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Evaluating Actively Managed Stock Funds With iM’s Terminal Value Rating System

This rating system identifies funds which may provide better returns than a benchmark index-fund by measuring fund performance from the perspective of savers who make regular monthly contributions to funds. It compares the terminal value from periodic $1.00 monthly contributions to a fund with the terminal value from the same contributions to a benchmark index-fund over the same time period. Specifically, the system calculates 1-year and 5-year rolling terminal values from $1.00 monthly contributions to the fund and the benchmark index-fund. Predictive information comes from the relationship between the fund and the benchmark rolling terminal values, allowing an estimate of future fund performance relative to the benchmark index-fund. The Terminal Value Rating System Since most investors aim to save an adequate amount for retirement, it is appropriate to calculate the terminal value from monthly contributions to a particular fund and compare this to the terminal value if the same contributions had been made to a benchmark index-fund instead. (In this analysis SPY, the ETF tracking the S&P 500, is used as the benchmark index-fund, hereinafter referred to as benchmark.) This method provides a better picture of fund performance for savers as it measures the end value from periodic investments to a fund, rather than performance over standard fixed time periods. (Fund prices adjusted for dividends are mainly from Yahoo Finance. Also, the system only applies to funds with no front load fees.) An evaluation of the relationship between the 1-year and 5-year rolling terminal values for investments in a fund, and the corresponding rolling terminal values for investments in the benchmark, can provide a good estimate of future fund performance relative to the benchmark. The relationship is termed “Rolling Performance” and is defined in the Appendix. The ratings derived from this analysis range from a grossly underperforming ‘E’ to a good outperforming ‘A’. In the charts, the ratings are based on the most recent past 1-year and 5-year Rolling Performances, shown as “iM RATING: 1yr(5yr)”. Desirable funds should have a 1-year rating of ‘C’ or better, and a 5-year rating of ‘B’ or better. (See the Appendix for Rating Criteria) Over and above the simple 5-bin rating, charts are produced to visualize, and substantiate, the fund’s rating. How to interpret the charts The upper two graphs in the charts show the actual terminal values obtained from investing $1.00 every month in the fund and the benchmark. These are the sums of all contributions including all gains and losses to the end of November 2015, and indicate the total savings over time. A desirable fund would continuously have had higher terminal values than those for the benchmark. The lower two graphs in the charts are the 1-year and 5-year Rolling Performances. The 5-year Rolling Performance should preferably be continuously positive, which would indicate that an investor would always have done better investing in the fund than in the benchmark over a five year period. For future fund performance to be better than the benchmark would require the 1-year and 5-year Rolling Performance graphs near the end to be positive and to have upward (positive) slopes as well. Positive 1-year and 5-year Rolling Performances show that a fund performed better than the benchmark over the last year and the last five years, respectively. Upward slopes of the Rolling Performance graphs would indicate that fund performance had constantly gained over the benchmark while the slopes were positive and should also signal further excess gains for the fund over the benchmark in the near-term future. Example of a fund likely to outperform SPY An example of a fund that should continue to provide better performance than the benchmark is T. Rowe Price Growth Stock (MUTF: PRGFX ) with an iM-Rating of B(A). Had one invested $1.00 each month starting on the last day of February 1993, one would have contributed a total of $274 including the last contribution at the end of November 2015. The terminal value, that is the sum of all contributions including all gains and losses to November 2015, would have been $893. Had one made the same contributions to SPY, then the terminal value would have been $746. A saver would have had 19.7% more money at the end from investing in PRGFX than from investing in SPY. The upper pair of graphs in the chart which are plotted to a semi-log scale shows the performances over time. (click to enlarge) (click to enlarge) The terminal value rating system is especially useful to determine the likely future performance trend for a fund. The 1-year and 5-year Rolling Performances are shown by the green and purple graphs, respectively, at the bottom of the chart. One can see that since May-2000 for most of the time PRGFX provided better returns over five years for savers than SPY. As of 11/30/2015, the value of the 5-year Rolling Performance is +7.6%, and the 1-year Rolling Performance is +2.8%. This indicates that over the last five years and one year a $1.00 per month investor would have had, respectively, 7.6% and 2.8% more savings from PRGFX than from SPY. Both Rolling Performance values are positive and the slope of the 5-year Rolling Performance graph since Aug. 2014 is also positive, which is a good indication that performance of this fund relative to SPY should be higher also for the near-term future. Example of a fund likely to underperform SPY An example of a fund that will likely continue to underperform the index-fund is the CREF Stock Account (QCSTRX) with an iM-Rating of D(E). This is one of the oldest and largest actively managed stock funds in the U.S. with about $117-billion in assets, representing about 13.5% of total assets under management at TIAA-CREF. Had one invested $1.00 each month starting on the last day of February 1993, one would have contributed a total of $274 including the last payment at the end of November 2015. The terminal value, that is the sum of all contributions including all gains and losses to November 2015, would have been $651. Had one made the same contributions to SPY then the terminal value would have been $746. A saver would have had 14.6% more money at the end from investing in SPY than investing in the CREF Stock Account. The upper pair of graphs in the chart which are plotted to a semi-log scale depicts the performances over time. (click to enlarge) (click to enlarge) The fund versus benchmark 1-year and 5-year Rolling Performances are shown by the green and purple graphs, respectively, at the bottom of the chart. One can see that QCSTRX provided worse 5-year returns for savers than SPY from 1998 to 2002 and then again from 2011 to 2015. The latest value of the 5-year Rolling Performance for QCSTRX is -8.2%, meaning that over the last five years a $1.00 per month investor would have had 8.2% less savings from the CREF Stock Account than from SPY. Similarly, the 1-year Rolling Performance for QCSTRX is -2.2%, meaning that over the last year a $1.00 per month investor would have had 2.2% less savings from the CREF Stock Account than from SPY. Both Rolling Performance values are negative, and at the end the trajectories of both Rolling Performance graphs also point lower. This indicates that this fund is likely to provide lower returns for investors than SPY in the foreseeable future as well. Conclusion Of the many actively managed stock funds we investigated only a few funds have produced better returns than the benchmark SPY, and are likely to continue to outperform SPY. These funds are characterized with 1-year and 5-year ratings better than ‘C’, and would have had positive 5-year Rolling Performance over longer periods. The charts and iM-Ratings for three such large-cap stock funds, JGASX, FDGRX and GTLLX are provided in the Appendix. Appendix Special terms and abbreviations Terminal Value (TV): The sum of all contributions including all gains or losses from a specified starting date to the present or to a specified past date. PRGFX(+1/mo), QCSTRX(+1/mo), SPY(+1/mo): Terminal values from all past consecutive monthly $1.00 contributions made in PRGFX, QCSTRX, and SPY. 1-year Rolling Performance: The percentage difference between the terminal values from the past 12 consecutive rolling monthly $1.00 investments made in a fund and the benchmark, calculated as (TV12 (fund) – TV12 (bench) ) / TV12 (bench). 5-year Rolling Performance: The percentage difference between the terminal values from the past 60 consecutive rolling monthly $1.00 investments made in a fund and the benchmark, calculated as (TV60 (fund) – TV60 (bench) ) / TV60 (bench). iM-Rating Criteria The Rating criteria are based on the most recent past 1-year and 5-year Rolling Performances with the thresholds as listed below. Performance Rating Thresholds Rating Thresholds A above 6% B 2% to 6% C -1% to 2% D -5% to -1% E below -5% Other Funds likely to outperform SPY JPMorgan Growth Advantage Sel (MUTF: JGASX ) with iM-Rating C(A). The funds VHIAX, JGACX, JGVRX, JGVVX are of the same class family and all enjoy the same rating. (click to enlarge) (click to enlarge) Fidelity Growth Company (MUTF: FDGRX ) and FDEBX of the same class, both have an iM-Rating of C(A) (click to enlarge) (click to enlarge) Glenmede Large Cap Growth (MUTF: GTLLX ) with IM-Rating C(A) (click to enlarge) (click to enlarge) No Recession Is Signaled By iM’s Business Cycle Index: Update December 31, 2015

ETF Investing Strategies To Brave Volatility In 2016

Global stocks were in a mess in 2015, stymied by the sudden currency devaluation in China, spiraling Chinese economic slowdown and the resultant shockwaves across the world. Also, the return of deflationary threats in Eurozone despite the QE measure, a sagging Japanese economy, the oil price rout and a slouching broader market complicated the scenario. Back home, putting an end to prolonged speculation, the Fed finally hiked the key interest rate by 25 bps at the tail end of the year. All these put the New Year in a critical juncture. The investing world may be at a loss of ideas on where to park money for smart gains. For them, below we detail possible asset class movements in 2016 and the likely smart ETF bets. Bull or Bear in 2016? The million-dollar question now is whether U.S. stocks will buoy up or drown in 2016. While policy tightening and overvaluation concerns give cues of an end to the bull run, a dubious performance in 2015 raises hopes that the stocks will rebound soon. After all, the Fed is not hiking rates to rein in inflation. The tightening is reflective of U.S. economic growth and lower risk of deflation, both of which are encouraging for stocks. Thus, stocks should offer decent, if not spectacular, returns next year. Investors can capitalize on a steady U.S. economy via the momentum ETF iShares MSCI USA Momentum Factor (NYSEARCA: MTUM ) . To rule out the negative impact of a higher greenback, investors can also try out more domestically focused small-cap ETFs; but a value notion is desirable to weather heightened volatility. S&P Small-Cap 600 Value ETF (NYSEARCA: VIOV ) is one such fund. Investors dreading interest rate hike may also try out this rate-restricted ETF PowerShares S&P 500 ex-Rate Sensitive Low Volatility ETF (NYSEARCA: XRLV ). Sectors to Hit & Flop Since investors will be busy in speculating the pace and quantum of Fed rate hikes in 2016, rate sensitive sector ETFs would be winners and losers. Financial sector ETF PowerShares KBW Bank ETF (NYSEARCA: KBWB ) and insurance ETF Dow Jones U.S. Insurance Index Fund (NYSEARCA: IAK ) generally perform better in a rising rate environment. Plus, Consumer Discretionary ETFs like Consumer Discret Sel Sect SPDR ETF (NYSEARCA: XLY ) and tech ETFs like Technology Select Sector SPDR ETF (NYSEARCA: XLK ) also perform well in the early rate hike cycle as per historical standard. Lower gasoline prices should also help consumers to create a wealth effect. On the other hand, high-yielding sectors and the sectors which are highly leveraged will falter in a rising rate environment. So Utilities Select Sector SPDR ETF (NYSEARCA: XLU ) and Vanguard REIT ETF (NYSEARCA: VNQ ) could be at risk. Having said this, we would like to note that these are just initial blows and after a few upheavals, the market movement should even out. Where Will Bond Markets Go? The year 2016 may mark the end of the prolonged bull run in the bond market as the first U.S. rate hike in a decade may make investors jittery in 2016. This is more likely if rates steadily move up in the coming months, with the Fed’s current projections hinting at four rate hikes in 2016. Agreed, interest rates environment remained benign even after the lift-off, owing to the global growth worries. But the scenario may take a turn in 2016 if economic data come on the stronger side, inflation perks up and wage growth gains momentum. On the other hand, the possibility of another solid year for fixed income securities can’t be ruled out, especially when stocks are not that cheap. However, investors should note that yield curve is likely to flatten ahead. Since the inflation scenario is still muted, long-term bond yields are expected to rise at a slower pace while short-term bond yields are likely to jump. Yield on the 6-month Treasury note soared 39 bps to 0.50% since the start of the year (as of December 29, 2015) while the yield on the two-year Treasury note jumped 43 bps to 1.09% and the yield on the 10-year Treasury note rose just 18 bps to 2.32%. Thanks to the potential flattening of the yield curve, the inverse bond ETF iPath US Treasury Flattener ETN (NASDAQ: FLAT ) could be a hit next year. Now that interest rates will be topsy-turvy, floating rate ETFs like iShares Floating Rate Bond (NYSEARCA: FLOT ) should do better going ahead. Investors can also take a look at the interest rate-hedged high yield bond ETFs as solid current income from these securities can make up for capital losses. High Yield Interest Rate Hedged ETF (BATS: HYHG ) is one such option, yielding over 6.50% annually. However, one should also note that the high-yield bond market is presently undergoing a tough time due to the energy market default. So, less energy exposure is desired in the high-yield territory. About 14% of HYHG is invested in the energy sector. Drive for Dividends The Fed may hike key interest rates, but it has hardly left any meaningful impact on long-term treasury yields. So, the lure for dividends will remain intact. U.S.-based dividend ETFs including Vanguard High Dividend Yield ETF (NYSEARCA: VYM ) and Schwab US Dividend Equity ETF (NYSEARCA: SCHD ) could be useful for investors in waiting out the volatility via current income. Want to Visit Abroad? Where? It’s better to stay diversified as far as the global market investing is concerned. Due to the divergence in monetary policies between the U.S. and other developed economies, many analysts are wagering on Europe and Japan (where substantial and prolonged QE reassures are on). Per an analyst , earnings in both regions “will make them attractive from a standpoint of possible capital appreciation.” Plus, the European markets were in occasional disarray this year due to economic hardships. This has made the stocks compelling. However, currency-hedging technique is warranted while visiting foreign shores. Europe Hedged Equity Fund (NYSEARCA: HEDJ ) and Japan Hedged Equity Fund (NYSEARCA: DXJ ) are two choices in this field. Investors can also stop over at China but with a strong stomach for risks. Golden Dragon Halter USX China Portfolio (NYSEARCA: PGJ ) should be a modest bet for this. Occasional Volatility to Crack the Whip Volatility has been pretty strong in the market in 2015 and the trend should continue in 2016. Investors can deal with this in various ways. First comes low volatility ETFs like SPDR S&P Low Volatility ETF (NYSEARCA: SPLV ) and iShares MSCI Minimum Volatility ETF (NYSEARCA: USMV ) , second are defensive ETFs like U.S Market Neutral Anti-Beta Fund (NYSEARCA: BTAL ) and AdvisorShares Active Bear ETF (NYSEARCA: HDGE ) , and last but not the least in queue are the volatility ETFs themselves such as C-Tracks on Citi Volatility Index ETN (NYSEARCA: CVOL ) and ProShares VIX Short-Term Futures (NYSEARCA: VIXY ) . Notably, as the name suggests volatility products are quite rowdy in nature and thus suit investors with a short-term notion. Original Post

The S&P 500 Is Ready For A Correction – Buy SDS

Summary Historical bull and bear market cycle suggests we are overextended. Earnings are weak, valuations are high. Interest rates are on the way up. This is probably the most hated bull market in history. All along, the bears have been in denial and have been calling for a big crash. To their dismay, the S&P 500 kept moving up and continued making new highs. The bulls have completely demolished the bears. It has reached a point where the bulls don’t give importance to the weak data points; they are happy concentrating on the few positives that still exist. With this backdrop, I want to short the US markets because I believe the markets are ripe for more than a 10% correction with limited upside risk compared to the possible downside. I shall use the historical bull and bear market cycles, the presidential four-year election cycles, the earnings performance and the market valuations to prove my point. As this is a contrarian call, I don’t expect many to agree with me. Previous bull and bear market runs Bull Market data The history of bull market cycles is an important guide, which gives us an idea about the current leg of the bull market. The second half of the 20th century witnessed strong bull runs. I have chosen to study the market cycles from 1942 to the present date; the selected time frame is skewed in favor of the bulls. The first half of the last century wasn’t considered because it had to deal with two world wars and “The Great Depression”. The economical and the geopolitical situation, though fragile, aren’t comparable to that of the early 1900s. Bull Markets with at least a 20% rise, without a 20% drop on a closing basis from 1942 till now SL Start End No of Months % Change 01 28-Apr-42 29-May-46 49.7 157.7% 02 19-May-47 15-Jun-48 13.1 23.89% 03 13-Jun-49 02-Aug-56 86.9 267.08% 04 22-Oct-57 12-Dec-61 50.4 86.35% 05 26-Jun-62 09-Feb-66 44.1 79.78% 06 07-Oct-66 29-Nov-68 26.1 48.05% 07 26-May-70 11-Jan-73 32 73.53% 08 03-Oct-74 28-Nov-80 74.9 125.63% 09 12-Aug-82 25-Aug-87 61.3 228.81% 10 04-Dec-87 24-Mar-00 149.8 582.15% 11 21-Sep-01 04-Jan-02 3.5 21.4% 12 09-Oct-02 09-Oct-07 60.9 101.5% 13 20-Nov-08 06-Jan-09 1.6 24.22% 14 09-Mar-09 ? 82 215.54% Average 52.59 145.40% Maximum 149.8 582.15% Source: BofA Merrill Lynch Global Research, Bloomberg Both in longevity and percentage rise, this market has come a long way and is placed in the third and fourth position respectively. However, the conditions during this bull run are different because the central banks have never printed such massive amounts of money around the world. The excess liquidity was plowed back into the stock markets in search of better returns because gold and a few other base metals peaked in 2011 and have been in a downtrend ever since. Though, this argument holds merit, the current situation is changing. The US Fed has long back stopped its bond purchase, it has gone ahead and raised rates for the first time in a decade. The cushion of the excess liquidity made available every month isn’t there anymore. We shall see higher rates in 2016 and the liquidity situation is likely to tighten further. In the absence of “The Fed Put”, the law of averages should catch up and pull the markets down. Bear Market data Bear markets with at least a 20% drop, without a 20% rise in between on a closing basis since 1942 SL Start End No of Months % Change 01 29-May-46 19-May-47 11.8 -28.47% 02 15-Jun-48 13-Jun-49 12.1 -20.57% 03 02-Aug-56 22-Oct-57 14.9 -21.63% 04 12-Dec-61 26-Jun-62 6.5 -27.97% 05 09-Feb-66 07-Oct-66 8 -22.18% 06 29-Nov-68 26-May-70 18.1 -36.06% 07 11-Jan-73 03-Oct-74 21 -48.2% 08 28-Nov-80 12-Aug-82 20.7 -27.11% 09 25-Aug-87 04-Dec-87 3.4 -33.51% 10 24-Mar-00 21-Sep-01 18.2 -36.77% 11 04-Jan-02 09-Oct-02 9.3 -33.75% 12 09-Oct-07 20-Nov-08 13.6 -51.93% 13 06-Jan-09 09-Mar-09 2.1 -27.62% Average 12.28 -31.98% Maximum 20.7 -51.93% Source: BofA Merrill Lynch Global Research, Bloomberg The average drop during a bear market is 32%; from the all-time high such a fall will take the S&P 500 to 1,452, a level unimaginable now, but that’s what history suggests. I’m not suggesting we will go down to those levels now, even a 20% fall will be highly profitable for us. The risk is, what if this is the mother of all bull markets and the bull run extends by another 70 months with a 300% rise. Anything can happen in the markets; hence, we shall use a stop loss to protect our capital. 2016 is the presidential election year in the US, let’s analyze the stock market performance before and after the new president is elected. Presidential year market performance According to various studies, the stock market gains 9-10% during the first two years of the new president, whereas, the third and the fourth year are comparatively more bullish, yielding higher returns. History suggests a limited upside risk in the next two years; however, since 1952, the last seven months of the election year have yielded positive results but two aberrations have occurred since 2000. The S&P 500 returns from January to March in the election year are mildly positive followed by negative returns in April and May, states a UBS report. I expect the markets to fall during the first five months. Though, the cycles indicate a possibility, stock market returns are closely linked to earnings and valuations. We shall analyze these in the next two sections of this article. There’s a slowdown in earnings Let’s look at a few data points on earnings. According to Bloomberg , the second and third quarter of 2015 have seen negative profit growth for the S&P 500 companies. The expectations for the 4Q 2015 earnings are also negative. A Thomson Reuters report states that compared to 26 positive EPS preannouncements by corporations, there were 86 negative EPS preannouncements by the S&P 500 corporations for Q4 2015. The negative/positive preannouncements ratio in Q4 2014 was 5.1 and in Q4 2015 was 3.3. Both readings are above long-term aggregate ratio of 2.7 taken since 1995. This indicates that the companies are not able to meet their expectations and guidance. Though, Thomson Reuters expects earnings to pick up in Q1 and Q2 of 2016 by 3% and 4% respectively, the current quarter has experienced a downward revision for seven of the ten sectors of the S&P 500. With the current trend, I won’t be surprised if we see negative revisions for the first and second quarters of 2016 going forward. Though 43% of the companies have reported revenue above analyst expectations in Q3 2015, it’s below the long-term average of 60% and lower than the last four quarters’ average of 52%. This shows a declining trend. However, Thomson Reuters states, on the earnings front, 70% has beaten analyst expectations, which is above the long-term average of 63%, and in line with the average of the last four quarters at 70%. In Q3 2015, the share-weighted profits were down 3.3%, the worst figure since 2009, states Bloomberg. Low energy prices and a strengthening dollar are negative for revenues as well as profits. After the first rate hike by the US Fed in almost a decade, the dollar is likely to strengthen further in 2016, with another 0.50-0.75% of rate hike expected by the experts. Some more negative signs for the stock markets In the first nine months of the year, Standard & Poor’s Ratings Services has downgraded US companies 279 times compared to 172 upgrades, this is the worst figure since 2009. Even Moody’s Investors Service has downgraded the credit rating of 108 US non-financial companies against 40 upgrades in the month of August and September. This is the most two-month period downgrades since May and June 2009. According to one metric followed by Morgan Stanley, the ratio of debt to earnings before interest, taxes, depreciation and amortization for investment-grade rated companies was 2.29 in the second quarter. In June 2007, just before the start of the crisis, the same ratio was 1.91. The Wall Street Journal has raised concerns about the balance sheets of the US companies. According to Casey research , the US companies have issued $9.3 trillion in new debt since the financial crisis. The companies have issued record bonds both in 2014 and 2015. Bloomberg business reported that the S&P 500 companies spent 104% of their profits on share buybacks and dividends instead of using it to invest in their business. The last time share payouts crossed 100% was in Q2 2007, just before the end of the bull market. A lot has been written about the junk bond market crash recently. Warning signs are all over the place. What’s the CAPE ratio indicating Are the markets over or undervalued according to the p/e ratio? We use the popular CAPE ratio also known as the Shiller p/e for our study. Shiller p/e Mean: 16.7 This is a popular ratio having both its followers and critics. Though, the reading during the dot-com bubble and Black Tuesday was higher compared to current readings, all other tops have formed at or below the present value. We might not fall just because the ratio is high, but it warrants caution. What does all this indicate We have used multiple studies to arrive at our conclusion about the current state of the bull market. The cyclical study, the drop in revenue and earnings, the red flags in the bond markets, high valuation compared to historical averages all indicate that the average investor should be careful about his holdings. With the US fed tightening interest rates, the trajectory of the rates is on an uptrend. Though, the US economy has displayed strength, the commodity markets, the energy markets, the slowdown in the Chinese economy don’t bode well for the bull run to continue. The markets will likely see a drop in 2016 and we want to go short the S&P via the ETF route. How to take advantage of the drop in S&P 500 Let’s look at a few options one can use to benefit from a drop in the S&P 500. Shorting futures It’s the favorite tool used by professional traders to benefit from a fall. However, it might not be a suitable option for the inexperienced trader, because you have to maintain a margin account to enter the trade. You have to actively manage your positions, you can’t short it and forget it. Buying puts The risk is limited in this trade, however, time value eats into the option premiums. Even if the markets remain at current levels, you will lose all your money if you buy at-the-money or out-of-the money options. Professional traders use complex options strategies to limit their risk and benefit from a fall. To benefit from options, you have to get both the timing, direction and the extent of the fall correctly, which might be difficult. Buying inverse ETFs Leveraged inverse ETFs like the ProShares UltraShort S&P 500 ETF ( SDS) Leveraged inverse ETFs can be bought and sold like stocks. SDS is -2x inversely leveraged against the S&P 500, which means, if the index falls by 1% in a day, the SDS ideally should gain by 2%. In the short term, the correlation is maintained; however, as the calculations are done on a daily basis, over the long term, the correlation is not perfect and can reduce well below 2 times. It’s called as beta-slippage. If the markets rise by 1%, your investment in the SDS will drop by 2%, hence, the risk and reward are maximized. As I expect most of the fall to happen during the first five months, I have advised a buy on SDS to profit from the leverage. In case you are not comfortable with the option of using 2x leverage, you can also buy the ProShares Short S&P 500 ETF (NYSEARCA: SH ), which is -1x inverse correlation to the S&P 500. Here, your risk and reward both are lower compared to SDS. If the markets make a new high and the S&P 500 trades at 2,175 levels (2% more than the current all-time high), we shall close our position and accept our assumption to be wrong. In reference to the current S&P 500 levels, the stop loss is around 5% and the profit objective is more than a 10% fall on the index. Conclusion Calling a top is very difficult, but the indications of a fall are building up. I believe the markets are ripe for a fall and investors should use this opportunity to profit from the fall. I recommend a buy on SDS at the current level of $19.54.