favor.

Index Tracking ETFs Keep Costs Low

Up until now, each of the hundreds of ETFs listed is designed to track an index. There are ETFs that track stock indexes, ETFs that follow bond indexes, ETFs that track commodities, real estate, specific sectors… you name it.

Index tracking ETFs, like the Vanguard index mutual funds that came before them, are very low cost investments. No active management means no high management fees. As a result, the average expense ratio for ETFs is less than 0.4%, while actively managed mutual fund expenses average 1.2% -- three times higher!

Investors are attracted to ETFs for this very reason (among others)… low fees. Lower fees mean higher investment returns. Compound that over enough years in the market, and it’s easy to see why index ETFs are so appealing. In fact, they tend to outperform most mutual funds.

Who Needs Actively Managed ETFs Anyway?

According to Bruce Bond, CEO of PowerShares, the introduction of actively managed ETFs “is a watershed event for the industry because people have not had access to active management within the ETF structure before now.” Bond claims that active ETFs will transform the industry landscape. Somehow, I seriously doubt that.

There are more than 10,000 conventional mutual funds in existence today. The vast majority of these are actively managed funds, with high-priced fund managers collecting fat fees in return for their investment skills.

Sadly, over 90% of these actively managed mutual funds cannot beat the market index return; most fall well short in fact. In other words, investors are paying higher management fees for nothing. No wonder index-tracking ETFs are so popular.

Other big advantages of ETFs are liquidity and transparency. Actively managed mutual funds can only be bought once a day, at the end of the day, when financial markets are closed. ETFs  by contrast are listed on major stock exchanges and can be bought and sold throughout the trading day, minute by minute, and tick by tick.

Transparency: Another Key Advantage is a Roadblock for Actively Managed ETFs

With ETFs you always know what you own. That’s because regulators require ETF sponsors to disclose all their positions every day.  Mutual funds are only required to disclose fund holdings once every six months.

One of the stumbling blocks that PowerShares new actively managed ETFs had to overcome was this transparency issue. Active fund managers – that is the few ace managers who actually can beat the market – like to keep their investment strategies under wraps to some extent. If other investors could plainly see what they’re buying then those stocks would shoot higher, eliminating the active manager’s edge.

According to one industry expert, if “you talk to any active manager that actually has skill, they don't want to disclose what they have every day… that’s the last thing any money manager wants.”

As a result, I very much doubt that actively managed ETFs will attract many talented money managers who could earn much more money by running traditional mutual funds (not to mention hedge funds). Far from being a “watershed event”, the holy grail of actively managed ETFs just doesn’t make much sense to me.

Instead of transforming the industry, active ETFs look like they’re dead-on-arrival in my opinion.