Tag Archives: applicationtime

Are Rate Spreads And Volatility Good Market-Timing Indicators?

Summary This is part of a research on systemic market indicators. A summary on two rate spreads and the VIX index used as market timing indicators. A reminder of a 4-component systemic indicator presented in a former article. MTS (Multi-Timing Scores) are systemic aggregate indicators, focused on a long-term investing horizon and including the 4 main categories of market analysis: sentiment, economy, fundamentals, technicals. MTS10 is used in GHI Premium Service to send market timing alerts and size a hedge according to the systemic risk. A GHI subscriber asked me if adding parameters on credit spreads and volatility might improve it. Here is a summary of my thoughts on 3 related indicators. 10-year / 3-month spread Yield curve inversion (when long-term yields fall below shorter-term yields) has been studied in academic publications as a predictor of economic recessions in the US and other countries. The most studied data in the U.S. is the spread between rates of the 10 year bond (NYSEARCA: IEF ) and the 3 month bill (NYSEARCA: BIL ). It has worked quite well to predict recessions since 1960, with only 1 miss (the spread didn’t cross the zero line before 1960 recession) and two false signals in 1966-67. However, it gives little information about the timing. It just tells that a recession may happen in the next 6 to 20 months. Moreover, the signal (negative spread) may have disappeared before the recession really starts. It looks useful for economists and politicians, but of little help for investors. (click to enlarge) Source: New York FED As the average elapsed time between a negative spread and a recession is about 1 year, some economists have inferred a probability of recession 12 months ahead. This method predicts a probability of recession below 5% until June 2016. (click to enlarge) TED Spread The TED spread is the difference between the 3-month LIBOR and the 3-month U.S. T-bill rate. For this one, a spike is a bad omen. It did a good job at “predicting” the 1987 crash (in fact I doubt that someone was interested in it at this time) and the 2008 recession. But it was late in 1990, gave a bunch of false signals, missed the 2001 recession, and gave a late signal in 2011 during the latest meaningful market correction. (click to enlarge) Source: Saint Louis FED VIX index The VIX index measures an aggregate implied (expected) volatility on S&P 500 stocks calculated from their options. It is known as the “fear index” and may be seen as an indicator of the cost of insurance against a large market move. It usually goes up when stock indices go down. The VIX can be traded using futures, options and ETNs ( VXX , VXZ ). Two of its most interesting properties are: an attraction to its moving averages a higher probability to go up again after a day up The risk increases when the VIX goes away from its average to the downside (a sign of possible complacency) or to the upside (a sign of nervousness). It is easier to put a trigger on the downside because both properties above play in the same direction. They are opposite when the VIX goes up, making the game riskier. The next chart represents the equity curve of investing in SPY , and going in cash when the VIX is below 2% under its 10-day simple moving average (benchmark in blue is SPY “buy-and-hold”). The choice of a 10-day sma is not random, it is well-known by traders interested in the VIX. (click to enlarge) Source: portfolio123 The chart looks great, but there are a lot of intra-week signals. Global Household Index is weekly. The performance of a weekly signal is much less attractive: (click to enlarge) It is even worse with a 0.1% rate for transaction cost ($10 for $10k): (click to enlarge) I think the VIX may be very useful in setups for swing-traders, much less for investors with a mid-term or long-term horizon. This is not an original idea: in this article Mark Hulbert came to the same with other arguments. Conclusion : The 10-year / 3-month credit spread is a good recession predictor, but not a good timer. The TED spread has given timely qualitative signals twice in the past, but signals were late, missing or flawed in other cases. I didn’t find a way to use it in a quantitative indicator. The VIX index gives signals that can be used as confirmations by traders, but doesn’t seem to be a great help for investors working in weekly or longer time units. I don’t plan to integrate these indicators in my market timing scores. MTS10 components cannot be disclosed here. Interested readers can use for non-commercial purposes ( CC BY-NC 4.0 International License ) an open-source variant with 4 indicators (MTS4). It is less robust and more sensitive to economic data revisions. The component indicators are S&P 500 companies’ average short interest (bearish when the 52-week sma is above the 104-week sma); unemployment (bearish when above its value 3 months earlier); S&P 500’s current-year EPS estimate (bearish when below its value 3 months earlier); and S&P 500’s price (bearish when the 50-day sma is below the 200-day sma). When all four are bearish, it’s time to go in full hedge. This page explains how to get a limited free access to MTS4 in a popular screener, backtest it and get its value at any time. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

5 Ways To Beat The Market: Part 4 Revisited

Summary •In a series of articles in December 2014, I highlighted five buy-and-hold strategies that have historically outperformed the S&P 500 (SPY). •Stock ownership by U.S. households is low and falling even as the barriers to entering the market have been greatly reduced. •Investors should understand simple and easy to implement strategies that have been shown to outperform the market over long time intervals. •The fourth of five strategies I will revisit in this series of articles is consistent dividend growth investing which has seen these stocks produce higher risk-adjusted returns over time. In a series of articles in December 2014, I demonstrated five buy-and-hold strategies – size, value, low volatility, dividend growth, and equal weighting, that have historically outperformed the S&P 500 (NYSEARCA: SPY ). I covered an update to the size factor published on Wednesday, posted an update to the value factor on Thursday, and published an update on the low volatility anomlay on Friday. In that series, I demonstrated that while technological barriers and costs to market access have been falling, the number of households that own stocks in non-retirement accounts has been falling as well. Less that 14% of U.S. households directly own stocks, which is less than half of the amount of households that own dogs or cats , and less than half of the proportion of households that own guns . The percentage of households that directly own stocks is even less than the percentage of households that have Netflix or Hulu . The strategies I discussed in this series are low cost ways of getting broadly diversified domestic equity exposure with factor tilts that have generated long-run structural alpha. I want to keep these investor topics in front of the Seeking Alpha readership, so I will re-visit these principles with a discussion of the first half 2015 returns of these strategies in a series of five articles over five business days. Reprisals of these articles will allow me to continually update the long-run returns of these strategies for the readership. Dividend Aristocrats While people can complicate investing in a myriad of ways, only two characteristics ultimately matter – risk and return. My personal and professional investing revolves around the simple maxim of trying to earn incremental returns for the same or less risk. The strategy highlighted below has accomplished this feat over long time horizons, and is easily replicable in financial markets. In addition to the bellwether S&P 500, Standard and Poor’s produces the S&P 500 Dividend Aristocrats Index . (Please see linked microsite for more information.) This index, which is replicated by the ProShares S&P 500 Dividend Aristocrats ETF (NYSEARCA: NOBL ), measures the performance of equal weighted holdings of S&P 500 constituents that have followed a policy of increasing dividends every year for at least 25 consecutive years. To put this into perspective, the average S&P 500 constituent now stays in the index for an average of only eighteen years , so the list of companies who have had the discipline and financial wherewithal to pay increasing dividends for an even longer period is necessarily short at 52 companies (10.4% of the index). Detailed below is a twenty-year return history for this index relative to the S&P 500. The Dividend Aristocrats have produced higher average annual returns, outperforming the S&P 500 by 2.4% per year. This approach has also produced returns with roughly three-quarters of the risk of the market, as measured by the standard deviation of annual returns as demonstrated in the cumulative return profile graph and annual return series detailed below: (click to enlarge) (click to enlarge) Source: Standard and Poor’s’ Bloomberg Notably, the Dividend Aristocrats outperformed the S&P 500 in every down year for the latter index (see shading above), gleaning part of its outperformance through lower drawdowns in weak market environments. Another notable factor of the dividend strategy is that when it underperformed the S&P 500 by the largest differential (1998, 1999, and 2007) the market was headed towards large overall losses. Maybe then it is a negative sign that the underperformance of the Dividend Aristocrats in the first half of 2015 was its largest since the 2007 top. The Dividend Aristocrats posted their first negative return for a half-year since 2010. Perhaps, this correlation between Dividend Aristocrat underperformance and market tops is spurious and not a leading indicator, but it makes sense that prior to the tech bubble burst in the early 2000s that the Dividend Aristocrats naturally featured less recent start-ups because of the long performance requirements for inclusion. It also makes sense that when markets were heading to new all-time highs in 2007, the market correction in 2008 would be less severe for the high quality constituents in the Dividend Aristocrats index, which have demonstrated the ability to manage through multiple business cycles. I have now dedicated several paragraphs to dividend growth investing in companies with a policy to offer consistent and growing dividends without addressing the elephant in the room. Do dividends matter?! Certainly academics have long contested that dividends should not matter to the value of the firm, and can even be inefficient given shareholder taxation. Absent taxes, investors should be indifferent between a share buyback and a dividend, which are different forms of the same transaction – returning cash to shareholders. Paying dividends when the firm has projects that can earn a return above their cost of capital would lower the value of the firm over time. Merton Miller, Nobel Prize winner and one of the fathers of capital structure theorem, tackled the debate in a 1982 paper entitled ” Do Dividends Really Matter .” My takeaway from his qualitative analysis is that paying consistently rising dividends is a discipline that ensures that the company is appropriately levered and making well planned investment decisions. In Friday’s update article on exploiting the Low Volatility Anomaly , I demonstrated that lower risk stocks have outperformed the broader market and higher risk stocks over the last twenty plus years in markets around the world. The business model of Dividend Aristocrats must be inherently stable and produce continual free cash flow through the business cycle or these companies would not be able to maintain their record of paying increasing dividends for over a quarter century. The return profile of the Dividend Aristocrats is much more correlated to the S&P Low Volatility Index ( SPLV , r= 0.92) than the S&P 500 (r = 0.84 ), which lends credence to the strategy’s low volatility nature and stability through differing market environments. I have chosen to detail the Dividend Aristocrats and Low Volatility stocks separately because I believe part of the strong performance of the Dividend Aristocrats is also attributable to the fifth factor tilt highlighted in my concluding article in this series update to be published tomorrow. Disclaimer: My articles may contain statements and projections that are forward-looking in nature, and therefore inherently subject to numerous risks, uncertainties and assumptions. While my articles focus on generating long-term risk-adjusted returns, investment decisions necessarily involve the risk of loss of principal. Individual investor circumstances vary significantly, and information gleaned from my articles should be applied to your own unique investment situation, objectives, risk tolerance, and investment horizon. Disclosure: I am/we are long NOBL, SPLV, SPY. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

How To Avoid The Worst Style ETFs: Q2’15 In Review

Summary The large number of ETFs has little to do with serving your best interests. Below are three red flags you can use to avoid the worst ETFs. The following presents the least and most expensive style ETFs as well as the worst overall style ETFs per our 2Q15 sector ratings. Question: Why are there so many ETFs? Answer: ETF providers tend to make lots of money on each ETF so they create more products to sell. The large number of ETFs has little to do with serving your best interests. Below are three red flags you can use to avoid the worst ETFs: 1. Inadequate Liquidity This issue is the easiest to avoid, and our advice is simple. Avoid all ETFs with less than $100 million in assets. Low levels of liquidity can lead to a discrepancy between the price of the ETF and the underlying value of the securities it holds. Plus, low asset levels tend to mean lower volume in the ETF and larger bid-ask spreads. 2. High Fees ETFs should be cheap, but not all of them are. The first step here is to know what is cheap and expensive. To ensure you are paying at or below average fees, invest only in ETFs with total annual costs below 0.49%, which is the average total annual cost of the 289 U.S. equity Style ETFs we cover. Figure 1 shows the most and least expensive Style ETFs. QuantShares provides three of the most expensive ETFs while Schwab ETFs are among the cheapest. Figure 1: 5 Least and Most-Expensive Style ETFs Sources: New Constructs, LLC and company filings Investors need not pay high fees for quality holdings. Arrow QVM Equity Factor (NYSEARCA: QVM ) earns our Very Attractive rating and has low total annual costs of only 0.72%. On the other hand, no matter how cheap an ETF, if it holds bad stocks, its performance will be bad. The quality of an ETFs holdings matters more than its price. 3. Poor Holdings Avoiding poor holdings is by far the hardest part of avoiding bad ETFs, but it is also the most important because an ETF’s performance is determined more by its holdings than its costs. Figure 2 shows the ETFs within each style with the worst holdings or portfolio management ratings . Figure 2: Style ETFs with the Worst Holding Sources: New Constructs, LLC and company filings State Street, iShares, and PowerShares appear more often than any other providers in Figure 2, which means that they offer the most ETFs with the worst holdings. Our overall ratings on ETFs are based primarily on our stock ratings of their holdings. The Danger Within Buying an ETF without analyzing its holdings is like buying a stock without analyzing its business and finances. Put another way, research on ETF holdings is necessary due diligence because an ETF’s performance is only as good as its holdings’ performance. PERFORMANCE OF ETF’s HOLDINGS = PERFORMANCE OF ETF Disclosure: David Trainer and Max Lee receive no compensation to write about any specific stock, style, or theme. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.