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The History Of The Global Equity Portfolio

One of the nice things about thinking of the world in macro terms is that you are less inclined to fall victim to a fallacy of composition. That is, in the financial world we tend not to think in terms of aggregates so we often extrapolate personal or localized experiences into broader concepts which often results in mistakes. The most common economic fallacy of composition is thinking that if you save more then you’re better off, therefore everyone else should save more. This obviously can’t be true at the aggregate level because if everyone saved more then everyone would have less income. Likewise, in “the markets” we often think of “the market” as being something like the S&P 500 (or worse, the Dow 30) when the reality is that the “stock market” is a global market that is much broader than the S&P 500. And the financial markets are much broader than the stock markets. I got to thinking about all of this as I was going through the Credit Suisse Global Investment Returns Yearbook ( see here ). They had this fabulous chart of the dynamism of the global equity market over the last 100+ years: This chart is interesting because it shows a number of things. First, the USA was once a relatively small slice of the total market cap of outstanding stocks. Second, the reason the USA has performed so well over the last 100 years is, in large part, the result of a massive capture of market share by US corporations. This has huge implications for portfolios going forward. There is, in my opinion, a strong likelihood that the USA will lose market share to foreign firms as emerging markets become the growth engine of the world and the US economy matures and slows. So a slice of global equity market exposure not only makes sense for broad diversification, but also when considering a strategic allocation towards potentially higher growth regions. This image also shows how important it is to be dynamic and forward-looking in your portfolio to some degree. John Bogle recently made headlines for stating that a US investor shouldn’t be invested abroad. I’d be willing to bet if Bogle had been in the UK in 1899 talking about his portfolio preferences, he would have said a UK investor should stay fully invested in the UK. Why even bother investing in an emerging market like the USA? I am sure that investing in the USA back then looked fairly silly to a foreign investor. That was obviously a huge mistake. The point is, the future composition of the outstanding mix of global financial assets will change and investors who shun forecasting and some degree of necessary dynamism in their portfolios are very likely to generate returns that will be based on recency bias and extrapolative expectations (expecting the future to look like the past). One of the big lessons from history is that the future rhymes, but it rarely repeats. And a little bit of intelligent forecasting about what the future might look like could go a long way to helping your portfolio in the future. Are you Bullish or Bearish on ? Bullish Bearish Neutral Results for ( ) Thanks for sharing your thoughts. Submit & View Results Skip to results » Share this article with a colleague

Time To Worry About Utility ETFs?

Utilities – one of the best performing sectors of 2014 – started the year on a good note with smart gains logged for January. An uncertain global economic outlook, interest rate cuts in developed to emerging markets, sliding commodity prices, political instability in Greece and a surprise move by the Swiss central bank to abandon its currency cap against the euro created panic among investors driving treasury yields lower at the start of the year. However, the sector has lately given up almost all of its gains and in fact is trading in the red in the year-to-date frame. The most popular product in the space – Utilities Select Sector SPDR (NYSEARCA: XLU ) – has lost 7.4% in the past one month as against a 4% return by SPDR S&P 500 (NYSEARCA: SPY ) over the same time frame. An improved U.S. economy and a strong U.S. jobs report have sent government bond yields sharply higher in the past few weeks, making the utility sector less attractive. The U.S. economy has added more jobs than expected in January, fuelling optimism about the strength of the job market. Moreover, the U.S. average hourly earnings rose at a better-than-expected pace of 0.5% in January. The upbeat labor market data has raised optimism about the pace of economic growth, leading many to believe that a rate hike by the Fed is surely on the cards this year. Expectations of a rate hike this year has caused the 10-year Treasury bond yield to spike to a four-week high of nearly 2%, a sharp and sudden increase from levels which were in the 1.65% range earlier in the month (read: Rising Interest Rates Are Great News for These Bond ETFs ). Utilities are quite sensitive to interest rates though they offer steady and strong yields. Thus, rising Treasury yields, an improving U.S. economy and strength in the jobs market have reduced the appeal of utilities as investors are shunning defensive bets to move to sectors more closely tied to growth. Moreover, utility companies rely on a large amount of debt for conducting operational activities. Hence, any rise in interest rates would push up their borrowing costs (see 3 Sector ETFs to Profit from Rising Rates ). Given the rising yields and concerns over a hike in short-term rates this year, below we have highlighted some of the large-cap funds in this space which have been among the hardest hit by the move towards cyclical securities and away from safety. Investors who believe that this is just the beginning of the slide in the space should clearly stay away from this space. XLU is the largest and the most popular ETF in its space with an asset base of $7.8 billion and average daily trading volume of 14.7 million shares. The fund is also one of the cheapest in its space with 15 basis points as expense fees. The fund tracks the Utilities Select Sector Index, holding a basket of 30 stocks. Duke Energy (NYSE: DUK ) occupies the top spot with 9.3% allocation, followed by NextEra Energy (NYSE: NEE ) and Southern Co. (NYSE: SO ), each with a little more than 7.5% exposure. XLU has lost 4.4% in the year-to-date frame after having gained 16% in the past one year. The fund has a solid dividend yield of 3.31%. iShares Dow Jones US Utilities Sector Index Fund (NYSEARCA: IDU ) The fund too gives investors an exposure to U.S. utility stocks and manages an asset base of $1.9 billion. IDU is home to 60 stocks and is also heavily concentrated in its top 10 holdings. Duke Energy Corp. (8.3%), NextEra Energy Inc. (6.65%) and Dominion Resources Inc. (NYSE: D ) (6.3%) are the top three holdings of the fund. Sector-wise, the fund invests more than half of its assets in electric utilities, while the rest go towards multi-utilities, gas and water (see all Utilities/Infrastructure ETFs here ). The fund charges 43 basis points as fees and has a 30-day SEC yield of 2.62%. IDU has lost 7% in the year-to-date frame but up 16% in the past one year. Vanguard Utilities ETF (NYSEARCA: VPU ) VPU tracks the MSCI US Investable Market Utilities 25/50 Index to provide exposure to a basket of 78 stocks. Sector-wise, electric utilities dominate here as well, followed by a 34% allocation to multi-utilities. The fund is also quite popular in its space with an asset base of $2.1 billion and an average expense fee of 12 basis points. The fund has a 30-day SEC yield of 3.08% and has lost 7.2% in the past month.

Ford Vs. Tesla

Summary I am not particularly bullish – slightly bearish, in fact – on the auto industry, but I see a relative value play between Ford and Tesla. Ford had a very solid 2014 and should build on that in 2015, barring a macro economic downturn. Tesla ended 2014 on a low note and will continue to bleed money into 2015 and beyond. A pair trade could be a low-risk way to play F and TSLA and largely mitigate the risk of economic distress. Earlier this month, I began a new mock portfolio here on Seeking Alpha: the Pairs Trade Portfolio; today I continue it with trades on Ford (NYSE: F ) and Tesla (NASDAQ: TSLA ). A pair trade is a market-neutral hedge in which an investor essentially pits one company against another. Getting a return on a pair trade is not dependent upon a particular stock rising or falling necessarily, but dependent upon the relative price moves between two stocks (or other financial instruments). I won’t go into details about the hows and whys of pair trading here, as I have already described the theory in detail in a previous article. Please take a look at the link for more information on why pair trades might be a good investment. Previous articles with pair trades for the portfolio: The Auto Industry The industry is extremely sensitive to the global economy as a whole. By and large, people don’t have a pressing need to buy a car and the purchase can normally be put off for months and even years and therefore in tough economic times car sales plummet. I think that notion of “purchase delay” has never been more true than now due to the fact that automobiles are more reliable now than ever. Because of the auto industry’s reliance on a good economy, I’m actually somewhat bearish to neutral on auto companies right now. I predict the global economy will underperform expectations over the next couple of years (at least) with an excellent chance of stock market crashes and recessions. I wrote a piece about the top 7 economies – that account for 74% of world GDP – in an article titled ” The Ingredients For An Imminent Bear Market Are In Place ” in which I noted why I felt that US equities, in particular, were due for a fall. So, why am I buying Ford and shorting Tesla for my Pairs Trade Portfolio? Well, because the whole point of a pair trade is to make an investment that takes out the uncertainty of outside events. By buying Ford and selling Tesla, I am making a bet on Ford vs. Tesla and that is all. If Ford stock drops to $8 per share and Tesla drops to $50, I’ve made money. If I am completely daft about the state of the economy and Ford moves to $30 while Tesla moves to $300, then I’ve still made money, though obviously not as much as I would have being solely long. The phrase “market-neutral hedge” is critical when talking about a pair trade. Again, if the reader has lingering questions about it, please click on the link near the top of this article for more information. And now onward to discussion of the two companies. Ford’s Prospects I consider Ford to be the best risk/reward choice of the automakers for a number of reasons, but three big ones come to mind immediately: Lower gas prices means more large vehicle sales and the higher profits that go with them. Ford rules in the pickup arena and 2015 could be a banner year for F-150 sales given low gas prices along with a redesign of the truck. Asia/Pacific sales. Cheap valuation. As for pickup sales, Ford is still the king and will likely stay that way throughout 2015. In January 2015 , Ford sold over 54,000 F-Series trucks compared to 36,000 Chevy Silverado sales. It appears that the public is responding well to the revamped F-150 and I expect it to be the best selling vehicle in the US for the 34th year in a row in 2015. I want to go into the Asia/Pac region in a bit more detail as I consider that region to be extremely important in the long run. I wrote about it in a previous article on Ford, saying that: Ford is executing well in Asia Pacific, which is the region with the most growth potential for the next decade (at least). However, keep in mind that Asia Pacific is not currently a large component of Ford’s business. Units sold in the Asia Pacific region represented about 21% of the total units sold for the company in Q1 2014. However, the revenues by region are as follows: Asia Pacific: 7.8% of the company total; North America: 60.4% of the company total; Europe: 22.9% of the company total. Those numbers were from Q1 2014. Today I am looking at Ford’s most recent investor presentation and I see many highlights pertaining to the region including: Asia/Pac employment increased 25% from 2013 to 2014; China market share increased from 4.1% to 4.5% (Y/Y); Record profit in Asia/Pac in 2014; Revealed new global Explorer and the all-new Everest for Asia/Pac; Over 1 million units sold in Asia/Pac in 2014. Clearly, Ford’s strategy in Asia is working well and the company is picking up profits in the region at a record pace. The growth prospects are enormous in that region and it is one that I will continue to keep my eye on. Finally, the valuation of Ford is cheap based on analyst expectations . The stock’s forward P/E for 2015 and 2016 is at 10.0 and 8.7, respectively. I’ve already noted that I am still not fully bullish on Ford because I think those estimates don’t take into account the risk of a serious miss. But it is worth noting the price of the shares based on those analyst expectations. There is solid upside to the stock based on earnings alone if macro events don’t derail it. Tesla Prospects I’ll stick with the Asia theme to start off and note that in January 2015, Tesla sold about 120 cars in China. That linked article also notes that “Musk has previously said he expected China sales could rival those in the United States as early as 2015.” The shortfall is important not just because Tesla’s market in China is non-existent, but also it shows just how incredibly off the mark Musk was in his prediction. If there is one common theme amongst the Tesla stockholders, it is the unshakable belief in the “Temple of Elon.” He is not infallible. As for China, Tesla has, to date, wasted its time and money on the country since 2013 (when orders began there) as it has basically nothing to show for its efforts. Moving on to some financial considerations, the company is spending money at an alarming rate. For example: The company spent $970 million in capital expenditures in 2014 while the 2013 capex was $264 million. A poor Q4 performance saw it post a loss of over $100 million – the loss was nearly $300 million for the full year. The company burned through a considerable amount of cash in Q4: $465 million. Long-term debt and “other long-term liabilities” increased from $881 million in 2013 to $3.069 billion in 2014. In addition to the added debt, Tesla is diluting its stock steadily in order to fund operations (the large steps upward) and pay management (the slower, grinding upward slopes): TSLA Shares Outstanding data by YCharts We can clearly expect to see more dilution and more debt in for the next several years in order to fund operations, capex, and compensation. Elon Musk predicted GAAP profitability in 2020 and I estimate that (if and only if all goes well) Tesla will show solid positive cash flow a year or two before that. Until then Tesla will need a lot of additional financing. There’s nothing wrong, per se, for a company to spend lots of money, incur debt, and even dilute its stock. However, when a company does those things and has a stock price that is (still) quite high and full of expectations, the bar is set extremely high for that company to execute. In other words, Tesla better be spending all that money wisely. Some Valuation Comparisons Ford’s market cap is about $62 billion and Tesla’s cap is about $25.5 billion and thus Ford is valued at just under 2.5 times that of Tesla. Some of the charts comparing the two companies are actually comical, but I think they illustrate my point well. First, the difference in revenue: F Revenue (TTM) data by YCharts Ford has about 45x the revenue of Tesla. Tesla is growing revenue much faster than Ford, but is so far behind its more established rival. The cash from operations: F Cash from Operations (TTM) data by YCharts Tesla has bounced up and down from negative to positive and back to negative again as the company struggles to limit the bleeding. I showed Tesla’s dilution above, now let’s see Ford’s shares outstanding: F Shares Outstanding data by YCharts There is a bit of upward creep there over the last few years, but it is minor – especially compared to Tesla. None of the above charts should be of any surprise to an investor in either company, but I think they do serve to show us the amount of faith that Tesla investors have. For the company to be valued at 40% of Ford means that an incredible amount of success is priced into the stock. In my opinion, TSLA should be no more than 10% of Ford. Conclusion At this point, a lot of things have to go right for TSLA stock to be worth the price it currently commands. The company will add more debt and it will dilute the stock further. Not only must Tesla continue to grow revenues and deliver cars at a rapid pace, but it must soon start to give us a glimpse of a profitable future. Moreover, Tesla is about to encounter ramped up competition in its EV space. General Motors (NYSE: GM ) has announced the development of a 200-mile range electric car that should directly compete with Tesla’s Model 3, set to debut in 2017. I have no doubt that many, if not all, major manufacturers will be making similar announcements of long-range EVs throughout 2015, including Ford (heck, maybe even Apple). At some point in the not-too-distant future, carmakers will have multiple EVs in the stable including luxury and sport models. How can TSLA stock stay, or indeed rise from, the level it is at when the company will no longer be unique? Ford, for its part is reasonably predictable, at least relative to Tesla. The stock does not move quite “…as peacefully and leisurely as a python digesting a Valium addict.” (Tom Robbins from Skinny Legs and All ), but it does trade, in the main, based on fundamentals instead of sentiment and hope. The company has a long history of success and should continue to grow and expand its success into new locations and with new models, including EV models. Ford (and all established car makers) has the advantage of being able to invade Tesla’s market whenever and however it chooses. Ford can and will make EVs that compete more directly with Tesla than they do now and when a big company like Ford moves into a small company’s space, there is a tendency for bad things to happen to the smaller company. The Portfolio At 8 p.m. Eastern Time on February 17 I’m buying F and shorting TSLS in my Seeking Alpha portfolio. Here is what the mock portfolio looks like so far after three pair trades (note that I plan on adjusting, adding, and updating this for years): A wee profit! Nice to see, although fairly meaningless this early in the game. Be sure to click “follow” if you would like to get real-time alerts on my future articles. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.