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Expensive Junk Stocks Are Killing High-Quality Value Stocks, YTD

By Wesley R. Gray, Ph.D. In general, investors focused on affordable stocks with strong fundamentals have been taken to the cleaners year-to-date. Meanwhile, expensive stocks with poor fundamentals have been rocking ! Some Basic Statistics: Below, we document some core performance figures using Ken French’s data on value/growth portfolios (proxy for cheap/expensive) and high-profitability/low-profitability portfolios (proxy for high-quality/low-quality). We look at the value-weight returns for the top and bottom decile portfolios. The monthly returns runs from 1/1/2015 to 6/30/2015. Results are gross of fees. All returns are total returns, and include the reinvestment of distributions (e.g., dividends). Specifically, here are the four portfolios: Expensive = Value-weight returns to the bottom decile formed on B/M. Cheap = Value-weight returns to the top decile formed on B/M. Low-Quality = Value-weight returns to the bottom decile formed on profitability. High-Quality = Value-weight returns to the top decile formed on profitability. Here are the month-by-month results – a nasty year for cheap value stocks (as proxied by B/M) and high-quality stocks (as proxied by profitability): Month Expensive Cheap Outcome Low-Quality High-Quality Outcome 201501 0.04% -6.87% Lose -1.68% -2.17% Lose 201502 6.71% 3.56% Lose 9.64% 6.55% Lose 201503 -0.69% -1.59% Lose -0.31% -0.66% Lose 201504 0.19% 1.81% Win -0.53% 0.80% Win 201505 2.17% 0.58% Lose 5.18% 0.78% Lose 201506 0.61% -0.71% Lose -1.38% -1.24% Win The results are hypothetical, and are NOT an indicator of future results, and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request. How have Expensive Low-Quality Stocks Performed Relative to Cheap High-Quality Stocks? In this section we look at the YTD performance of expensive low-quality stocks versus cheap high-quality stocks. We examine value-weight returns for the cheap high-quality quintile and the expensive low-quality quintile. The daily returns run from 1/1/2015 to 6/30/2015. Results are gross of fees. All returns are total returns, and include the reinvestment of distributions (e.g., dividends). Specifically, here are the two portfolios: Cheap, High-Quality = Value-weight returns to the cheap high-quality quintile . Expensive, Low-Quality = Value-weight returns to the expensive low-quality quintile . (click to enlarge) The results are hypothetical, and are NOT an indicator of future results, and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request. Year-to-date, a portfolio of cheap high-quality socks is down around 6% , before fees and expenses (probably more like -7% if those were included). In contrast, a portfolio of the most expensive, lowest-quality firms is up around 12% , before fees and expenses (probably around 11% after fees). On net, the spread is almost 18% YTD. Incredible, but not unsurprising . When we look to the marketplace for live strategies focused on market-neutral strategies anchored on cheapness and quality, Gotham Funds’ Gotham Neutral Fund (MUTF: GONIX ) is probably the most prominent example. The fund isn’t completely market-neutral, but at a 25% net long exposure, that is about as close as we’re gonna get. YTD, the Gotham Neutral Fund is down 10.39%. That is pretty terrible, and it would have been worse if they were truly market-neutral, but in the context of the results above, where one goes long generic value/quality and short generic expensive/junk, -10%+ isn’t half bad . One could argue on a factor basis that they added value (I know, that sounds odd). As we’ve said time and time again, active value investing has been digging manager graveyards since 1900 … but that is the nature of the active value investing game… long horizons are required, and volatility relative to the standard benchmarks can be expected. Original Post

Water: Investing In The Future

Summary Water is a scarce commodity. Water scarcity already affects every continent. Around 1.2 billion people, or almost one-fifth of the world’s population, live in areas of physical scarcity. Water Resource Portfolio ETF offers an excellent opportunity to invest in the water industry. Even though water is something which seems normal for the average Joe in a developed country, it is definitely not as normal as it seems . Water is a scarce commodity and an absolute necessity for every living creature on the planet. The United Nations indicate that roughly 1.2 billion people (around 1/5th of the world’s population) live in the areas where there is no physical abundance of water. India for example is faced with the prospect of becoming water scarce by 2025 where demand of water will exceed all the current sources of supply of water. India might seem far away, but closer to home such as in California water scarcity is becoming a serious problem. Businesses will have to treat this precious resource far more carefully in the future. Source : Getty Images (a footbridge spans a completely dry river bed in Porterville, California) One way of investing in water is to invest in the PowerShares Water Resources Portfolio ETF (NYSEARCA: PHO ) , one of the largest water ETFs in the world. This article will cover the fundamental analysis of Water Resource Portfolio. Water ETF: Main holdings Source : etfdb.com The issuer of this ETF is Invesco, a large independent investment management company incorporated in Bermuda. The expense ratio of 0.61% is a reasonable number and not incredible expensive. With 800 million assets under management it’s not a large ETF. They are currently trading 10% under its year high and 3% above its year low. ETF: Main Holdings Source : Invesco The 3 largest holdings are Ecolab (NYSE: ECL ), Pentair (NYSE: PNR ) and First Solar Inc (NASDAQ: FSLR ) which in total hold more than 1/4th of the assets. Ecolab is an American provider of hygiene, energy technologies and water. It’s a firm of considerable size with over 45.000 employees. Ecolab is currently priced only $3 underneath its 52 week high , they recently announced earnings which was roughly in line with expectations. Revenue was $3.4B, a miss of $70M. Pentair is an industrial company headquartered in Manchester delivering a variety of water, fluid and technical solutions. The firm is a bit smaller in contrast to Ecolab with revenue of around $7 billion. First Solar is an American Photovoltaic manufacturer of solar panels and supporting services which include end-of-life panel recycling. First Solar is currently trading at P/E of around 20, almost $30 dollars below its 52wk high. It has been beaten quite significantly lately. Nevertheless, corporate earnings will be announced on the 4th of August and based on a recent well informed article published on Seeking Alpha by Nir Nabar, I’m expecting a rebound. ETF: Fund Characteristics Source: Invesco It’s important to realize that the ETF does not come at a massive discount. At a P/E of over 30, it is not cheap. Yet the share price has sharply dropped over the last few weeks presenting itself as a buy. Source : Ycharts Conclusion Water is an incredibly important commodity. As it’s scarce, business can’t do without proper water management. In today’s society there are plenty of solid water management firms. This ETF provides an excellent opportunity to invest in the business flow of water related businesses: from management, production to filtering of water, this ETF has a solid mixture between small and large cap related firms. With one of its largest holdings close to a 52wk low and it will publish earnings soon, I’m expecting a rebound in this ETF. Water remains an investment in the future. PHO is a buy. Disclosure: I am/we are long PHO. (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.

Does X Mark The Spot?

Heavily weighted towards cyclically sensitive sectors. The fund has holdings in top Asia-Pacific companies, excluding Japan. The exclusion of the Japanese economy doesn’t seem to serve any purpose. From its recovery after an ill-conceived, devastating global conflict, Japan underwent a complete restructuring under the leadership of Prime Minister Hayato Ikeda in the 1950s. The constitution was rewritten and modernized, heavy industry and infrastructure was reconstructed, bank regulations were eased and protectionist policies were instituted in order to focus on rebuilding the economy, organically. By the 1960s, referred to by economist as Japan’s ‘golden 60s’, the economy took off and continue to expand, from about $91 billion in 1965 to well over an astonishing $1 trillion by 1985. However, as often happens when left unchecked, growth became unsustainable leading to an asset bubble, which collapsed in 1989. For the next 25 years the economy was trapped in deflationary stagflation, during which time, plan after plan failed to re-inflate the economy. During this same period, the People’s Republic of China was in the process of transitioning from a communist agrarian economy to a more global free market industrial economy with great success. Other countries in the region benefited from the commodity demand generated; Australia, India, Korea, Taiwan, Singapore, India and New Zealand, to name a few. Indeed, Japan still plays a leading role on the Asia Pacific stage, but is no longer the sole regional super-economy. In our present time the Asia-Pacific region has developed into an astonishingly productive and efficient contributor to the entire global economy, with several regional trillion dollar economies. So the question becomes, how well do the Asian Pacific funds perform when Japan is removed from the equation? First, using the Seeking Alpha ETF Hub, and filtering Global/Intl Equities by positive one-year performance results with several ‘ex-Japan’ funds. Excluding ‘specialized’ funds, like ‘Ultras’, ‘Small Cap’, ‘Enhanced’ and the like leaves a few plain vanilla, Asia ex-Japan funds summarized in the table below. ( Data from respective fund websites ) In this category, the Deutsche X-Tracker MSCI Asia Pacific ex Japan Hedged EquityETF ( DBAP ) , as the name suggests includes Asia Pacific economies, excluding Japan. Although hedged, this does not entirely eliminate currency risk, but will dampen currency volatility. (Data from X-Trackers) The fund is most heavily weighted in Financials, 30%, followed by Information Technology, 25%; Industrials, 6%; Materials, 5%; Telecom Services, 4%; Consumer Discretionary, 5%; Consumer Staples, 4%; Energy, 4%; Utilities, 3% and Healthcare at 13%. (Data from X-Trackers) It’s also interesting to note the heaviest sector weightings by country. Australia has the heaviest weightings in Consumer Staples, Financials, Health Care and Materials. China holds the heaviest weightings in Energy, Industrials, Telecom, and Utilities. Hong Kong leads the way in Consumer Discretionary and Korea weights most in the IT sector. This is important to note. China and Australia are major trade partners. Slowing demand in China means a slower Australian economy. Australia has its heaviest weightings are mostly defensive with just one very cyclical sector, Materials. (Data from X-Trackers) At this point, a few words need to be said for the trade dynamic in the region. Japan’s major export partners in the region are China, South Korea, Thailand, Hong Kong, Indonesia, Australia, Singapore and Malaysia. Top export products include Cars, Vehicle Parts, Industrial Printers, Specialized Machinery, Construction Equipment and numerous other industrial products. Hence, by omitting Japan, a major industrial manufacturer, supplier and regional economic contributor, that is to say, a potential major contributor to the fund’s performance is omitted. Excluding the Asia-Pacific region, Japan’s second largest import partner is the United States. Even a slow US economy will conduct sizable trade with Japan, particularly in durable goods. Hence, by omitting Japanese industry from the fund, a major factor is omitted. (It should be noted that other non-Asia-Pacific top export partners include Germany, Mexico, Russia, Canada and the U.K.). (click to enlarge) (Data from OEC) Japan is an integral part of the Asia-Pacific region. Even if the Japanese economy is excluded, its presence implicitly impacts the region, hence the fund, to some extent. China, Australia, Singapore, Hong Kong, New Zealand, South Korea and Indonesia, are developed or recently emerged economies. So excluding Japan does not make this an ’emerging market’ fund, nor can it be really be considered a ‘regional economy’ fund without Japan. The fund seems to be structured on the premise that Japan is the leading economy in the region, whose metrics overwhelm the other regional economies. However, by any measure, Japan fits right in with the locals. The point being is that when compared to its regional neighbors, there is nothing overly exceptional nor detracting about the Japanese economy which dominates the region, necessitating its exclusion. (click to enlarge) The fund trades in a rather strong premium to NAV range: mostly 0.5% to 1.0% and at times as much as 1.5% to 2.0% of NAV, rarely trading at a discount to NAV. Also, management fees are slightly on the high side with a net expense ratio of 0.60%. The fund has been trading since October of 2013. Naturally, before making any investment, it’s always worth reading the fund’s prospectus . 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. Additional disclosure: “CFDs, spread betting and FX can result in losses exceeding your initial deposit. They are not suitable for everyone, so please ensure you understand the risks. Seek independent financial advice if necessary. Nothing in this article should be considered a personal recommendation. It does not account for your personal circumstances or appetite for risk.”