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3 Economic Headwinds That Matter More Than You Think

It is not surprising to see central bank authorities describe current economic circumstances in glowing terms. Unfortunately, the U.S. economy may not be in the greatest shape. The jobs picture is not as rosy as the Fed would have us believe. Neither is household spending. Manufacturing is a mess, while the global economy is under serious pressure. Is the U.S. economy on solid footing? Federal Reserve Chairwoman Janet Yellen seems to think so. In particular, Yellen expressed confidence in household spending as well as job growth during prepared testimony before Congress on Thursday. It is not surprising to see central bank authorities describe current economic circumstances in glowing terms. Later this month, members of the Federal Reserve Open Market Committee (FOMC) hope to hike borrowing costs for the first time in nine years. Unfortunately, the U.S. economy may not be in the greatest shape for the Fed to act. For example, while the headline unemployment rate is only 5% – a condition that Yellen describes as close to full employment – the percentage of working-aged Americans (25-54) with a job has not been this low in more than three decades. (Back then, Michael Jackson was thrilling music fans with “Thriller” and Prince was going insane with “Let’s Go Crazy.”) Let’s examine the chart above in detail. The 25-54 year old demographic is the prime working-aged sector of the American population. Grammy and grandpa are not the ones who have stopped working entirely; rather, millions upon millions of 25-54 year olds are no longer counted as participants in the workforce. Indeed, when you strip out millions upon millions of working-aged individuals, your headline unemployment rate is going to move lower. Yet that’s not full employment. How can we be close to full employment when 19.3% of 25-54 year old Americans don’t hold a job? If you want to see genuine job growth, look no further than 1985-1989 and 1995-1999. During those periods, you see the percentage of 25-54 year olds with employment catapulting higher. During a five-year span (1989-1994) that encompassed the early 1990s recession? Jobs were hard to come by. That’s why one can see the flattening of the 25-54 year old demographic at that time. Similarly, one of the reasons that the mainstream media called the 2002-2007 economic expansion a “jobless recovery” was due to the flattening of the labor force participation rate in the 5-year run. How, then, can Fed committee members express so much confidence about labor market gains? At best, the chart might be showing signs of a bottoming process, where the new normal is a 19% rate of unemployed Americans (25-54). The rate of decline does appear to have slowed over the last few years. At worst? The pace of declines in the percentage of working-aged individuals who have left the workforce re-accelerates. Of course, Yellen did not merely point to labor gains in Thursday’s testimony. She described vibrant household spending in a nod to a service-oriented economy. What are the problems here? For one thing, families are planning to spend less in the coming year. According to the New York Fed Survey of Consumer Expectations, the median household expects its spending to grow a mere 3.47% as of mid-October, which happens to be near its lowest level in the survey’s two year history. Similarly, the Conference Board’s Consumer Confidence Index fell to 90.4. Not only did the reading on consumer confidence severely miss consensus estimates of 99.5, it was the lowest reading since September 2014. It gets worse. The personal savings rate hit 5.6% in October – the highest level since December of 2012. The combination of higher savings, lower confidence and plans to curtail spending habits hardly supports Yellen’s contention that household spending will be a bright spot. Of course, sometimes what Fed committee members don’t say about the economy is telling as well. Yellen seems entirely unperturbed by the manufacturing sector’s flirtation with recession. That was not the case in 2012 when the Federal Reserve unleashed its boldest stimulus measure to date – a third iteration of quantitative easing affectionately dubbed “QE3.” Then, the prospect of a manufacturing recession mattered. Now it’s irrelevant? From my vantage point, the manufacturing slide is very relevant. First of all, the more important service-oriented sector will have to demonstrate impressive acceleration to offset the drag of a shrinking manufacturing sector. (The personal savings rate, household spending plans and consumer confidence are not particularly supportive of such an offset.) Second, manufacturer struggles forewarn additional layoffs in high-paying jobs as well as ongoing corporate revenue declines at U.S. multinationals. Demand by foreign countries continues to wane. Granted, Yellen tried to boost morale when she explained that downside risks from abroad have lessened. Unfortunately, this one does not pass the sniff test. At least one financial institution, Citi (NYSE: C ), expects China to become the first major emerging market to slash interest rates to zero, precisely because of economic deceleration. Meanwhile, Brazil’s economy shrank by a monumental 4.5% in its most recent reading. The fact that Brazil’s gross domestic product fell by a record 4.5 per cent in its third quarter tells you that Latin America’s largest country is staring down the barrel of one of its worst recessions ever. Okay, then. The jobs picture is not as rosy as the Fed would have us believe. Neither is household spending. Manufacturing is a mess, while the global economy is under serious pressure. What does it all mean for stock investors? Well, if you believe perma-bull hype, stocks are in phenomenal shape. On the other hand, if you look beyond the S&P 500 – if you examine broader market indices like the New York Stock Exchange (NYSE) Index – you have reservations about overexposure to stock risk. Consider the admonition of billionaire hedge fund manager, David Tepper, in May of 2014. “Don’t be too frickin’ long.” That was 18 months ago. For those who insist that the stock market keeps grinding higher, broader stock market indices suggest otherwise. The commentary herein, and the caution that I have been expressing since early 2014, has focused on how one should position himself/herself in late-stage bull markets. Long-time readers understand that the majority of my clients still own long-time positions such as the Vanguard High Yield Dividend ETF (NYSEARCA: VYM ), the Technology Select Sector SPDR ETF (NYSEARCA: XLK ), the iShares USA Minimum Volatility ETF (NYSEARCA: USMV ) and the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ). What I have largely proposed over the last 18-21 months is that investors reduce their overall exposure to risk, lightening up on the asset class canaries – small caps, high yield bonds, commodity-related companies and emerging markets. In other words, don’t be too freakin’ long. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

High-Yield Utility That Has Fallen Off Everyone’s Radar

Summary Brookfield Renewable Energy yields 6.6%, over 1.6% higher than the typical utility that yields under 5%. The company is riding on the mega-trend train of a global growing demand in renewable energy, and the business has the expertise to bank on acquisition opportunities. The business forecasts dividend growth of 5-9% per year through 2020 and a long-term shareholder return of 12-15%. I’m primarily a dividend growth investor. So, current income and growth of that income is important to me. Utilities are typically known for their high yields. So, buying utilities, I expect a good part of returns to come from their dividends. The lower the price goes, the higher the yield climbs. That’s the case with Brookfield Renewable Energy Partners LP (NYSE: BEP ), as it has fallen over 18% from a year ago. (click to enlarge) Compared to most other popular utilities, Brookfield Renewable has performed quite poorly price-wise in the past year. Particularly, I’ve put it in a chart with Consolidated Edison, Inc. (NYSE: ED ), Duke Energy Corp (NYSE: DUK ), WEC Energy Group Inc (NYSE: WEC ), and Southern Co (NYSE: SO ). Source: Google Finance The utility group typically yields in the 4-5% range, and Brookfield Renewable stands out by yielding 6.6%. But, perhaps, that’s because it is viewed as higher risk with an S&P credit rating of BBB, while the others all have a rating of A-. BEP Dividend Yield (TTM) data by YCharts To consider it as a potential utility holding, the question you want answered is probably: “Is Brookfield Renewable Energy’s distribution sustainable?” First, let’s find out if it’s the kind of business you want to own. Business and Assets Brookfield Renewable has started investing in hydropower facilities 20 years ago. Today, it has become one of the biggest public pure-play renewable businesses with global assets. It focuses on accumulating long-life and low-cost assets that will continue generating cash flows. Since it requires deep operational knowledge and marketing expertise to enter the space, there’re significant barriers to entry. Brookfield Renewable has $19B worth of power assets, including around 250 power generating facilities across 14 markets in 7 countries. 81% of its 7,300 MW capacity is generated by hydroelectric facilities with about 18% generated by wind power. Currently, 50% of its assets are in the U.S., 25% are in Canada, 20% are in Brazil, and 5% are in Europe. Not Just an Income Play, But Also a Growth Play Demand for renewable energy has been growing. New investments in renewables around the globe have grown from $45B in 2004 to $270B in 2014, a CAGR of 19.6%. More recently, from 2013 to 2014, they grew at a rate of 16.4%, which is still admirable growth. Specifically, hydro power capacity grew at a CAGR of 4% over the decade, and 3.6% from 2013 to 2014. Although its growth only keeps pace with inflation, hydro power generation is low cost, and is more reliable than wind power generation. On the other hand, wind power capacity grew at a CAGR of 22.7%, and 16% from 2013 to 2014. In the last four years, Brookfield Renewable acquired and developed about 3000 MW, which is a CAGR of about 14%. How Does Brookfield Renewable Grow? Over the next 5 years, Brookfield Renewable plans to deploy over $3 billion of equity, expecting 15% returns. The focus will continue to be on hydro power generation, and acquiring global renewable assets at attractive prices. For example, in 2004, Brookfield Renewable acquired a 600MW capacity pumped storage asset with its 50% joint partner during a period of low power prices for $99M. It then entered into a 15-year contract that creates a predictable cash flow stream. At the same time, it’s not shy from selling for good profit as well. For example, in 2009, Brookfield Renewable acquired an early-stage wind power development project for $90 million. It finished constructing it and optimized operations by leveraging its wind expertise to maximize value. In July 2015, it sold the asset by attracting global bidders and generated an internal rate of return of about 30%. Like it did in North America and Brazil starting in 2011, Brookfield Renewable can continue its value creation process and repeat it in Europe, Latin America, and other new markets. A Safely Growing Dividend As Brookfield Renewable grows, it doesn’t forget to reward shareholders. From the distribution that commenced in 2011, it has grown from a quarterly distribution of 33.75 cents per share to 41.5 cents per share this year, a CAGR of 5.3%. About 90% of Brookfield Renewable’s cash flows have a 17-year average contract term with inflation-linked escalation, so its cash flows remain stable to support its distributions. Further, it targets an FFO payout ratio of 70%. With FFO expected to increase by $220-$280M a year, Brookfield Renewable forecasts distribution growth of 5-9% per year through 2020. Valuation Brookfield Renewable believes it’s intrinsically worth $34 a share even when excluding potential for rising prices, and existing project pipelines. At $25, it is discounted by over 26%. Adding in organic growth, the business believes it’s easily worth over $40 in the future, implying a significant discount of over 37%. (click to enlarge) Source: Brookfield Renewable October Investor Meeting – Slide 35 What Should Be Your Returns Expectation? Other than forecasting distribution growth of 5-9% per year through 2020, the business’s objective is to deliver long-term total returns of 12-15% to shareholders annually. With a current yield of 6.6% and the distribution estimated to grow at least 5%, that implies a rate of return of at least 11.6%, which is close to the low-end of that objective. Conclusion I just added to my position in Brookfield Renewable last week. How about you? Did you buy any utilities recently? Share in the comments below! If you like what you’ve just read, follow me! Simply click on the “Follow” link at the top of the page to receive an email notification when I publish a new article. Resources and References Brookfield Renewable October Investor Meeting ( pdf ) Brookfield Renewable November Presentation ( pdf ) Ren21 Renewables 2015 Report ( pdf )

November And YTD Asset Class Performance

The final month of the year is now upon us, but before thinking about December, let’s recap what happened across asset classes in November. Below is our matrix of key ETFs that highlights the recent performance of domestic and international equities, currencies, commodities and fixed income. For each ETF, we show its performance since the close on 11/20, during the month of November, and year-to-date through November. As shown, small-cap and mid-cap ETFs have done very well over the last ten days, and they outperformed for the month as well. The Russell 2,000 (NYSEARCA: IWM ) ETF gained 3.26% in November versus a gain of just 0.37% for the S&P 500 (NYSEARCA: SPY ). Looking at the ten U.S. sectors, Financials (NYSEARCA: XLF ) did the best in November with a gain of 1.99%, followed by Materials (NYSEARCA: XLB ), Industrials (NYSEARCA: XLI ) and Technology (NYSEARCA: XLK ). Outside of the U.S., just three of the country ETFs featured gained in November – Australia (NYSEARCA: EWA ), Germany (NYSEARCA: EWG ) and Japan (NYSEARCA: EWJ ). India (NYSEARCA: INP ) fell the most with a decline of 4.27%. For the year, Russia (NYSEARCA: RSX ) remains the big winner at +14%, while Brazil (NYSEARCA: EWZ ) is down by far the most at -38.4%. Commodities were crushed in November, with oil (NYSEARCA: USO ) and natural gas (NYSEARCA: UNG ) leading the way lower. Gold (NYSEARCA: GLD ) and silver (NYSEARCA: SLV ) both fell sharply as well. And while Treasury ETFs have bounced back since last Monday, they were down across the board for the month.