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Investors – Your Hair Is Not On Fire, You Don’t Have To Get Out Of The Market

Summary The media woods (including Seeking Alpha) are full of dire predictions of market corrections, retrenchment, collapse, from anticipated Fed interest rate hikes, Greek intransigence in the EU, Putin’s Ukranian grab. Oh, woe! It’s all bad. ISIS amok. Massive panicked African emigration to Europe. Police stations and bible study groups becoming shooting ranges. Our own government and AT&T telling lies. Wouldn’t you think folks who help big-$-fund Portfolio Managers realign their holdings would see a market decline coming? But they sure don’t behave like they believe it’s so. What’s the matter with them? Or is it with us? Rational Behavior under threats The normal actions of informed humans sensing impending danger is to erect defenses and plan strategies to deflect or overcome attacks. That is what market-makers [MMs] do in their ordinary course of moving a large part of a trillion dollars of equity investments each day from one set of hands to another. To get balance between buyers and sellers where volume transactions in stocks involve tens and hundreds of $-millions, the MMs usually have to put firm capital at risk temporarily. Hundreds of times a day, every day. They are no strangers to risks and threats. They are highly skilled practitioners of hedging and arbitrage. Those art forms are integral to their enviable successful progress in protecting their capital from harm. So what are they doing to protect against market declines? Nothing out of the ordinary. Just what they have been doing, day-in and day-out. That includes world-wide watching, listening, questioning, reporting, recording, evaluating, communicating. It’s strange that organizations so well resourced and disciplined would miss the threats that so many others claim to be about to harm all of us. Yet MMs continue to behave in the same manner, hedge to the same degree, pay for protection about the same amounts, in deals structured the same way as they have been, over many past months. We have been watching their behavior for decades They clearly behave quite rationally, rather systematically, given what they know at various times. In our recent SA article of “Worry, worry, worry” we demonstrated the differences present as they sense impending problems or ongoing good times. Our behavioral analysis of their hedging practices daily has not changed over decades. It shows the asymmetry of their price change expectations for 3,000 or more stocks day after day. For each stock we produce what they must think their serious, powerful clients are likely to do to the prices of stocks the clients want to own in the future, and to ones they no longer want to own. And to the price points where the clients might change their minds. The ranges of possible price prospects get described by a single simple measure, the Range Index. Its job is to tell the balance between upside price change potentials and downside price change exposures. Each stock, ETF, or equity market index has a Range Index [RI] whose number tells what percentage proportion of that subject’s likely coming price range lies below its current market quote. A low RI suggests limited downside, ample upside. So the RI becomes a common denominator for price expectations, a very useful yardstick to compare the expectations of many varied issues. And, in the aggregate, to have a sense of what the market outlook overall might be. That’s what is shown at various stages of market price change anticipations in the “Worry, worry, worry” article. Figure 1 updates that distribution of informed professional expectations to last night. Figure 1 (click to enlarge) (used with permission) The average Range Index of the 2,500+ names covered in this picture is 28, meaning that the typical stock has better than twice as much upside as downside. A 50 RI would make the odds of up vs. down a coin-flip. How many in Figure 1 have that kind of prospect, or worse (a higher RI than 50)? A negative RI means that the subject’s current price is lower than the bottom of the price range regarded as likely or justifiable. That condition sounds like “cheap” to many Graham & Dodd folks. Figure 2 tells what has happened to stock, ETF, and market index prices in the 16 weeks following the daily observation of Range Indexes for this population during the past 4-5 years. Some 2,959,450 observations built this display. Figure 2 (click to enlarge) That 1 : 1 blue row of Figure 2 is the overall population average, positioned at the 50 RI level. That’s where up and down price change prospects are held equally likely. The green rows above are of progressively lower Range Index (or cheaper) forecasts, and the red rows below the blue row are of progressively more expensive RIs. The maroon-count row just above the blue row is coincident with today’s population average. But we should be more interested in what can be done to improve an existing investment portfolio than in speculating about what might happen to the market as a whole. Play the game better What is of interest to active investment managers is the potential payoffs and odds for success in buys of those stock or ETF RI forecasts up in the top rows of the table. And what might best be purged from a portfolio where the holding’s RI is among those below the 50 blue-row level – higher RIs than 50. For perspective, take a look back at Figure 1. Today, just as in most daily experiences, there are many promising prospects for purchase off to the left in the Figure 1 distribution. To the extent that these have proven to be reliable, credible forecasts, then it is likely that what happens to the market as a whole has little impact on their near-term future. And it is their near-term future that active investors should be concerned with. In today’s global, high-tech, communicative and competitive networks of business activity, reaching out with forecasts as much as a year or more is not investing, it is just speculating. While overall-market forecasters are speculating as to where the averages will be a year or more from now, active investors will have the opportunity to have capitalized on interim opportunities, compounding their triumphs (often 3-4 times in a year) net of their mistakes (typically 1 in 2 years) to produce rates of gain that may be multiples of what the market averages may have produced in capital gains. Those kinds of odds, 6 out of 8, or 7 out of 8 wins in two years for each allocation of capital, are quite doable when good guidance is provided. Usually the rates of gain in the wins are well above those of the market, and the effect of compounding can multiply the progress in wealth-building well beyond the (now highly competitive and economical) transaction costs or infrequent loss. As an example, using market-maker forecasts to compare over 2,500 equities daily, and ranking them based on how well prior forecasts similar to the current-day forecast have performed, over 1900 opportunities have been identified so far in this 2015 year at a rate of 20 a day. Following a time-efficient discipline standard of portfolio management to all, of the closed out positions (more than half) the average annualized rate of net gains are +31%, compared to that of SPY at +5.1%. Conclusion There are nearly always attractive stocks or ETFs to buy, regardless of overall market prospect appearances. The diversity of opportunities among over 3,000 potential quality portfolio investment candidates provides a rich field of perpetually price-renewed prospects. But investors need to have a portfolio management strategy and discipline urging them to be frequently aware of developing opportunities and maturing prior actions in need of reinvesting. This is called active investing, and will involve more attention and time commitment than many investors are willing or need (the most fortunately capitalized) to make. The rewards for active investing are demonstrably far better than most investors of all types have been led to believe. Those investors faced with impending capital-requirements having fixed time deadlines may find that the only way now that will satisfy their needs makes adoption of active investing a most sensible practice. 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.

Public Service Enterprise: Facing A Long-Term Decline

Summary Public Service Enterprise is facing many headwinds in the form of an unsustainable business model and an aging infrastructure. The company’s continual infrastructure build out should prove to be counterproductive in the long-run. While societal electricity usage will likely increase dramatically over the next few decades, Public Service Enterprise should still feel downward pressure in the long-term. Public Service Enterprise Group (NYSE: PEG ) is currently one of the nation’s oldest and largest electric utilities. The company dominates the New Jersey electricity landscape, providing millions of individuals with electricity. The company has been one of the top performing electric utilities over the past few years, consistently beating investor expectations on many fronts. Despite all of this, PEG will likely underperform investor expectations moving forward. While PEG may continue to do well in the near-term, the company’s long-term prospects are dimmer. PEG is a diversified electric utility, which means that it incorporates all types of energy sources into its business model. While this business model makes it more competitive against non-diversified electric utilities, the company is still too highly valued at $20.74B . The energy landscape is starting to shift away from a one dominated by centralized generation, and PEG will likely be one of the first companies to feel the effects of this change. Given that PEG’s business model has remained unchanged for countless decades, the company should have a hard time adapting to changing realities. Continual Grid Build-Outs Are A Long-Term Negative PEG makes much of its money by building out grid infrastructure in order to sell more electricity. This only makes sense given that the only way to reach more residences/buildings is to expand its grid system. In fact, PEG expects to spend approximately $1.6B in 2015 on its transmission infrastructure. The company’s transmission investments are expected to continue rising moving forward, which could actually dampen the company’s long-term prospects. Such grid investments incur huge sunk costs, as PEG expects to spend $2.6B in upgrades on its electric/gas distribution and transmission systems. While this would be a great investment under the assumption that centralized methods of generation will remain at similar levels of profitability for the foreseeable future, this is far from certain. Distributed generation methods is becoming more promising by the day, especially with the progress being made in energy storage technologies. As such, these growing grid infrastructure investments could very well end up as billions of dollars in unrecoverable sunk costs. Given the rather slim margins of PEG, these investments would only be recouped if individuals continue buying electricity from the company’s power plants at current rates. With the proliferation of alternative energies, distributed generation has become more viable than ever, and could force PEG to reduce electricity costs in order to remain competitive. This will make it increasingly hard for PEG to recoup investments. Given PEG’s centralized generation model, the company needs to continue expanding and maintaining its infrastructure in order to grow. On the bright side, PEG is implementing many grid efficiency programs, which is actually conducive to distributed generation. The company is planning to spend an additional $95M on increasing energy efficiency over the next three years, although this amount is minimal in the grand scheme of things. Given that distributed generators still requires a grid to function, improving grid efficiency is a win for everyone. Regardless, PEG is still spending enormous amounts of money building out its grid, which may actually end up costing the company in the long-run. Aging Infrastructure With PEG’s aging infrastructures, increasing amounts of investments will be needed just to sustain the company’s current grid. Given that PEG has one of the oldest grid systems in the country, grid maintenance investments will likely ramp up moving forward. Even worse, these grid maintenance costs cannot be avoided, which means that more and more of PEG’s expenditures will go purely towards maintaining its current infrastructure. Such a model of centralized generation reliant on a rapidly decaying grid infrastructure is not sustainable in the long-run, and is one more reason why PEG should increasingly lose revenue to distributed forms of generation. On top of this, many policies restrict PEG from entering into the distributed energy game due to concerns about monopoly power abuse. For instance, regulators rightly fear that utilities will enter the distributed power game for the sole purpose of eliminating the competition to keep the centralized generation model dominant. This scenario is realistic given that such utilities already have countless billions of dollars invested in centralized power plants. The United States has some of the oldest electric grid infrastructures among the developed nations. PEG is no exception in this regard, and is planning to spend billions over the next few years just on upgrading/maintaining its grid. Source: tdworld The Silver Lining Unless PEG finds an alternative business model that is not reliant upon building out an aging infrastructure, the company will find itself in trouble. Unfortunately, the company has no real solution to this problem. In the best case scenario, PEG shifts its business model to become more conducive to distributed generators like rooftop solar by focusing more heavily on grid efficiency. In the worst case scenario, PEG ends up in a utility death spiral as a result of its current business model. The main point is that a business model dependent upon continually building out infrastructure to grow profits is not sustainable in the long-run. The good news for PEG is that the timeline for distributed generations rise is uncertain. While there are many reasons to believe that this model will overtake centralized generation in the future, this could happen much later than expected. Also, the future energy landscape could be a healthy mix between centralized and distributed generation, in which case PEG can still maintain a large portion of its revenues. Not only that, total future electric use could easily grow multifold due to the increasing electrification of the society(i.e. electric transport). The energy used in transportation alone is approximately equivalent to the energy used by households. This essentially means that PEG’s future may not be so pessimistic even if distributed generation starts to play a much larger role in the energy landscape. PEG’s annual revenue( $11.26B for 2014) could grow immensely if electric use were to indeed skyrocket in the long-term. Although PEG may look undervalued in this light, there still seems to be too many headwinds facing the company. With all things considered, PEG will likely still underperform the market over time. Conclusion From a rapidly aging infrastructure to the rise of distributed generation, PEG’s prospects are not looking great. The company has experienced an overall trend of declining profits over the last couple of years, which should only continue moving forward. Although PEG’s net income spiked in 2014 to $1.52B, the company will likely experience declining net incomes moving forward. While PEG’s business model has remained essentially unchanged for countless decades, this will almost certainly change in the future. Even assuming that electricity usage increases significantly over the next few decades, PEG’s P/E ratio of 12 is still much too high given current trends. 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.

Use Dividend Stocks And ETFs To Augment Long-Term Returns

Long-term investors should use high-quality dividend stocks and ETFs. Dividend stocks provide greater total returns, with dividend reinvestment, over the long term. While high dividends are nice, investors should also focus on high quality. Over the long term, high-quality, dividend-paying stocks and exchange-traded funds could produce outperforming results. Stocks with high dividend yields are the best way for investors to buy income in the current market, and if the positions are held over the long haul through short-term volatility, one may find the investment outperforming the overall market on a total return basis, writes Philip van Doorn for MarketWatch . For instance, the S&P 500 Dividend Aristocrats, which tracks over 50 stocks that have raised their dividends annually over at least 25 years, has outperformed the S&P 500 over long periods. Over the past 10 years, the S&P 500 Dividend Aristocrats have generated a 178% total return, with dividends reinvested. In contrast, the S&P 500 index has returned 117% over the same period. ETF investors can also track the S&P 500 Dividend Aristocrats through the ProShares S&P 500 Aristocrats ETF (NYSEArca: NOBL ) . NOBL has increased 11.4% over the past year, compared to the 10.4% gain in the S&P 500. The ETF also comes with a 1.62% 12-month yield. Additionally, research has found that high-quality, high-dividend stocks tend to outperform and produce better risk-adjusted returns. For instance, Chris Brightman, Vitali Kalesnik and Engin Kose found that among the largest 1,000 U.S. companies, a smaller group of 100 high-yield, high-profitability companies generated the highest total returns with the lowest volatility from 1964 through 2014. Brightman, Kalesnik and Kose also screened for quality, or distress risk, and accounting red flags, and found that the high-quality firms typically outperformed low-quality businesses. However, investors had to give up some dividend growth rates when picking high-quality companies. Investors can also track high-quality, high-dividend stocks through ETF options. For instance, the iShares Core High Dividend ETF (NYSEArca: HDV ) , which tracks high-quality U.S. companies that have been screened for financial health and relatively high dividends, has a 12-month yield of 3.40%. The Vanguard High Dividend Yield ETF (NYSEArca: VYM ) targets the largest and highest dividend-paying stocks and comes with a 2.84% yield. VYM does not sacrifice quality for its quest for yield. Instead, the ETF includes a blend of both approaches and includes about 50% of its assets in stocks with wide economic moats, according to Morningstar . Max Chen contributed to this article . 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. I have no business relationship with any company whose stock is mentioned in this article.