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ETF Relationships That May Tell You When The Worst Is Over

Businesses, consumers and the federal government have taken on enormous amounts of debt since the Great Recession. Optimists argue that total debt is irrelevant; that is, they believe the only thing that matters is the cost of servicing those debts. Fair enough. Then what happens when interest expense does rise? Assuming total debt remains the same, higher rates would increase the percentage of household income or the percentage of corporate/government revenue that must be allocated to debt servicing. In earlier commentary, I provided data showing how the total debt of corporations has DOUBLED since 2007. Thanks to seven years of zero percent rate policy, alongside a number of iterations of quantitative easing (QE), the average rate on corporate debt is down from eight years ago. More critically, however, average interest expense has risen substantially . That’s right. Corporations need to assign more and more of their “gross” toward paying back the interest on their loans. What about households? Well, we’re back to the 2007 record debt level of $14.1 trillion in mortgages, credit cards, auto loans, student loans and credit cards; the typical household has nearly $130,000 in total debt. The good news? Years of stimulative monetary policy has made it easier for households to service these debts. The bad news? Americans “re-leveraged” rather than “de-leveraged.” Any amount of rate hike activity would damage the ability of average Americans to borrow-n-spend. In fact, recent retail data demonstrate just how little Americans feel they have left over to spend, in spite of massive savings at the gas pump. Traditional home affordability measures like median sales price-median income illustrate just how dependent we are on ultra-low interest rates. Specifically, the historical home price-to-household income ratio is 2.6. Where are we at today? Back near the housing bubble highs of 4.0. It certainly does not get any better if one looks at U.S. government obligations. The national debt is roughly $19 trillion, excluding the country’s unfunded liabilities (e.g., Social Security, Medicare, Medicare prescription drug program, federal pensions, etc.). According to Dave Walker, the former head of the Government Accountability Office (NYSE: GAO ) under Presidents George W. Bush and Bill Clinton, the national debt is closer to $65 trillion, including unfunded liabilities. Does anyone believe that those numbers are going to get smaller? Or even, heaven forbid, remain the same? In other words, rising interest expense or rising debt levels would make it even more difficult for the government to honor its obligations. Is it any wonder, then, how schizophrenic riskier assets are? It is the direction of the Fed’s rate normalization path – no matter how gradual – that has nudged the bear out of hibernation . China? Its slowing economy adversely affects corporate profits, but it’s the Fed’s perceived reluctance to “save stocks” that has agitated market participants. Oil? Its rapid-fire descent highlights the possibility of a worldwide recession, though it is the Federal Reserve’s disinclination to “step in” that is rocking investor confidence. Fortunately, there are a number of ETF relationships that can help a cash-heavy investor identify when things may be getting better. More precisely, when “risk-off” relationships abate, one may feel more upbeat about shifting from a mode of capital preservation to a mode of wealth accumulation. Consider the relationship between gold and oil. When people prefer the precious metal to the natural resource, they are expressing a preservation preference. And vice versa. When investors speculate that oil prices will rise, they are typically expressing confidence in the growth of the global economy. It follows that the SPDR Gold Trust ETF (NYSEARCA: GLD ) : The United States Oil ETF, LP (NYSEARCA: USO ) price ratio is likely to climb in troubling times; it is likely to spike in panicky stock sell-offs. One might wish to see the slope of the GLD:USO 200-day moving average flatten out – and the GLD:USO price settle down a bit – prior to making huge commitments to riskier assets. Granted, the rapid depreciation of oil itself has had a fair amount to do with the general trend of GLD:USO. Nevertheless, all three of the most recent corrective phases in U.S. stocks – October of 2014, August-September of 2015, January of 2016 – dovetail perfectly with spikes in GLD:USO. In the same vein, the flattening of the yield curve tells market watchers that participants are concerned about recession probabilities. The difference between the 10-year Treasury bond yield and the 2-year Treasury bond yield has fallen to lows that we haven’t seen since the Fed shocked-n-awed the world with its most powerful stimulus ever, QE3. Of course, some folks prefer to remain in the world of specific ETF assets as well as rising/falling price ratio relationships. For those investors, I suggest that they track the iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ):iShares 1-3 Year Treasury Bond ETF (NYSEARCA: SHY ) price ratio. A rising price ratio implies that people are seeking safety in the middle of the yield curve, while others may be avoiding the short end of the yield curve due to Federal Reserve rate hike intentions. Thus, the yield curve is flattening when IEF:SHY is rising. Since the stock market highs in July, IEF:SHY has, for the most part, been on a steady path higher. A sustained reversal in this trend would be an indication that investors are growing more comfortable with the health of the domestic economy. 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.

Idacorp Is Overvalued In Light Of 2016’s Weather Forecast

Summary Electric utility IDACORP’s shares performed strongly in the second half of 2015 despite the Federal Reserve’s interest rate increase and a disappointing Q3 earnings report. The share price increase has come even as the company’s earnings estimates have remained stable, however, and its operating outlook has diminished. Snow pack levels in Idaho are currently well below long-term averages, and forecasts of reduced spring precipitation are unlikely to make up the difference. IDA’s shares are overvalued given the prospect of a fall in hydroelectric output at the same time as El Nino results in a hot early summer. Shares of Idaho electric utility IDACORP (NYSE: IDA ) have defied conventional wisdom over the last several months, setting a new all-time high last December despite announcement of the first U.S. interest rate increase in nearly a decade and persistent drought conditions in the company’s service area. In an article published in July, I recommended the company’s shares at the right price, highlighting its excellent earnings and dividend increase records. IDACORP’s share price proceeded to increase 20% by the end of the year, making it one of the market’s better performers as the S&P 500 lost a bit of ground over the same period (it has since lost some ground amidst wider market turmoil). Developments in the company’s service area are likely to impact its returns in 2016, however, and this article reevaluates IDACORP as a potential long investment opportunity. Q3 Earnings IDACORP reported Q3 earnings that, while disappointing compared to expectations, only caused a short pause in the ascent of its share price. The company reported revenue of $369.2 million, down 3.4% from the previous year as the presence of lower temperatures in late summer caused its total sales volume to decline. This was partially offset by a 1.8% increase to customer numbers as the service area’s economy continued to perform well. The company’s cost of revenue fell to $126.4 million from $141.5 million over the same period as energy prices continued to fall after rebounding during the previous quarter. Gross profit rose slightly as a result, from $240.7 million to $242.8 million YoY. Operating income fell slightly to $104.7 million despite this improvement. While customer growth provided $3.4 million in additional income, this was more than offset by a $9.4 million reduction resulting from reduced electricity demand in the service area. IDACORP’s Q3 net income came in at $73.3 million, down from $86.9 million YoY. Contributing to the negative impact of reduced electricity demand was a $11.1 million increase to the company’s income tax following a change to its tax accounting methodology. It should be noted that the company’s net income would have fallen by only 3% but for the one-time accounting change. As it was, the company reported a diluted EPS of $1.46, down from $1.73 YoY and missing the consensus analyst estimate by $0.08. Its EBITDA, which was the best indicator of Q3 performance due to its exclusion of tax costs, fared better, falling only slightly from $154.7 million to $152.9 million over the same period. IDA’s balance sheet remained strong at the end of Q3 for a utility, boasting a current ratio of 2.4x and an assets-to-liabilities ratio of 1.5x. While the company’s free cash flow fell during the quarter on a YoY basis, management felt comfortable enough with its performance to continue its dividend increase record by increasing the quarterly payout by 8.5% to $0.51/share. This decision was aided by management’s expectation that it will not be required to return any revenue to its customers in 2015 following weather-related demand weakness despite returning nearly $5 million in the previous year. Q4 and FY 2016 Outlook IDACORP’s management maintained its previous EPS guidance for FY 2015 of $3.75-3.90 despite the Q3 earnings miss, a decision likely influenced by the fact that the miss fell within the guidance range. Equally important was its announcement that it continues to expect to incur up to $310 million on capex in FY 2016, indicating that it does not expect to have any difficulties financing its operations despite the presence of higher interest rates. This expectation is reasonable given the continued strength of its balance sheet. In July, I discussed the presence of sustained drought conditions in IDACORP’s service area and the potential for this to negatively affect its operations, which rely heavily on hydropower for generating capacity. Management reduced its FY 2015 hydroelectric production estimate from 6-7 MWh in July to 5.7-6.2 MWh at the end of Q3 due to persistent dry conditions during the quarter. Reduced hydroelectric supply didn’t negatively impact the company’s FY 2015 guidance due to reduced cooling degree-days in its service area in late summer and the seasonal weakening of electricity demand in Q4. There is a higher probability that continued dry conditions in Idaho will negatively impact IDACORP’s earnings in 2016, however, especially as hot conditions return in Q2 and Q3. This year’s particularly strong El Nino event has resulted in lower-than-average winter precipitation levels in Idaho, with the company forecasting a 40-50% chance of drier-than-average conditions between November and January. While the forecast period has yet to end, the precipitation data suggests that this has indeed occurred. The snow pack in the areas surrounding the company’s hydroelectric capacity is currently 20-25% smaller than average, and in some areas, snow pack levels are currently on track to set record lows (although it should be noted that it normally doesn’t peak until mid-April). The snow pack will need to achieve 125% of its normal growth rate between now and April just to reach its average peak level. Such a result is increasingly unlikely to occur given that past El Nino event’s have been associated with reduced precipitation levels in Idaho over the same period. While Idaho’s snow pack levels are not yet expected to fall to the lows seen in California that have resulted in a sharp reduction in hydroelectric output, the state’s output is likely to fall even as electricity demand in IDACORP’s service area exceeds the long-term Q2 average. Previous El Nino events have also been associated with early summer temperatures that are well above average . Q3 has historically been a major contributor to the company’s annual earnings, generating 33% of its annual EPS over the TTM period, for example. A shortfall in hydroelectric output could force the company to utilize capacity with higher variable costs and, while a favorable regulatory scheme would mitigate the impact of such an increase on its bottom line, higher prices could also result in another reduction to sales volumes despite the presence of warm temperatures. One topic that I didn’t cover in my previous article was the Clean Power Plan, which the Obama administration rolled out last summer. The plan requires U.S. states to achieve predetermined reductions to the carbon intensities (i.e., greenhouse gas emissions per kilowatt-hour of electricity generated) of their electric utilities. While many Mountain West states are required to achieve large reductions under the plan, Idaho’s heavy reliance on zero-emission hydroelectric capacity means that it must achieve only a 10% reduction to its carbon intensity by 2030. Only 31% of the company’s generating capacity is coal-fired, with the rest being either zero-emission hydro or low-emission natural gas. IDACORP is unlikely to be impacted by the Clean Power Plan’s implementation as a result, especially in light of Idaho’s low burden under it. Conclusion Idaho electric utility IDACORP’s share price was a strong performer in the second half of 2015 as its robust balance sheet and advantageous operating location offset investor concerns about higher interest rates. Even a Q3 earnings result that missed the consensus estimate failed to daunt the company’s investors for more than a few weeks. This resilience has caused the company’s P/E ratio to continue rising, however, reaching 18x its FY 2016 earnings late last month before settling to 17x today. While it is tempting to encourage investors to view IDACORP as a port of safety during this time of market turmoil, I am concerned that an unusual set of weather conditions will begin to have a negative impact on the company’s earnings in 2016. While its heavy exposure to hydroelectric generating capacity will allow it to mostly avoid the terms of the Clean Power Plan that were laid out last August, this same exposure will also prove a challenge in Q2 if above-average temperatures resulting from El Nino combine with reduced snow pack levels to push generating costs higher. The company’s favorable regulatory environment will insulate it to a certain degree, of course, and I do expect its shares to continue to outperform the broader market in the short term should the current volatile trading environment persist. That said, IDACORP’s shares are very expensive at 18x its FY 2016 earnings estimate, and earnings growth does not seem likely at this time. I encourage potential investors to wait for a better buying opportunity before initiating a long position since the shares’ premium does not reflect the headwinds that the company is likely to encounter in the first half of 2016.

MLP ETFs Trading At A Huge Discount To NAV

The collapse in oil price has battered the energy sector as a whole, not sparing the master limited partnerships (MLPs) either. In fact, some MLP ETFs have fallen faster than the value of their underlying securities, creating a huge discount to their net asset value or NAV. This suggests an attractive entry point for long-term investors. This is especially true as the authorized participants (NYSE: AP ) of a discounted ETF steps in and redeems the underlying shares to remove the discount and restore the fund’s value back to its NAV. This process results in profits for the ETF holder when the market price rises relative to NAV (read: Is This the Worst Time For MLP ETF Investing? ). MLP: Is A Good Bet Right Now? Trading at deep discounts, the outlook for MLPs is bright amid the oil price rout. This is because most MLPs, which are engaged in the processing and transportation of energy commodities such as natural gas, crude oil, and refined products, are best positioned to withstand the decline in oil prices and be the major beneficiaries of an oil boom in the long term. Acting as toll-takers, these MLPs earn revenues on the volumes flowing through pipes and not on the commodity price. This nature of business will definitely give a boost to these stocks given that worldwide oil production is on the rise. Unlike exploration and production companies whose profits are directly correlated with commodity prices, MLPs have relatively consistent and predictable cash flows, making them safer and less risky than other plays in the broader energy space (read: Oil Hits 12-Year Low: Short Energy Stocks with ETFs ). Beyond the stability, yields are also pretty high thanks to some favorable tax rules – like we see in the REIT space – that push firms in the MLP space to pay out substantially all of their income to investors on a regular basis. Further, MLPs represent a great way of tapping the growing revolutionary developments in the field of unconventional energy. As a result, the steep decline in MLP stocks and ETFs provides an attractive investment opportunity to long-term investors, looking for growth and income. Below, we highlight some products that were trading at a steep discount to NAV as of January 15 (as per Fidelity ): UBS ETRACS Alerian MLP Infrastructure Index ETN (NYSEARCA: MLPI ) : Discount – 5.32% This product tracks the Alerian MLP Infrastructure Index, which comprises 25 mid-stream energy infrastructure MLPs. It has attracted $1.5 billion in AUM and trades in solid volume of 967,000 shares per day. The note charges 85 bps a year in fees and pays out a hefty yield of 8.04%. Credit Suisse Equal Weight MLP Index ETN (NYSEARCA: MLPN ) : Discount – 5.13% This ETN follows the 30 MLP Index, an equally weighted index that uses a formulaic, proprietary valuation methodology and comprises of 30 midstream MLPs. It has attracted $365.5 million in its assets base so far and sees good average daily volume of more than 325,000 shares. Expense ratio came in at 0.85%. The note pays out 7.53% in annual yield. UBS ETRACS Wells Fargo MLP Index ETN (NYSEARCA: MLPW ) : Discount – 4.69% This note tracks the Wells Fargo Master Limited Partnership Index, which provides exposure to all energy MLPs listed on the New York Stock Exchange or NASDAQ with market cap of at least $200 million. It failed to garner enough investor interest with AUM of just $7 million and sees paltry volume of about 13,000 shares. MLPW charges 85 bps in annual fees and expenses, and pays a solid yield of 9.82%. UBS ETRACS Alerian MLP Index ETN (NYSEARCA: AMU ) : Discount – 4.68% This product tracks the performance of the Alerian MLP Index, which provides exposure to 50 publicly traded energy MLPs. It has amassed $351.4 million in its asset base and trades in solid volume of nearly 468,000 shares. It charges 80 bps in annual fees and sports a dividend yield of 7.16%. RBC Yorkville MLP ETN (NYSEARCA: YGRO ) : Discount – 4.57% This note seeks to offer return of the Yorkville MLP Distribution Growth Leaders Liquid Index, which offers access to 25 MLPs exhibiting the highest distribution growth and superior liquidity profiles. It is also unpopular with AUM of $14.5 million and average daily volume of around 15,000 shares. Expense ratio came in at 0.90% and dividend yield stands at 8.54%. MLP ETNs vs MLP ETFs Unfortunately, there are some tax headaches when using the MLP structure, namely the possible need of a K-1 form at tax time. But this issue can be avoided by looking at MLPs that use an exchange-traded structure. This is because ETNs do not actually hold the securities of an underlying index. Instead, an ETN is an unsubordinated debt security that promises to pay out a return that is equal to an index. This is completely unlike an ETF that buys and sells the securities making up a particular benchmark. Due to this advantage, investors can buy MLP ETNs without the hassle of K-1 at tax time, making the above-products excellent choices for those seeking high yield without the taxation headache. Link to the original post on Zacks.com