Tag Archives: etfs

PFF Dodges Bullets From The Banking Sector

Preferred stock ETFs were once considered a tiny corner of the alternative income marketplace that had dodged the bullet of credit contraction. High yield mainstays like junk bonds, master limited partnerships, and even REITs have felt the pain of income investors reeling in their risk targets and running for the safety of high quality bonds. That picture changed dramatically this month as the iShares U.S. Preferred Stock ETF (NYSEARCA: PFF ) fell 5% from high to low and is scrambling to claw its way out of the abyss. This uptick in volatility may come as a surprise to many who had become accustomed to small prices changes in the index over the last several years. Preferred stocks are somewhat of a hybrid instrument that carry qualities of both equity and debt instruments. Therefore, with interest rates falling, it must be an equity-driven event that is causing this turmoil. A quick check behind the scenes of PFF reveals that this fund owns a diversified mix of 260+ individual preferred securities. Yet the single largest underlying sector is banks (42%) and diversified financial companies (18.50%). Together these two groups make up over 60% of the total portfolio and will therefore contribute an outsized portion of the fundamental price action. An overlay of PFF versus the SPDR S&P Bank ETF (NYSEARCA: KBE ) shows that the preferred stock index began a pronounced downside move in tandem with the sharp dive in publicly traded bank stocks (blue line). Click to enlarge PFF had a much more muted percentage drop than KBE. However, it is clear that the stress in banking stocks is also translating to a measure of fear in the underlying preferred market as well. Another interesting phenomenon with this price action has been the relatively swift and sharper recovery in PFF versus KBE. While banks are barely off their lows, PFF has been able to recover more than half of its corrective move. Only time will tell if this V-bottom formation will hold or if there will be another round of selling that will again test the resolve of income investors. I have owned PFF for clients in my Strategic Income Portfolio for a number of years and have been pleased with its makeup and performance over that time frame. A fund of this nature provides us with exposure to an alternative asset class with a much lower beta than a traditional dividend equity fund. It has also demonstrated a much stronger comparable income stream than a diversified bond fund. We view preferred stocks as a tactical opportunity in the context of a diversified income portfolio . This means that they are typically sized smaller than a core holding and may be added or removed as necessary to accommodate the current interest rate or stock market environment. Moving forward, I will be closely monitoring the price action in this sector to determine if we should scale back our position or continue to hold as this recovery develops further. Either way, our process will entail incremental steps and a thorough evaluation of the income landscape to ensure proper alignment with our conservative mandate . Disclosure: I am/we are long PFF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: David Fabian, FMD Capital Management, and/or clients may hold positions in the ETFs and mutual funds mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell, or hold securities.

Best And Worst Q1’16: Utilities ETFs, Mutual Funds And Key Holdings

The Utilities sector ranks last out of the ten sectors as detailed in our Q1’16 Sector Ratings for ETFs and Mutual Funds report. Last quarter , the Utilities sector ranked fifth. It gets our Dangerous rating, which is based on aggregation of ratings of nine ETFs and 34 mutual funds in the Utilities sector. See a recap of our Q4’15 Sector Ratings here . Figure 1 ranks from best to worst eight Utilities ETFs and Figure 2 shows the five best and worst-rated Utilities mutual funds. Not all Utilities sector ETFs and mutual funds are created the same. The number of holdings varies widely (from 20 to 255). This variation creates drastically different investment implications and, therefore, ratings. Investors should not buy any Utilities ETFs or mutual funds because none get an Attractive-or-better rating. If you must have exposure to this sector, you should buy a basket of Attractive-or-better rated stocks and avoid paying undeserved fund fees. Active management has a long history of not paying off. Figure 1: ETFs with the Best & Worst Ratings – Top 5 Click to enlarge * Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity. Sources: New Constructs, LLC and company filings Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5 Click to enlarge * Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity. Sources: New Constructs, LLC and company filings The Fidelity MSCI Utilities Index ETF (NYSEARCA: FUTY ) is the top-rated Utilities ETF and the American Century Quantitative Equity Utilities Fund (MUTF: BULIX ) is the top-rated Utilities mutual fund. Both earn a Neutral rating. The Guggenheim S&P 500 Equal Weight Utilities ETF (NYSEARCA: RYU ) is the worst-rated Utilities ETF and the ICON Utilities Fund (MUTF: ICTVX ) is the worst-rated Utilities mutual fund. RYU earns a Dangerous rating and ICTVX earns a Very Dangerous rating. 79 stocks of the 3000+ we cover are classified as Utilities stocks, but due to style drift, Utilities ETFs and mutual funds hold 255 stocks. PPL Corporation (NYSE: PPL ) is one of our favorite stocks held by Utilities ETFs and mutual funds. It is the only Utility stock that earns an Attractive rating. Since 1998, PPL has grown after-tax profits ( NOPAT ) by 10% compounded annually. Over this timeframe, PPL has improved its return on invested capital ( ROIC ) from 6% to 7%, which is the highest ROIC of all 79 Utilities stocks under coverage. Despite the continued strength of PPL’s business, the stock is only up 6% over the past decade and shares are currently undervalued. At its current price of $36/share, PPL has a price to economic book value ( PEBV ) ratio of 0.6. This ratio means that the market expects PPL’s NOPAT to permanently decline by 40% from its current levels. If PPL can grow NOPAT by just 3% compounded annually for the next decade , the stock is worth $59/share today – a 64% upside. Connecticut Water Service (NASDAQ: CTWS ) is one of our least favorite stocks held by Utilities ETFs and mutual funds and earns a Very Dangerous rating. Throughout the history of our model, which dates back to 1998, Connecticut Water Service has never generated positive economic earnings . The company’s ROIC has declined from 5% to 3% over the same timeframe. However, at its current price of $41/share the stock remains significantly overvalued. To justify its current price, Connecticut Water Service must grow NOPAT by 7% compounded annually for the next nine years . While this may not seem like much in terms of profit growth, keep in mind that CTWS has failed to generate economic profits in any year for nearly two decades. Figures 3 and 4 show the rating landscape of all Utilities ETFs and mutual funds. Figure 3: Separating the Best ETFs From the Worst ETFs Click to enlarge Sources: New Constructs, LLC and company filings Figure 4: Separating the Best Mutual Funds From the Worst Mutual Funds Click to enlarge Sources: New Constructs, LLC and company filings D isclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, sector or theme. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

A New Leading Indicator Of Stock Market Direction

Click to enlarge I just discovered a new leading indicator of U.S. stock market direction, and I’d like your thoughts on its efficacy. The following graph shows the history of the indicator going back to 1998. It forecast the market declines in 2000 and 2008, and is currently forecasting another market correction. A high indicator precedes a market sell-off. A low indicator signals a recovery, and a flat indicator is a predictor of average returns. The returns shown in the graph are the average quarterly returns over the year following the indicator date. They’re rolling 4-quarter averages. Click to enlarge The Indicator I created and maintain the Surz Style Pure indexes that break the stock market into large, middle and small, and within each of these sizes into value, core and growth. Morningstar style boxes use a similar approach, and were introduced several years after I launched my indexes. My index definition for large companies is the top 65% of the market. I sort the 6000 companies in the U.S. stock market by capitalization and start adding until I get to 65% of the total capitalization. I’ve recently noted that the breakpoint for large companies has recently reached its highest point ever – $22 billion. A large company, by my definition, is currently above $22 billion. There are currently 227 U.S. companies that meet this rule, with total capitalization of $16 trillion, which is 65% of the $25 trillion total market size. This large company breakpoint is the indicator shown in the graph above. It has successfully predicted the last two market cycles, and is signaling that a major market decline started last year with more to come. This supports my prediction for a 19% loss in 2016 based on pure fundamentals. So why does this breakpoint indicator work, and most importantly will it work this time? Here are some possible explanations: Mega cap market domination is cyclical, and the (capitalization-weighted) market goes where the mega caps go. It’s just another measure of overpricing, big companies becoming too expensive. Investors flee to the safety of big companies when they’re worried, and worry ultimately turns into panic. It’s not a leading indicator at all. The apparent correlations are spurious. What do you think? Have I stumbled onto something? What is it telling us about 2016? Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.