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Feeling Sensitive? Interest Rate Hikes May Tickle These Sectors

Greek uncertainty aside, the debate around a Federal Reserve interest rate hike is still a matter of when , not if . In this climate, which rate-sensitive stocks stand to benefit, and which could be stung by Fed moves? Indexes – Broadly Thinking Market interest rates – those set by the bond market – are already moving higher, reflecting trader belief that the Federal Reserve will crank up the interest rate dial at least once this year, possibly as soon as September. Ultra-low interest rate policy has goosed a bull market in the S&P 500 (NYSEARCA: SPY ) since March 2009. But now, economic prosperity will necessitate interest rate increases to keep growth from overheating and inflation from bubbling up. That means tighter interest rate policy is bullish for the broad market, even if it’s met by a collective grumble on Wall Street. That’s true at least for a time because it means the economy is on the right track. Watch for volatility, however, as traders speculate on how aggressive the Fed might be. Traders are mindful that the Fed could overshoot. Financials – In Their Best Interest Traditional banks and insurance companies can pull in more funds with higher interest rates, which means Fed hikes tend to be pro-financial stock. Banks that focus on traditional lower-risk community lending – more of a savings-and-loan model – will also potentially benefit from rising rates on the money they lend. Higher rates help insurance “float” portfolios earn more. Float is the gap between premium collection and claim payout. As that portfolio sits around, it needs to collect interest for the insurer. Conversely, the trading risk that can come with higher rates can reveal the risky underbelly of investment banks and their bond exposure. Consumer Spending – Who and What? Think luxury retailers, travel stocks, casinos, automakers – this type of spending tends to ramp up, not because of rate hikes, but because of the economic conditions triggering those rate hikes. It’s important to remember that consumer discretionary tends to do best in the early part of a rate-hike cycle, market history shows. That’s when the euphoria of the economic bounce is strongest and the bite of higher rates is less pronounced. Key for this pick is combing for attractive valuations and hidden gems in a category that could itself get pretty expensive. One might assume then – based on market history – that consumer staples don’t perform as well in a rising-rate environment. Investors might pick specific retailers or think about the growing e-commerce marts that offer all kinds of goods, both frivolous and fundamental. Technology – A Step Ahead Hey, if consumers are spend-happy in this environment, it’s likely that businesses are too. That means they’re retooling their technology needs. And as companies jockey to outrun any inflation risks, those most nimble with pricing power may come out on top. That’s because innovation (being early to market) can carry its own pricing power, which is potentially advantageous in this stage of an economic cycle. Utilities – Put in the Subs These typical dividend-payers are largely considered a bond alternative. During 2014, for example, when Treasury yields tumbled, the utilities sector more than doubled the 14% total return of the S&P 500 Index, according to Standard & Poor’s data. Because newly issued bonds will presumably pay higher issues in line with other rising interest rates, they tend to make the utilities alternatives less attractive. But utilities are a good example that more goes into stock-picking than just interest rate considerations. Utilities, for instance, win favor from some diversification-seeking investors because utilities are one way to limit exposure to U.S.-only consumer markets. That might sound good to investors who are casting a nervous eye toward Europe about now. Drilling Down – Think Companies, Not Sectors As for company-by-company selection, stock-picking criteria might focus on balance sheet health. Companies that need to borrow extensively to operate or innovate may struggle when money becomes more expensive. Investors should feel empowered to think of a Federal Reserve tightening period creatively. For instance, investors might consider a direct play on the improving job market with a look at job search companies; they stand to draw higher traffic as confident workers go for better pay and benefits. Robust payroll counts could also raise demand for payment processing companies or firms that run employee security checks. Bottom line: A big difference for this rate-hike campaign compared to others is the pace at which the Fed is expected to move. The economic recovery, and global turbulence, is still spotty, which could constrain the central bank to gradual hikes – hopefully providing enough time for stock investors to adjust accordingly. Inclusion of specific security names in this commentary does not constitute a recommendation from TD Ameritrade to buy, sell, or hold. Market volatility, volume, and system availability may delay account access and trade executions. Past performance of a security or strategy does not guarantee future results or success. Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options. Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request. The information is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading. TD Ameritrade, Inc., member FINRA / SIPC . TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2015 TD Ameritrade IP Company, Inc. All rights reserved. Used with permission.

The Chinese Government Just Rigged The Market In Your Favor

Summary The Chinese government has taken unprecedented measures to support its A-shares market. Both intuition and history indicate that these measures will likely be successful. Buy A-shares now, or on any dip. The Chinese stock market crash has been making headlines recently, with much of the focus being on the government’s unsuccessful and seemingly desperate efforts to engineer a reversal. From cutting interest rates and reserve ratios, to suspending new IPOs and directing various government entities to purchase shares, nothing seemed to work. Eventually, the People’s Bank of China began providing “unlimited liquidity” to state-owned China Securities Finance Corp in order to fund stock purchases. History has taught us that when central banks print money in order to buy publicly traded assets, the prices of those assets go up relative to the currency being printed. So this on its own was a very big deal. While it was becoming increasingly clear that the Chinese government really , really wants their mainland stock market to go up, their next move was so heavy-handed, and so fundamentally alters the risk-reward calculus for owning Chinese stocks, that it all but guarantees a profit for anyone buying A-shares (NYSEARCA: ASHR ). China makes it illegal to sell stocks On July 8, 2015, the China Securities Regulatory Commission (CSRC) announced that directors, supervisors, senior management personnel, and anyone with more than 5% of the stock outstanding in a company, are not allowed to sell their shares for the next 6 months . This is in addition to having already directed state-owned pension funds, insurance companies, securities firms and other institutions to buy and hold shares. Private companies are not allowed to sell equity because IPOs are frozen. Public companies have been instructed not to sell and are required to submit reports on measures they will take to support their share price. The 21 largest Chinese brokerages have pledged to buy stock and not sell any of it until the Shanghai Composite goes above 4500. China Investment Corporation, the country’s sovereign wealth fund, has begun purchasing Chinese ETFs. You get the picture. All of these people and entities are forbidden from selling. You’re kidding me If this sounds incredible, keep in mind that the Chinese government has immense power over its people and is not shy about exercising its authority in ways that the West might consider uncouth. This is the same government that filters internet search results and imprisons non-violent political dissidents. Recognizing that the sell-off in A-shares was caused by the fear of losing money, the Chinese government has decided to counter this fear with the greater fear of being imprisoned, tortured and sent to a forced labor camp . The Ministry of Public Security has already launched investigations into “malicious shortselling” of Ping An ( OTCPK:PIAIF ) and PetroChina (NYSE: PTR ) stock on July 8th. So who can sell? Individual investors, who hold 25.03% of A-shares by market cap , can sell unless they fall under the CSRC’s definition of an insider as mentioned above. Professional institutions make up only 14.22% of the A-shares market cap, and only some of them, including qualified foreign institutional investors, can sell. Judging from the CSRC data below, I estimate that less than 10% of professional institutions would be able to sell without being charged with a crime. The rest of the market cap is owned by general institutions, which cannot sell . We can thereby deduce that less than 35% of the A-shares market cap is held by entities which are not prohibited from selling. We then need to halve this number because more than half of all stocks on the Shanghai and Shenzhen exchanges have been halted . Thus, less than 17.5% of the A-shares market cap is now available to be sold. Supply and Demand To sum it up, the supply of A-shares available to be sold has been dramatically reduced by government edict and the demand for A-shares has been dramatically increased by government purchasing. Anyone who has taken an introductory course in microeconomics knows that a decrease in supply or an increase in demand, much less a simultaneous occurrence of both, will cause the price of the good in question to go up. Which is why on July 9, 2015, the Shanghai Composite had its biggest daily gain since 2009. If only a minority of people can sell, and the government is printing money to buy everything in sight, then the supply of stock certificates not held by the government will decrease, and thereby command progressively greater prices. In other words, China is now the mother of all “low float rockets,” a colloquialism often used in the momentum investing community. Chinese stock exchanges impose a 10% limit on daily price increases, and only three trading days have elapsed since the government first announced its ban on selling. This means that there is still plenty of upside remaining as the government continues to push share prices to levels that reflect their narrative of an intact bull market. Valuation It is worth noting that valuation metrics on the Shanghai Composite appear cheap, and are nowhere near previous highs: (click to enlarge) Legendary investor Jim Rogers began buying the dip as early as June 26th . Goldman Sachs, Fidelity, and many others have recently turned bullish. Investment Thesis However, valuation is not at all important to my investment thesis, which is instead based on two very simple premises: 1) The Chinese government wants Chinese stock prices to rise and 2) The Chinese government is capable of causing Chinese stock prices to rise. If you believe these two statements are true, then by necessity, the Chinese stock market must go up. There are a myriad of reasons for why the Chinese government wants to rescue its stock market: avoiding financial contagion , transforming into a consumer-driven economy , and keeping their citizens from revolting , to name a few. Their actions, however, are what speak volumes about how serious and committed they are to this cause. I believe that they are willing to do whatever it takes to make their stock market go up, and there are rumors that they are readying an even larger fund for direct stock purchases . The second premise, the question of capability, is even more intuitive. The Chinese government has unequivocal authority to regulate assets domiciled in China and traded on Chinese exchanges. Shares in Chinese companies only have value within the context of Chinese corporate law, and because the law is written by the government, and the higher levels of government are not accountable to voters, there is nothing to stop the government from doing whatever they want. Wealthy Chinese shareholders aren’t going to risk imprisonment just to make a few extra yuan. Even if they were stupid enough to try placing a sell order, brokerages are simply refusing to execute those orders . Historical Precedent The media has been a harsh critic of this market intervention, just as they were harshly critical of previous market interventions such as the Federal Reserve’s Quantitative Easing (QE) program and the Hong Kong Monetary Authority’s famous short squeeze of the Hang Seng Index. It’s true that market interventions such as these reduce liquidity and thereby increase fragility and systemic risk. The global asset bubble is something that keeps me awake at night. But regardless of whatever long-term consequences may arise as a result of such market interventions, no one can deny that when central banks print money to buy assets, those assets do rally. (click to enlarge) The closest historical analogue to China’s ban on selling occurred when Japan’s Ministry of Finance instructed its banks not to sell stocks on August 18, 1992. The Nikkei responded by rallying 32% over the next three weeks in a straight, almost uninterrupted line. The chart above is not exhaustive, history is littered with examples of successful market interventions. Some countries such as Taiwan have funds permanently designated for supporting stock prices. Momentum Once investor confidence is restored, rising prices will lead to more rising prices, which will catalyze a second leg to this rally and possibly even reflate the bubble. China does not yet have much of a stock market investing culture, and only 13% of household wealth is invested into its stock market versus about 50% for U.S. households. If Chinese households decide to hop on for the ride, they have ample dry powder to do so. Human beings are genetically predisposed to move in herds, and if it happened before, it can happen again. Risk Factors The government could change their mind and give up on trying to support share prices, which I truly believe will not happen, but anything is possible. It’s also possible that they could lose control of the market, especially if large shareholders figure out a way to sell their holdings without being detected. In order to combat this possibility, the government is asking brokerages to provide the names and national ID numbers of its account holders . The largest risk for foreign retail investors such as the readers of this article, is probably ETF tracking risk. It’s possible that due to half of the A-shares market being halted, ETFs such as ASHR will have trouble tracking their underlying indices. In other words, when Chinese stocks decline, the U.S. traded ETFs that track them could decline by a much greater amount. The opposite is also true. Last Friday, the ChiNext index on the Shenzhen stock exchange rose by 4.11%, but (NYSEARCA: CNXT ), the ETF that aims to track it, rose by 23.32%. A nice surprise for the traders who went long the day before. Disclosure: I am/we are long ASHR. (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: I am long ASHR in client accounts through my investment management company, Honey Badger Capital Management.

Pinnacle West Capital Looks Very Attractive On Solid Growth Fundamentals

Summary Given PNW’s stock trading at a discount with strong fundamentals, I believe it is a good opportunity for investors to take a position. Strong earnings growth supports dividend growth. Key credit metrics are strong with scope for further improvement. Strong case to take position at the current level. I believe the key drivers for Pinnacle West Capital Corporation’s (NYSE: PNW ) earnings include: (1) solid base growth outlook, (2) around $1.4bn of capex spend/annum, (3) improving industry fundamentals (mainly housing recovery in Arizona), (4) a rate case filing in 2016 for 2017 rates ($60-70m revenue increase), and (5) an attractive valuation. Strong growth outlook More than 90% of PNW’s revenues come from a regulated retail rate base and transmission business (a stable growth business). The rate base growth opportunity for PNW is better than most of the regulated utilities companies (4-6%). The company has guided a rate base growth of 6-7% CAGR from 2014 to 2018. Where is the expected growth to come from? The company has a large spending plan of $3.7bn for 2015-2017, which is higher than its previous $2.7bn spend from 2012-2014. Interestingly, most of the spending will be in transmission and distribution. Investors should know that the increased spending plan should result in compounded annual rate-base growth of above 6%. I believe the company will use most its earnings (around 50%) and raise debt to fund capex and not require any equity issuance that will support the upside for stock. On the margin side, I expect higher margins for PNW given its well-disciplined cost management. Though revenues have grown by 9% in the last four years, operations and maintenance costs (O&M) have grown only by 4%. Moreover, the company estimates flat O&M in a growing phase in the next four years. The company has also guided an EPS growth of 4-6% CAGR from 2014 to 2018. Source: PNW investor presentation Better than industry dividend growth with scope for improvement PNW’s management raised dividend growth guidance last year from 4% off a 2013 base of $2.27 to 5% off a 2014 base of $2.38. The increase in dividend signals that the management is expecting a high EPS growth. I believe this is a positive move from PNW given its high capex spend plan for the next 3 years. The current one-year forward (FY15) dividend yield for PNW is around 4.3%, which is well above the industry average of 4%. I estimate that the dividend payout ratio will stay at the low 60s (similar to the utilities industry) even with 5% annual growth in dividend as the capex spend will take out most of its earnings. Source: PNW investor presentation Key credit metrics remain strong PNW has a solid capital structure with 46% debt/capital. I expect this ratio to increase slightly given higher rate of capex spend (capex guided at 13% CAGR from 2014 to 2017). PNW had an FFO/interest expense ratio of 5.8 in 2014, which is well above the 4-5 times of a typical utility. I expect the ratio to be in a range of 4.5-5 times during the next five years as a result of higher capex spend and interest expenses. The company has around $300m of debt maturing in 2015, $250m in 2016 and $125m in 2017. It has no debt maturities in 2018. In the current debt markets, I do not expect any trouble issuing new debt. I am positive on the company’s approach in using debt and free cash flow to fund future capex/acquisitions and not resorting to equity issuance. Source: PNW investor presentation Increase in solar penetration is not worrisome for PNW but benefiting APS’s power portfolio, a wholly owned subsidiary of PNW, includes 1,200MWs of renewable energy, most of which is solar fueled by Arizona’s abundant sunshine. In the most recent numbers from the Solar Electric Power Association, APS ranked fourth nationally in overall solar capacity, and fifth in solar capacity per customer. APS plans to install 10MWs of solar panels on roughly 1,500 customer homes. The growth in solar is a natural and productive development for Arizona given its significant natural resource base. The permits for new solar projects have remained healthy since 2014 and grown significantly since 2015 for APS. The drop in solar costs has attracted customer interest in adding solar systems leading to significant growth for APS’s renewable energy segment. APS will likely continue to have investment opportunities in both utility scale and distributed solar with the next rate case (the opportunity for the company to pursue additional investments). Source: PNW investor presentation Attractive Valuation With a solid growth outlook (EPS growth of 4-6% from 2014-2018), strong capex plans and continued O&M cost management, PNW will only see upside if the economy starts to get better. I see PNW stock as very attractive relative to peers as it is currently trading at a discount of around 4%. I believe the stock should trade above its peers in the near term, as the probability of the company’s achievement of growth targets is high. I recommend investors to take a position in PNW at the current level to earn at least 16% return (12% share appreciation + 4% dividend yield) in one year. Bear case Base case Bull case 2016 EPS $4.00 2016 EPS $4.10 2016 EPS $4.20 P/E Multiple 15.0x P/E Multiple 15.0x P/E Multiple 15.0x Discount 10.0% Premium 10.0% Premium 20.0% Value $54.00 Value $67.65 Value $75.60 Current price $60.32 Current price $60.32 Current price $60.32 Upside -10.5% Upside 12.2% Upside 25.3% Source: Google Finance 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.