Tag Archives: government

Why TIPS Deserve A Spot In Your Portfolio

Summary TIPS represent only 10% of the Treasury market but should play a larger role in diversified portfolios. TIPS protect bond investors against unexpected inflation while capping deflation risk. Only TIPS can provide an inflation hedge, the prospect of real returns, and the safety of the backing of the U.S. Treasury. We’ve written several articles in the past about what investments and asset classes shouldn’t be in your portfolio, such as commodities , currency funds , and bank loan funds . We also wrote a few articles about asset classes that should be in your portfolio, such as international bonds . But we’ve never discussed how to assemble a comprehensive, well-diversified portfolio. It’s important to note we are talking about an investment portfolio so we will not be considering cash which would be part of someone’s savings portfolio. In this ongoing series of articles, we’ll be discussing each of the asset classes we use to assemble client portfolios. Over the next few weeks, we’ll be discussing each asset class in depth and talking about what risk and reward attributes they bring to a portfolio. For this series of articles, we’ve divided the asset classes into three conceptual categories: low risk, medium risk, and high risk. The links to previous articles are below. Low Risk Treasury Inflation Protected Securities (( OTC:TIPS )): Why TIPS Deserve a Spot in Your Portfolio Domestic Government Bonds Medium Risk High Risk Real Estate Domestic and International Stocks Summary How to Assemble a Comprehensive Investment Portfolio What are Treasury Inflation Protected Securities or TIPS? Treasury Inflation Protected Securities or TIPS are a relatively recent invention having only been issued by the U.S. Treasury since 1997. TIPS represent a small minority of the Treasury securities market, with only about a 10% market share, but we believe they could play a much bigger role in investors’ portfolios. Like the name suggests TIPS are designed to protect investors from unexpected rises in inflation by adjusting the income and principal investors receive when inflation changes. How TIPS Work TIPS function just like normal bonds but with one key difference. Like a traditional bond, a TIPS bond pays a fixed percentage coupon and the investor receives the par value of the bond back at maturity. However, TIPS protect investors against inflation by adjusting the par value of the bond upwards when inflation rises. The coupon payments also increase since they are based on the new, higher par value of the bond. Inflation data is calculated using the non-seasonally adjusted U.S. City Average All Items Consumer Price Index for All Urban Consumers (CPI-U) index published by the Bureau of Labor Statistics. The inflation data is calculated every six months when the TIPS pay interest (like most bonds, TIPS make interest payments twice per year). To see how this works, let’s look at a hypothetical TIPS bond that has a par value of $1,000 and pays a coupon of 2%, and then what happens after a year that sees 10% inflation. For simplicity’s sake, we are going to just pretend TIPS pay interest once per year while in reality they make two coupon payments each year (each one being one-half the calculated interest rate). Year Inflation/Deflation Par Value Coupon Rate Coupon Payment Initial Year n/a $1,000 2% $20 Second Year 10% inflation $1,100 2% $22 As you can see in the table, the 10% increase in inflation increases the par value of the bond by 10% or $100. The coupon is 2% of the new par value of $1,100 or $22. Now, an important thing to take note of is that this process also works in reverse. If inflation, as measured by CPI-U, is negative, then the par value of the bond will decrease. However, the value will never drop below the initial par value the bond was issued at (in this case $1,000). To see how deflation affects TIPS, let’s take the same example we used above but now add a third year where we have 5% deflation. The table below shows what will happen. Year Inflation/Deflation Par Value Coupon Rate Coupon Payment Initial Year n/a $1,000 2% $20 Second Year 10% inflation $1,100 2% $22 Third Year 5% deflation $1,045 2% $20.9 The par value of the bond is reduced from its previous value of $1,100 by 5% to $1,045. The coupon rate as always stays the same at 2% and the new coupon payment is 2% of the new par value of $1,045 or $20.90. It’s also important to note that the fluctuation of the par value of TIPS will have an effect on the taxes an investor pays. An investor will be liable for taxes on the adjustments to the par value of the bonds. Increases in the par value of the bonds are treated as interest income in the year the increases occur, even though the investor may only receive the increase in par value years in the future when the bond comes due. For example, if an investor received $2,000 in interest and the par value of the bonds rose $500, then the investor would be taxed on $2,500 of income ($2,000 in interest plus a $500 increase in par value). Likewise, decreases in the par value of the bond due to deflation are treated as reductions in interest income. For example, if an investor received $2,000 in interest payments but the par value of the bonds dropped by $500, the investor would only be taxed on $1,500 of income ($2,000 in interest minus $500 reduction in par value). What TIPS Can Add to Your Portfolio We’ve spent almost the last decade in an environment of very low to no inflation so TIPS may seem like they provide little value. In fact, we’ve basically been in a period of falling inflation and falling interest rates over the past few decades which have been great for traditional bonds. But the recent past is certainly not an indication of the future. The chart below shows the year-over-year change in the inflation measure used by TIPS (CPI-U). As you can see, inflation has been much more volatile in the past. Unexpected, high inflation is the exact type of risk that TIPS are designed to protect investors against. In periods of unexpected rising inflation, TIPS behave the opposite of normal bonds. If inflation were to rise unexpectedly, the fixed coupon payments of traditional Treasury securities would become less valuable in real terms. Investors would demand higher interest rates and the price of bonds would fall. With TIPS, both the coupon payment and the par value of the bond would be adjusted upwards to match inflation. TIPS also benefit from the fact that inflation below expectations (remember all bonds have inflation expectations built into them in the form of what interest rates investors demand) or deflation will only reduce the value of a TIPS bond down to its par value. Thus, losses due to negative inflation adjustments are effectively capped. TIPS offer investors unlimited inflation upside and limited deflation downside. It’s virtually impossible to find any other type of investment with capped downside and unlimited upside risks in respect to inflation. The Case for TIPS over Other Hedges While TIPS certainly aren’t the only type of inflation hedge out there, they are one of the best. Specific types of stocks can be good inflation hedges. Stocks of companies that have significant pricing power and strong brands, the stereotypical example of cigarette companies come to mind, can provide a powerful hedge against inflation. They also come with the higher risk and volatility that comes with all stocks. Commodities are often cited as providing a hedge against inflation. However, as we showed in two of our previous articles last year ( here and part two here ), over the long term, commodities have only provided a hedge against inflation. They offered no real return above inflation. Also, as recent events have shown, commodities can be quite volatile as well. TIPS offer investors a hedge against inflation, the opportunity for real returns, and the safety of the backing of the U.S. Treasury. No other asset class can offer that combination to investors and that is why TIPS should play an important role in any diversified portfolio. Investors can purchase TIPS directly from the U.S. Treasury or via any number of ETFs or mutual funds, a few of which are shown in the table below. Fund Name (Ticker) Expense Ratio iShares TIPS Bond ETF .20% Vanguard Inflation-Protected Securities Fund (MUTF: VIPSX ) .20% Schwab U.S. TIPS ETF (NYSEARCA: SCHP ) .07% SPDR Barclays TIPS ETF (NYSEARCA: IPE ) .15% Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks. Disclosure: I am/we are long TIP. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

IBB: Trees Don’t Grow To The Sky

Summary The collective market capitalization of the biotech index is disconnected from actual sales. Given the huge U.S. Federal deficit (now $18 trillion) and skyrocketing healthcare costs, the costs of biotechnology drugs are unsustainable. The U.S. spends far more than other developed nations for healthcare as a percentage of GDP and on a per capita GDP basis. Unless you are reading the children’s story, Jack and the Beanstalk, the last time I checked, trees don’t grow to the sky. Evidently, the iShares Nasdaq Biotechnology ETF (NASDAQ: IBB ) didn’t get the memo. Let me be clear, I don’t have a science background. So my angle and perspective aren’t derived from actual industry experience or academically grounded. However, as an investor, I don’t need to be able to build the watch, I simply need to tell what time it is. Through a series of charts, common sense, and a general awareness of the world around me, I will lead the reader towards the notion that IBB is priced for perfection. That said, I am not discounting or doubting the remarkable innovation and scientific breakthroughs that are occurring in this gilded age of biotechnological. Rather, I’m simply suggesting the collective valuation is a disconnected sanity. Here are some high level statistics on U.S. healthcare spending. In 2013, U.S. healthcare spending was 17.4% of GDP, or $2.9 trillion. (click to enlarge) Here is a chart comparing per capital spending versus other major industrialized nations: (click to enlarge) Here is another chart depicting spending as a percentage of GDP. As you can clearly see, U.S. spending is off the charts: Source Here are the top holdings within IBB. I also added the rounded market caps. of each top holding (as of September 11, 2015). (click to enlarge) Source: IBB website Although I am much more concerned about IBB than big pharma, I included some of the major pharma names for perspective. The names below cumulatively have $1.7 trillion, that’s with a “T”, in market caps. This doesn’t include their debt as big pharma has been known to issue a lot of low interest rate debt to finance share buybacks and pay sporty dividends. (click to enlarge) Source: Google Finance Over the past five years, IBB has climbed 319% or $270 per share. Wow! (click to enlarge) Source: Google Finance Here is a detailed version of the U.S. healthcare spending: (click to enlarge) Here are the top global drug sales by specific drug and then ranked by the type of therapy area: Source: American Chemical Society Here is why IBB is overvalued and vulnerable to a sharp pullback. Essentially, there is a recognition and ground swell by members of the medical community that drug costs are unsustainable. Given that the government and private health insurers negotiate the prices for these drugs, I’m arguing there will be cost controls and regulatory risks. It is when not if in my mind. Lower-cost generic drugs are on the horizon due to the excessive costs charged by biotechnology companies. These companies have let their greed get the better of them and they may have killed the golden goose. (click to enlarge) Source: WSJ Remember, since 2000, U.S. public debt has grown from $6 trillion to $18 trillion in fifteen years. We have been running deficits every year since the dot-com bubble. Our healthcare costs are at least 600 bps points higher than other industrialized nations and higher on a per capita GDP basis. With the exception of the super-wealthy, the vast majority of people simply can’t afford to buy these expensive medications. (click to enlarge) Andrew Pollack’s NYT article “Drug Prices Soar, Prompting Calls for Justification” published on July 23, 2015, captures this theme poignantly. Here is a direct quote from the article: Pressure is mounting from elsewhere as well. The top Republican and Democrat on the United States Senate Finance Committee last year demanded detailed cost data from Gilead Sciences, whose hepatitis C drugs, which cost $1,000 a pill or more, have strained the budgets of state and federal health programs. The U.A.W. Retiree Medical Benefits Trust tried to make Gilead (NASDAQ: GILD ), Vertex Pharmaceuticals (NASDAQ: VRTX ), Celgene (NASDAQ: CELG ) and other companies report to their shareholders more about how they set prices and the risks to their businesses from resistance to high drug prices. The trust cited the more than $300,000 per year price of Vertex’s cystic fibrosis drug Kalydeco and roughly $150,000 for Celgene’s cancer drug Revlimid. Here is an NPR article with the same theme, “Doctors Press For Action To Lower “Unsustainable” Prices For Cancer Drug.” Here are two direct quotes: “A lot of my patients cry – they’re frustrated,” says Dr. Ayalew Tefferi , a hematologist at the Mayo Clinic. “Many of them spend their life savings on cancer drugs and end up being bankrupt.” The average U.S. family makes $52,000 annually. Cancer drugs can easily cost a $120,000 a year. Out-of-pocket expenses for the insured can run $25,000 to $30,000 – more than half of a typical family’s income. Lastly, written by Robert Pear , here is another NYT article “Health Insurance Companies Seek Big Rate Increases for 2015.” This was published on July 3, 2015. Here is a direct quote from the article: “Health insurance companies around the country are seeking rate increases of 20 percent to 40 percent or more, saying their new customers under the Affordable Care Act turned out to be sicker than expected. Federal officials say they are determined to see that the requests are scaled back.” Conclusion Yes, I understand that 2014 was a great year for purveyors of prescription drugs , with sales climbing 12% at their fastest percentage growth rate since 2002. However, as a society, the political pendulum is tipping towards increased awareness and anger. Given the skyrocketing costs of healthcare, the federal deficits, and the nosebleed market capitalization of biotech stocks relative to sales, it would be prudent to take profits in shares of IBB. The risk greatly outweighs the benefits given the valuations. Remember, trees don’t grow to the sky and $300K drug therapies are unsustainable. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Will The Casino ETF Finally Hit Jackpot?

The casino gaming industry has seen much suffering over the last one year. Normally, large casinos hail from two cities – Las Vegas and Macau. While Las Vegas was a laggard a few years back on recession in the U.S. and Macau was a star performer, the story changed totally in a few quarters on hard landing fears in China. For more than a year now, Macau has been a pain for the casino operators as this Chinese region is the operating Mecca of leading casino operators like Wynn Resorts Ltd. (NASDAQ: WYNN ), MGM Resorts International (NYSE: MGM ) and Las Vegas Sands Corp (NYSE: LVS ). Notably, Macau is one of the largest casino gaming destinations in the world. Credit crunch issues in mainland China, check on illegal money transfers especially in VIP gaming and a broad-based slowdown in China are responsible for the latest drop-off in the casino industry. Though Las Vegas is gaining ground on an improving U.S. economy, a protracted upheaval in Macau hit hard the casino stocks and the related ETF. For the first eight months of 2015, gross gaming revenues declined 36.5% in the region. In August itself, revenues were off 35.5%. Turnaround Round the Corner? Though the decline in August was the fifteenth successive monthly decline and the twelfth consecutive double-digit decline, gaming kicked off on a slightly positive note in September. As per barrons.com , average daily table revenue in Macau’s casinos was 605 million Hong Kong dollars in the first six days of September. The weekly figure bettered the average August revenue of HK$550 million. Moreover, investors should note that though August appeared downbeat, mass market gaming showed improvement. Thanks to the crackdown on the VIP segment, most casino operators focused on the mass market segment, reduced minimum bets and shifted more tables from VIP to the mass market division. To add to this, to save the sector, the government is resorting to several measures. Per the recent media reports, the government would reportedly allow smoking in Macau casinos under certain conditions. Meanwhile, per a new norm implemented by the government from Jul 1, mainland China passport holders transiting through Macau can stay there for two more days and could gain entry into the city within 30 days instead of 60 days previously. So, the easing of tourist restrictions in Macau and the possibility of relaxation in bans on gaming-floor smoking rooms will rev up Macau casino revenues. Casino ETF: Buy on the Cheap? The outright negative mood so far weighed on the casino gaming ETF the Market Vectors Gaming ETF (NYSEARCA: BJK ) which is down about 17% so far this year (as of September 9, 2015). The fund lost about 30% in the last one-year and two-year frames, while the fund added over 1.5% in the last five days (as of September 9, 2015). Moreover, investors should note that casino stocks are extremely cheap in valuation after undergoing a steep sell-off. All these paint a brighter outlook for the casino ETF in the days to come. Granted, there is no short of economic bottlenecks yet slightly positive Macau vibes are in the air now. So those who are looking for a beaten-down space which might turn around in the coming days can try out their luck with BJK. BJK in Focus The fund looks to track the Market Vectors Global Gaming Index and provides investors a direct exposure to the casino gaming market. The product has so far been overlooked by investors as is evident from its paltry volume of about 30,000 shares daily. The fund has so far attracted $25.3 million in assets, invested in 45 holdings. The product is expensive as it charges 65 bps in fees per year which is on the higher end of the expense ratios of the consumer discretionary ETFs. The fund has now slid into an oversold territory as indicated by its relative strength index of 38.23 times. The fund currently has a Zacks ETF Rank #2 (Buy) with a High risk outlook. Link to the original post on Zacks.com