Tag Archives: health

Best Stock ETF/Fund Categories For Future Gains

I’ll start with the good news. The overall market, including nearly all subcategories of ETFs/funds, especially international ones, is no longer at what I previously felt was a dangerously high level. One year of relatively flat, or even negative returns, have helped restore fund performance to more sustainable levels. (However, more traditional measures of stock valuation, such as forward-looking price to earnings ratios remain elevated – over 17, vs. the long-term average of about 14 for the S&P 500, according to bloomberg.com). I look at both stock valuations and on-going momentum as important yardsticks in judging the relative attractiveness of a particular stock fund and its overall category. While over- vs. under-valuation tends to arise as a result of long-term factors, momentum (relatively positive or negative) can be regarded as more short-term in nature. Given this, I place somewhat more importance on valuation issues than momentum in determining which stock fund categories look the most and least promising over the next several years at any given point. Now for the not-so-good news: Unfortunately, most stock ETF/fund categories, while not appearing excessively overvalued, don’t appear undervalued either. Of course, any time stocks are undervalued, they can be assumed to have much better prospects than if they are overvalued, or even fairly valued. At the same time, virtually every category of stocks has lost the momentum they exhibited in early 2015. My most favored and least favored stock category selection procedures do not employ the use of economic variables, such as GDP, level of interest rates, etc. However, since stocks often become over- vs. under-valued or momentum-impacted based on investors’ reactions to such data, my procedures do, in a sense, indirectly reflect such variables. Using my proprietary selection procedures has resulted in my specific fund selections outperforming an equivalently composed portfolio of benchmark index funds over the most recently available 3 year period, 10.9 vs. 9.6%, as well as the entire 5 year period, 11.1 vs. 9.6%. (Data annualized thru Sept. 30, 2015; see here to review the data. Note: One, 3, and 5 year data that include the just completed 4th quarter will be published on my website during the 2nd week of Jan.) Based on current valuation and momentum factors, the best that can be said is that the majority of fund categories are what I consider to be HOLDs. There are very few categories that exhibit the characteristics I consider as meriting a BUY designation, along with a few REDUCE/SELLs; for specifics, see the tables below. All categories designated as HOLDs are expected to be worth holding over the next 3 to 5 years, generating decent returns if held over the entire period. Here, then, are my current category recommendations for the nine most recognized U.S. ETF/fund categories starting with those with the most positive longer-term prospects near the top to those with least promising prospects near the bottom: Fund Category Recommendation Large Growth HOLD Mid-Cap Growth HOLD Large Blend HOLD Small Growth HOLD Large Value HOLD Small Value REDUCE/SELL Mid-Cap Value REDUCE/SELL Mid-Cap Blend REDUCE/SELL Small Blend REDUCE/SELL Note that none of the above basic fund categories show up as having particularly strong prospects over the next several years according to my research. While not currently overvalued, each of these categories has run up considerably over nearly the last 7 years, limiting, in my view, their future prospects. International Funds The following table shows my current category recommendations for five international fund categories starting with those with the most positive longer-term prospects near the top down to those with least promising prospects: Fund Category Recommendation Emerging Markets HOLD Japan HOLD Europe HOLD Diversified Pacific/Asia HOLD Diversified International HOLD My research shows that the first 4 out of the 5 international stock fund categories shown above show better prospects than any of the above U.S. fund categories. International stocks have had their problems in recent years, but looking ahead, I believe that prospects, including the economic fundamentals not directly considered in the above recommendations, will improve going forward. Sector Funds While I am not a big advocate of sector funds/ETFs, I present this data for those relatively aggressive investors who might be. Note that because sector funds can be highly volatile and relatively unpredictable, even when considered as longer-term investments, there is an above average risk that any sector forecasts, including mine, will not turn out as expected. Additionally, while you may not choose to invest in sector funds at all, you may find that the non-sector funds you do invest in (or are considering) can have a sizeable proportion of their holdings within one or more sectors. To learn what the sector breakdown is, enter the fund symbol at morningstar.com and look for “Top Sectors.” If the fund overweighs sectors that show up near the lower end in the table below, you may want to factor in this information when considering your ownership of this fund. For example, the PRIMECAP Odyssey Growth Fund (MUTF: POGRX ), a fund highly recommended by Morningstar (see my Dec. Newsletter ), has about 36% of its investments in the Health sector. Since this sector is one that my research does consider highly overvalued and a REDUCE/SELL sector, one might want to be cautious about owning this fund. The following table shows my current recommendations for 14 sector fund categories starting with those with the most positive longer-term prospects at the top to those with least promising prospects near the bottom: Fund Category Recommendation Precious Metals BUY Natural Resources BUY Energy BUY Commodities BUY Technology HOLD Communications HOLD Consumer Defensive (Consumer Staples) HOLD Consumer Cyclical (Consumer Discretionary) HOLD Global Real Estate HOLD Real Estate (U.S.) HOLD Financials HOLD Health REDUCE/SELL Industrials REDUCE/SELL Utilities REDUCE/SELL

Profit Shortage + Economic Weakness + Stimulus Removal = Less Risk Taking

Since I first began identifying the breakdown in market internals in Q3 2014 equal-weight proxies like EWRI have gone nowhere. Virtually every traditional method suggests stocks are overpriced. I encourage all readers, thinkers and ETF enthusiasts to employ some type of portfolio protection to minimize the potential damage of a potential downtrend in 2016. Healthy bull market uptrends tend to feature similar risk-taking characteristics. Specifically, market-based participants will invest in a wide range of stock sectors (e.g., industrials, telecom, health care, energy, etc.) and asset types (e.g., large, small, foreign, preferreds, REITs, high yield corporate, convertibles, cross-over corporate bonds, etc.). There is little reason to discriminate because across-the-board risk leads to impressive returns. Late-stage bull markets are different. Fewer and fewer individual stocks succeed; fewer and fewer asset types gain ground. There is more reason to become selective because across-the-tape risk leads to discouraging results. I initially identified a “changing of the guard” in the third quarter of 2014 . In fact, it was the first time in the current cycle that I served up questions that challenged unbridled bullishness. (Note: Those who have been reading my commentary for the last decade and/or listened to me on national talk radio circa 1998-2005 know that I am neither a perma-bear nor perm-bull. Those who emotionally deride me as a perma-bear may wish to look at independent reviews of my articles over the years at this web link .) So what hit my radar in the third quarter of 2014? The small-company barometer, the iShares Russell 2000 ETF (NYSEARCA: IWM ), as well as the iShares Micro-Cap ETF (NYSEARCA: IWC ) were both wallowing in technical downtrends. The Vanguard FTSE Europe ETF (NYSEARCA: VGK ) was rapidly deteriorating. The PowerShares DB Commodity Index Tracking ETF (NYSEARCA: DBC ) had revisited 52-week lows. And, history’s favorite risk-off asset, long-term treasuries, had been experiencing a monster rally. In sum, a large percentage of asset types had begun to buckle such that I favored a barbell approach of large-cap stocks and intermediate-to-longer-term treasuries. In the August 2014 commentary, I also highlighted the similarities between monetary and fiscal stimulus removal in 1936/1937 and the QE stimulus removal in 2014 with subsequent anticipation of rate normalization efforts set for Q1 2015. I wrote: Most people are aware of the crash in 1929 as well as the capital depreciation that occurred through 1932. Yet many may not be aware of the government stimulus in 1933 that helped the market soar 200% over the next four years. While the stimulus may have aided in pulling the markets higher in the absence of organic economic growth, stocks eventually tanked nearly 50% in a ferocious 1-year bear (3/10/1937-3/31/1938). Here in December, you can find others who have recently started to talk about historical similarities with 1937 . More noticeably, you can find prominent commentators who are beginning to acknowledge the adverse implications of deteriorating market breadth; that is, the lack of breadth across the individual stock landscape, the ten stock sectors, the stock asset class and/or numerous asset types is a major headwind to a continuation of the bull rally. For instance, Jim Cramer of CNBC warned on 12/30 that six of the 10 key stock sectors are in downtrends. Meanwhile, Josh Brown of the extremely popular Reformed Broker didn’t mince words when he posted his “Chart of the Year” on 12/23. (See the chart below.) To wit, Mr. Brown wrote: You can see that the amount of stocks above this uptrend gauge has been cut in half from the start of the year. At present, just 28% of all NYSE names are in uptrends, or less than 1 in 3 stocks. That’s not a bull market. Since I first began identifying the breakdown in market internals in Q3 2014 – a breakdown that has been accompanied by increasing economic strain, undeniable stock overvaluation , a sales recession and a profit shortage – equal-weight proxies like Guggenheim’s Russell 1000 Equal Weight ETF (NYSEARCA: EWRI ) have gone nowhere. Equally troubling, like the vast majority of index-tracking investments, it has been many months since the fund has notched a new 52-week high. It is not just the deterioration in risk preferences (e.g., widening high yield credit spreads, treasury yield curve flattening, fewer stocks participating in the uptrend, etc.) that investors may wish to heed. As I type my final thoughts for the year (12/31), additional evidence on stock overvaluation as well as economic deceleration provide me with ample reason to reflect. For example, 42.9 on the Chicago Business Barometer is the worst reading since July 2009. The data point is a significant drop from 48.7 in November and it is miles away from the 50.0 reading that economists had expected. (Note: The region’s woes are hardly the only example of national economic headwinds .) As for the overvalued nature of U.S. stocks, virtually every traditional method suggests stocks are overpriced. This includes trailing P/E, forward P/E, price-to-sales (P/S), market-cap-to-GDP, CAPE and Tobin’s Q Ratio . Recently, Ned Davis Research may have come up with a progressive methodology: percentage of household assets. At the end of the 1981-1982 bear market, stocks as a percentage of household assets were a meager 15%. At the end of the 2007-2009 financial collapse, the data point was an exceptionally modest 21%. According to Ned Davis Research, the highest reading came at the height of dot-com euphoria in 2000. A whopping 47%. The third highest level going back to 1951 came before the financial crisis in 2007 (36%). At this moment? Stocks as a percentage of household assets hit 37% in 2015. The first and third highest percentages – 47% in 2000 and 36% in 2007 – occurred at significant market tops. Indeed, it is somewhat unsettling to recognize that 2015 lays claim to the second highest data point. Did we see the market top in the summertime? Perhaps. Bear in mind, the above-described markers line up perfectly with another valuation methodology, “Tobin’s Q.” The ratio at its peak in 2015 is second only to the ratio during “New Economy” insanity (2000). I am going to finish up with a quick anecdote. Although I live in California, I spent the previous week visiting family and clients in Florida. And every time that I go to Florida, I am shocked by the number of motorcycle riders who do not wear helmets. I’ve heard the arguments against their use before – everything from peripheral vision to neck injuries. Studies certainly show that helmets reduce the likelihood of brain injury and/or death. So while I recognize the freedom of choice issue, I still believe it makes sense for car drivers to “buckle up” and motorcycle riders to “helmet up.” In the same vein, I encourage all readers, thinkers and ETF enthusiasts to employ some type of helmet – some type of portfolio protection (e.g., multi-asset stock hedging, put options, limit-loss orders , tactical asset allocation, etc.) – to minimize the potential damage of a potential downtrend in 2016. And on that note, go forward to celebrate your happiness and your health! 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.

Comparing 3 Small Capitalization ETFs Tracking The Russell 2000 Indexes

Summary The highest dividend yield comes from IWN, but the lowest expense ratio comes from IWM. The sector allocations for IWN and IWO add up to the same allocations as IWM. Between IWN and IWO, I don’t see IWO as being substantially more aggressive despite being based on a growth index. There is a rare situation where an investor could benefit from combining the value and growth funds rather than using the main fund. One of the areas I frequently cover is ETFs. I’ve been a large proponent of investors holding the core of their portfolio in high quality ETFs with very low expense ratios. The same argument can be made for passive mutual funds with very low expense ratios, though there are fewer of those. In this argument I’m doing a quick comparison of several of the ETFs I have covered. Ticker Name Index IWM iShares Russell 2000 ETF Russell 2000 Index IWN iShares Russell 2000 Value ETF Russell 2000 Value Index IWO iShares Russell 2000 Growth ETF Russell 2000 Growth Index By covering a few of these ETFs in the same article I hope to provide some clarity on the relative attractiveness of the ETFs. One reason investors may struggle to reconcile positions is that investments must be compared on a relative basis and the market is constantly changing which will increase and decrease the relative attractiveness. Dividend Yields I charted the dividend yields from Yahoo Finance for each portfolio. All else equal, I consider higher dividend yields to be more favorable even if the expectation for total returns is the same. The preference for higher yielding ETFs comes from behavioral finance rather than modern portfolio theory. Under behavioral finance the human elements of investing are considered. A higher yield can encourage investors to stay invested when the market is done and to recognize lower prices as an opportunity to acquire shares that are “on sale” rather than a reason to panic and sell their portfolio at low prices only to repurchase the securities at higher prices. Expense Ratios I want diversification, I want stability, and I don’t want to pay for them. My general guideline for expense ratios is that I want to see the ratios below .15% on domestic equity ETFs and below .30% on international equity ETFs. However, there are times where it is reasonable to make an exception. Funds that must regularly rebalance their portfolio have a better case for having a high expense ratio than funds that simply follow a market capitalization approach. Sector I built a fairly nice table for comparing the sector allocations across each ETF to make it substantially easier to get a quick feel for the risk factors: (click to enlarge) For an investor with an emphasis on certain sectors there could be an incentive to take either the growth or value side. I find the health care sector to be a fairly defensive allocation, but it is heavily over weight in the growth fund and underweighted in the value fund. The other major defensive allocations are consumer defensive, which is similarly weighted, utilities, which is heavier in value, and real estate which is heavier in value. All things considered, I don’t find the growth ETF to be substantially more aggressive than the value ETF despite the growth ETF being characterized by funds with higher expected earnings growth rates and higher price to book ratios. Would You Ever Want to Combine IWO and IWN? IWM represents the entire Russell 2000 index and the weightings for IWM are consistently within a very small rounding error of the weightings for the other two funds because of the way the value and growth indexes are constructed. Because of the way the funds are constructed, I would expect IWM to consistently outperform a position of IWN and IWO since the investor would save on the expense ratios by paying .20% on their position rather than paying .25% on each of the other funds. On the other hand, theoretically if the funds were trading at a small discount or premium to NAV there could be a reason to take the two smaller funds. Returns I thought it would be interesting to run the returns on all 3 ETFs and see how similar or different the performance was across the ETFs. The results surprised me. Over the last 15 years or so the value side of the index performed dramatically better. Given the dot com crash early in the century, the results may be heavily biased. (click to enlarge) I entered the ETFs with the growth ETF first, the blended ETF second, and the value ETF third. It is interesting to note that the beta and annualized volatility moves down as we shift from growth towards value. That fits what I would expect, but it is interesting to see that the lower risk position (using beta) materially outperformed. However, when we restrict the performance to the last five years, the picture for returns changes: (click to enlarge) Despite the growth ETF offering superior returns over the last 5 years, it has still demonstrated a higher beta and higher volatility. Therefore, I would expect the higher level of volatility and beta on IWO to remain as a simple function of investing in small capitalization growth companies. Conclusion Over the last 15 years there was a strong outperformance by the value side of the index. Despite the strong performance of the value side through a period that saw two market crashes, the value side of the index does not look dramatically safer. The beta values indicate that the risk level on the growth side of the index is around 8% to 10% higher than the value side. In my opinion, the most attractive option for long term investments would be IWM for the lower expense ratio of IWN for the lower beta since I hold a substantial position in larger capitalization domestic equity.