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Guard Against Rising Rates With These ETFs

The latest Fed meeting saw mixed reactions from investors. As expected, the Fed remained dovish on rate issues citing a slowing job market, moderating U.S. economic growth, subdued inflation and most importantly, a shaky global market. All these issues were discussed in the September meeting itself and the investing world had pushed back the timeline of the lift-off to early next year, presuming a delayed U.S. economic rebound. But to their utter surprise, the Fed kept the December timeline on the table. A keen watch on employment and inflation data is now crucial for the U.S. monetary policy in the December meeting. After all, the global market turmoil has eased now with the Chinese economy resorting to fresh rate cuts and the ECB hinting at a stepped-up QE measure. The dual dose was sturdy enough to bring the global economy back on the growth path and encourage the Fed to mull over a December hike. Investors rapidly shifted their bets with futures contracts entailing a 43% December hike possibility compared with 34% preceding the statement. In anticipation of a faster lift-off, the 10-year Treasury bond yields jumped 14 bps to 2.19% in the two days (as of October 29, 2015). Given this, investors might seek to safeguard themselves from higher rates. For them, we highlight a few investing strategies and the related ETFs: Say Yes to Zero or Negative Duration Bonds Rising rates result in increasing losses for bonds since bond price and yields are inversely related to each other. As a result, zero or negative duration bonds are less vulnerable and better hedges to rising rates. Negative duration bond ETFs offer exposure to traditional bonds while at the same time short Treasury bonds using derivatives such as interest-rate swaps, interest-rate options and Treasury futures. The short position will diminish the fund’s actual long duration, resulting in a negative duration. As a result, these bonds could act as a powerful hedge and a money enhancer in a rising rate environment. The zero duration funds include the WisdomTree Barclays U.S. Aggregate Bond Zero Duration ETF (NASDAQ: AGZD ) and the WisdomTree BofA Merrill Lynch High Yield Bond Zero Duration ETF (NASDAQ: HYZD ) while negative duration funds include the WisdomTree Barclays U.S. Aggregate Bond Negative Duration ETF (NASDAQ: AGND ) and the WisdomTree BofA Merrill Lynch High Yield Bond Negative Duration ETF (NASDAQ: HYND ) (read: Negative Duration Bond ETFs: Right Time to Bet? ). Stick to Floating Rate Bond ETFs A floating rate note is a bond with a coupon that is indexed to a benchmark interest rate. Some of the popular benchmarks include LIBOR and Treasury rates. Since the coupon is adjusted to reflect market interest rates, at a regular interval, these bonds are less sensitive to increases in rates compared with traditional bonds with fixed rate coupons, which lose value as the rates go up. The i Shares Floating Rate Bond ETF (NYSEARCA: FLOT ) and the SPDR Barclays Capital Investment Grade Floating Rate ETF (NYSEARCA: FLRN ) are some of the floating rate bond ETFs to watch. Cycle into Cyclical Sectors Investors should note that rising rates are synonymous with economic improvement. Cyclical sectors like technology and consumer discretionary should perform better ahead. The Market Vectors Retail ETF (NYSEARCA: RTH ) and the PowerShares Dynamic Leisure & Entertainment Portfolio ETF (NYSEARCA: PEJ ) are a couple of consumer discretionary ETFs to watch. The SPDR S&P Semiconductor ETF (NYSEARCA: XSD ) and the PowerShares Nasdaq Internet Portfolio ETF (NASDAQ: PNQI ) are technology ETFs that investors can try out. Most importantly, a rising rate scenario is a great backdrop for financial ETFs as this corner of the market should soar on improving interest rate margins. This is because banks borrow money at short-term rates and lend the capital at long-term rates thereby benefitting from a widening spread between long- and short-term rates. Financials ETFs like the Financial Select Sector SPDR ETF (NYSEARCA: XLF ) and the SPDR S&P Bank ETF (NYSEARCA: KBE ) are some of the financial ETFs to be considered for gains (read: Guide to the 7 Most Popular Financial ETFs ). Withdraw Rate-Sensitive Sectors There are a few sectors that are highly associated with the Fed’s interest rate policy. Sectors like utilities and real estate are known for their high dividend payout and require huge infrastructure, leading to an immense debt burden and the consequent interest obligation. As a result, these sectors underperform in a rising rate environment. So, investors need to turn aside these sector ETFs or rather bet on inverse utility or real estate ETF to cash in on rising rates. The ProShares UltraShort Utilities ETF (NYSEARCA: SDP ) and the ProShares Short Real Estate ETF (NYSEARCA: REK ) are some of the opportunities in this field. Satiate Income Need with High Yield ETFs In this backdrop, yield-loving investors might be looking for ways to beat the benchmark Treasury yield and yet enjoy decent capital gains. Senior loan, preferred stock and business development ETFs could fit the bill for high-yield seekers. Senior loans are issued by companies with below investment grade credit ratings. In order to make up for this high risk, senior loans normally have higher yields. Since these securities are senior to other forms of debt or equity, senior loans give protection to investors in any event of liquidation. The PowerShares Senior Loan Portfolio ETF (NYSEARCA: BKLN ) and the Highland/iBoxx Senior Loan ETF (NYSEARCA: SNLN ) are examples of two senior loan ETFs yielding 3.97% and 4.23% as of October 29, 2015. Preferred stocks are hybrid securities having characteristics of both debt and equity. The preferred stocks pay the holders a fixed dividend, like bonds. These types of shares normally get priority over equity shares both in case of dividend payments as well as at the time of liquidation if the company fails. Preferred stocks are thus relatively stable and usually exhibit a low correlation with other income-generating assets. The iShares S&P U.S. Preferred Stock ETF (NYSEARCA: PFF ) yields about 6.02% as of October 29, 2015. Business Development Companies (BDCs) are firms that loan out to small- and mid-sized companies at relatively higher rates and often grab debt or equity stakes in those companies. BDCs dole out high cash payments together with capturing the equity performance of the borrower. The U.S. law obliges BDCs to hand out more than 90% of their annual taxable income to shareholders. The Market Vectors BDC Income ETF (NYSEARCA: BIZD ) yields 9.03% as of October 29. Link to the original post on Zacks.com

Rate Hike Coming In December? Financial ETFs And Stocks To Buy

As expected, the Fed kept the short-term interest rates steady at its two-day FOMC meeting concluded on October 28 but hinted at a December lift-off. The Fed stated that it will “assess progress toward its goals of maximum employment and 2% annual inflation” in determining whether to increase the interest rates for the first time in almost a decade at its next meeting on December 15-16. The central bank downplayed its previous expectations of global market turbulence as potential restraints to economic activity and inflation. Instead, it cited that recent headwinds are fading with substantial positive developments seen in the global economy and financial market lately. In particular, the Chinese economy is showing signs of stabilization on the back of better-than-expected GDP growth data and another rate cut while the Japanese and European central banks are taking additional stimulus measures to revive their economies. Apart from improving global fundamentals, the U.S. economy is expanding at a moderate pace and the unemployment rate remained steady at 5.1% despite the slowing pace of job growth. Household spending and business investments have increased at solid rates in recent months while the housing sector is on track for a recovery. Adding to the strength is the diminishing underutilization of labor resources. Immediately following the Fed comments, the odds of a December rate hike increased substantially to 47% from 34%. Given this, the financial sector seems to be a good bet, as it will be a major beneficiary of a rising interest rates environment. This is because the steepening yield curve would bolster profits for banks, insurance companies, discount brokerage firms and asset managers. Accordingly, we have highlighted three ETFs and stocks that are expected to see smooth trading in the next couple of months and lead the market higher since the December Fed rate hike possibility is back on the table. Top Financial ETFs While there are a number of ETFs in this corner of the market having a solid Zacks ETF Rank of 2 or ‘Buy’ rating, we have highlighted those that provide broad exposure across various industries within the segment. Financial Select Sector SPDR Fund (NYSEARCA: XLF ) This is by far the most popular financial ETF in the space with AUM of $17.8 billion and an average daily volume of over 35.8 million shares. The fund follows the Financial Select Sector Index, holding 90 stocks in its basket. It is heavily concentrated on the top three firms – Berkshire Hathaway (NYSE: BRK.A ) (NYSE: BRK.B ), Wells Fargo (NYSE: WFC ) and JPMorgan Chase (NYSE: JPM ) – which collectively make up for one-fourth of the portfolio while other firms hold less than 6% share. In terms of industrial exposure, banks take the top spot at 36.1% while insurance, REITs, capital markets and diversified financial services make up for double-digit exposure each. The fund charges 14 bps in annual fees and has added 0.2% in the year-to-date time frame. Vanguard Financials ETF (NYSEARCA: VFH ) This fund manages nearly $3.2 billion in asset base and provides exposure to a basket of 562 stocks by tracking the MSCI US Investable Market Financials 25/50 Index. The product sees solid volume of around 459,000 shares and charges 12 bps in annual fees. It is pretty well spread across each component as none of these holds more than 6.8% of assets. Bank accounts for more than one-third of the portfolio, followed by REITs (21%) and insurance (18%). The fund gained 1.6% since the start of the year. iShares U.S. Financials ETF (NYSEARCA: IYF ) This product follows the Dow Jones U.S. Financials Index and holds 289 stocks in its basket, which is pretty spread out across components with none holding more than 6.44% of assets. Banks take the top spot at 31% from an industrial look while diversified financial and real estate round off the top three spots with 24.6% and 21.3% share, respectively. IYF has amassed $1.5 billion in its asset base and trades in a good daily volume of about 471,000 shares per day on average. It charges an annual fee of 43 bps from investors and is up nearly 2% so far this year. Top Financial Stocks For stocks, we have chosen three top picks using our Zacks Stock Screener that fits our three criteria: stock Zacks Rank #1 (Strong Buy) or #2 (Buy), Growth Style Score of ‘A’ or ‘B’, and Industry Rank in the top 45%. Here are the three recommended stocks. SunTrust Banks Inc. (NYSE: STI ) Based in Atlanta, Georgia, SunTrust Banks is one of the nation’s largest and strongest financial holding companies providing a wide range of services to meet the financial needs of its growing customer base. Zacks Rank: #2 Growth Style Score: B Industry Rank: Top 42% eHealth Inc. (NASDAQ: EHTH ) Based in Mountain View, California, eHealth offers online health insurance services in the United States and China. The company’s ecommerce platform organizes and presents health insurance information that enables individuals, families and small businesses to research, analyze, compare and purchase a range of health insurance plans. Zacks Rank: #2 Growth Style Score: A Industry Rank: Top 14% Universal Insurance Holdings Inc. (NYSE: UVE ) Based in Fort Lauderdale, Florida, Universal Insurance offers an array of property and casualty insurance products via its subsidiary companies. Zacks Rank: #1 Growth Style Score: A Industry Rank: Top 24% Original Post

Don’t Bother With Small-Cap Growth ETFs – Invest In The Internet Instead

Summary I compared a highly diversified small-cap ETF with an Internet-based ETF. The Internet has not finished permeating our lives, yet we have no need to fear another Internet stock bubble. Going forward, a portfolio or ETF of Internet stocks should outperform both the market and small-cap growth stocks. Source: Wikipedia Commons Through my daily random analyses of stock prices, correlations, and whatnot with R software, I occasionally find something interesting. I especially enjoy looking for patterns in ETFs, as such patterns can give us an idea of where the economy is at and headed. Today I was looking at how Internet-based companies have performed in respect to other industries. Let’s start with the facts: Some investors like small-cap stocks in developed countries because of the huge upside associated with growing companies. Small-cap stocks of developed countries grow in strong economies with few restrictions on business. This makes them good stocks for speculation and for diversification into the “growth stock” sector. However, in these countries, many small-cap companies are heavily reliant on the Internet to run their businesses. In contrast to large-cap stocks that began prior to the time of the Internet, many of these small-cap companies would likely go under if they lost the power of the Internet to transcend geographics, save on communication costs, and monitor the habits and demographics of their clients. When I began looking into the correlation between Internet-based companies and small-cap stocks I found – unsurprisingly – that said correlation was quite high. Of course, not all small-cap stocks are Internet companies. However enough are to show a strong correlation between the two industries. In my analysis, I looked at the following ETFs: PowerShares NASDAQ Internet ETF (NASDAQ: PNQI ) iShares MSCI EAFE Small-Cap (NYSEARCA: SCZ ) The first is a portfolio of NASDAQ Internet companies. The included companies are large-cap growth stocks. The second is a portfolio of small-cap companies in developed countries, mainly the Europe and Japan. After importing the data from these two ETFs, I checked the correlation coefficient: an astounding 0.97! Yes, some of this correlation is due to an overall correlation with the general market, but below I’ll be showing some charts that show how these two ETFs differ from the market as a whole. Also realize that these portfolios have little overlap in actual securities: One is U.S.-centric (over 80%); the holds less than 1% of U.S. stocks. One is small-cap; the other large-cap. One is growth-only; the other mixes in some value stocks (I’m speaking of SCZ). Yet these two ETFs are almost perfectly correlated! It’s as if the NASDAQ Internet companies are working in tandem with small-cap companies. Or perhaps small-cap companies are gaining their business from NASDAQ Internet companies? Instead of speculating, let’s take a look at how the stocks move in respect to each other. I want to do this for multiple periods. I’ll explain why in a second: The Past Year: (click to enlarge) When you look at the first chart, it looks like PNQI and SCZ are pretty similar. It might appear that PNQI has done better in the past few months. But overall, these two ETFs look like the perform roughly at the same quality. Since the Existence of Both ETFs: (click to enlarge) Now we see a significant difference. Though these two ETFs are highly correlated, PNQI outperforms SCZ. That is, if you switched out small-cap growth stocks for large-cap Internet companies, you’d have realized a gain of over 200%. Sticking with the small-cap “growth” stocks, which are supposed to outperform during a bull market (the time period we are currently looking at), you would have underperformed – the SPDR S&P 500 ETF (NYSEARCA: SPY ), during this time, realized gains of 50%, while SCZ only grew 10%. The Past 3 Months: (click to enlarge) So here’s where things get interesting. While the previous two charts showed PNQI to be the better choice, in this chart, we see SCZ higher than PNQI. Notice that both these ETFs are in negative territory, so one explanation might be that PNQI is a risky ETF. However, to say that PNQI is risky simply not true, unless you believe that SPY is risky: both ETFs are down 4% in the past three months. Yet as we have seen in the chart going back to 2008, PNQI has outperformed SPY by 150%. That is, PNQI appears to have much more upside than both SCZ and SPY yet the downside is the same as that of SPY. Is SCZ an Outlier? To check if SCZ is an outlier, I checked other EAFE funds’ correlations to both SCZ and PNQI. The quick answer is that SCZ is not an outlier; the result holds for other EAFE small-cap and growth funds. For instance, SCZ and the iShares MSCI EAFE Growth ETF (NYSEARCA: EFG ) are 99% correlated. EFG is also 94% correlated with PNQI, showing a unique connection with EAFE small cap companies and Internet companies. Likewise, Vanguard MSCI EAFE ETF (NYSEARCA: VEA ) shows 0.99 and 0.94 correlations to SCZ and PNQI, respectively. The Future of Internet Companies The Internet bubble of the 90s taught us to be weary of investing too much in Internet-based companies. But unlike other bubbles (e.g., the housing bubble), we were dealing with a new invention in the 90s (Internet-based business). Today, we have a much better understanding of how Internet companies work. Thus, I don’t see PNQI’s extreme returns as a bubble but as the result of a legitimately good business model: putting your money where business is booming – online. The Internet has and will continue to permeate our lives (how are you reading this article right now?). And the last three months has shown that Internet companies don’t hurt more than the general market when a correction comes. Internet traffic is growing and bandwidth requirements are increasing for current users. One reason for this is the transition to video, which comes from two sources: A preference for consuming content in video form. A shift to streaming entertainment (e.g., Netflix (NASDAQ: NFLX ), which PNQI holds). By 2017, 70% of Internet traffic will be directed toward video, according to Cisco. The Internet is also changing how people shop. Today, consumers are using an omnichannel shopping method, which essentially means that they are browsing multiple sites at once to find the best deal. Such an activity would have been time-consuming and gas-consuming in the era where one had to drive store-to-store for price comparisons. Look at some of the holdings in PNQI to appreciate the fund’s appreciation of the growth of the omnichannel shopping preference: Amazon (NASDAQ: AMZN ) Priceline (NASDAQ: PCLN ) EBay (NASDAQ: EBAY ) Expedia (NASDAQ: EXPE ) Tripadvisor (NASDAQ: TRIP ) This is where the real growth is at. PNQI also has holdings in Chinese Internet companies, such as Baidu (NASDAQ: BIDU ), which PNQI first bought in 2008. To this, they’ve added other important Chinese Internet stocks, such as… JD.com (NASDAQ: JD ), an online “mall” for electronic products (omnichannel shopping). Ctrip.com (NASDAQ: CTRP ), an airline and hotel booking service (omnichannel shopping). NetEase (NASDAQ: NTES ), an IT company known for being the largest email service provider in China. …and anything else they can get their hands on via NASDAQ. Yet, investors looking for “growth” often turn to these investing concepts: “Invest in small-cap stocks.” “Invest in foreign countries; U.S. stocks are overpriced.” “Diversify among many growth stocks.” Investors agreeing with such statements would find SCZ the perfect ETF. SCZ does not hold more than 1% of its portfolio in a single stock – the maximum weight to any given stock is less than half a percent. And SCZ’s holdings are all over the place: Switzerland, the U.K., Japan… In contrast, PNQI attaches close to 10% of its portfolio. AMZN, PCLN, Facebook (NASDAQ: FB ), and Alphabet Inc (NASDAQ: GOOG ), all individually occupy more than 8% of the PNQI portfolio. PNQI also certainly doesn’t see U.S. stocks as overbought, as the vast majority of its portfolio is in the U.S. In other words, PNQI is virtually the antithesis of SCZ. Conclusion The two ETFs we just looked at correlate… but only one consistently outperforms. And I believe that PNQI will continue to outperform both SCZ and SPY, at least until the next big thing (can something possibly surpass the Internet?). We are not repeating the bubble of the 90s because the Internet is no longer a mere novelty but an integral part of culture in the developed world. The demand for the stocks PNQI holds will increase as long as the companies behind those stocks are continually making improvements in our lives (or finding ways to addict us to their products – FB, I’m looking at you). In addition, PNQI’s exposure to the Chinese Internet market shows a stark contrast to what I see in SCZ management sa being more of a “spray-and-pray” shotgun approach to a growth portfolio: Invest a little in everything and hope we keep attracting clients; no portfolio manager every gets fired for diversifying. I am assigning a strong buy rating for PNQI going into 2016 and an underperformer rating to SCZ. I would recommend, based on the most recent chart comparing PNQI to SCZ, that SCZ holders sell their shares now, while SCZ is above both the market and PNQI. Once sold, take the capital that was in SCZ and put it in PNQI, while it’s at a relative discount. Request a Statistical Study If you would like for me to run a statistical study on a specific aspect of a specific stock, commodity, or market, just request so in the comments section below. Alternatively, send me a message or email.