Tag Archives: onload

Is Retail In Retreat?

By Robert Goldsborough As fourth-quarter earnings reports have started coming across the wire, several themes already have begun emerging. One of the biggest themes, however, has been not company-specific, but rather a government report showing surprisingly weak retail sales numbers for December and a downward revision for November’s numbers. According to United States Commerce Department data, retail sales fell nearly 1% in December on a month-to-month basis (and were down fully 1% month-to-month excluding autos), while consumer core sales (retail sales less autos, gasoline, building materials, and food services) were down 0.4% month-to-month. The news surprised both the markets and economists, who had forecast basically flat retail sales in aggregate and a 0.4% rise in consumer core sales on a month-to-month basis. And it indicated that consumers enjoying lower gasoline prices did not take that extra cash in their pockets and spend it at other retailers. Some economists contend that the retail weakness simply is a matter of the calendar and timing differences involved in making seasonal adjustments to economic data. By other measures, they suggest, such as the Federal Reserve’s Beige Book or the National Retail Federation’s data, retail spending is solid. My colleague Robert Johnson, Morningstar’s director of economic analysis, acknowledges that on a headline basis, the retail sales numbers didn’t look great, but he notes that on a year-over-year basis, retail sales growth continues to be strong, exceeding 4% on a nominal basis and growing close to 3.5% on an inflation-adjusted basis. Going forward, he doesn’t see dramatic improvement ahead in retail sales, but he does anticipate generally solid data. Although the retail sector has outperformed the broader market over the past few months, the most recent news in the retail space has pressured the share prices of many retailers a bit. For investors who see this as a buying opportunity in a generally well-valued broader market, there are several exchange-traded funds that investors can consider. An Overview of Retail ETFs There are three passively managed, unleveraged ETFs devoted to the retail industry: SPDR S&P Retail ETF (NYSEARCA: XRT ) , Market Vectors Retail ETF (NYSEARCA: RTH ) , and PowerShares Dynamic Retail ETF (NYSEARCA: PMR ) . Easily the largest and most liquid retail ETF, XRT also offers broad exposure, tracking an equally weighted index of 102 U.S. retail firms. Because XRT’s index is equally weighted, heavyweights like Wal-Mart (NYSE: WMT ) sit shoulder to shoulder in the fund with relative pipsqueaks like women’s fashion specialty retailer Cato Corp. (NYSE: CATO ) . As a result, large-cap companies make up just 15% of assets, while mid-cap firms comprise 30.5% of the fund. Small- and micro-cap companies make up 35.5% and 16% of assets, respectively. XRT holds both defensive retailers, such as Wal-Mart, Costco (NASDAQ: COST ) , and Walgreens Boots Alliance (NASDAQ: WBA ) , and nondefensive retailers, such as specialty retailers and apparel stores. XRT also holds Amazon (NASDAQ: AMZN ) , but it does not hold home-improvement retailers such as Home Depot (NYSE: HD ) and Lowe’s (NYSE: LOW ) . The fund’s 0.35% price tag is appealing, but given the exposure to smaller firms, would-be investors should expect higher beta exposure relative to a more traditional, market-cap-weighted ETF that tilts toward larger firms. RTH tracks a market-cap-weighted benchmark of 25 retail companies. That means that the largest firms, such as Wal-Mart, CVS Health (NYSE: CVS ) , Amazon, and Walgreens Boots Alliance, hold the most sway. RTH is devoted almost entirely to large-cap names, with mega-cap retailers making up 35% of the fund and large-cap companies comprising another 59% of assets. Unlike XRT, RTH holds home-improvement retailers, which gives the fund more exposure to the housing market than XRT. RTH charges 0.35%. Finally, PMR is a small, thinly traded strategic beta ETF that tracks an enhanced index of 30 retailers. The index evaluates firms based on price momentum, earnings momentum, quality, and value, among other factors. The index rebalances and reconstitutes quarterly, ensuring higher turnover. In addition, PMR has a pronounced small-cap tilt, devoting almost 27% of assets to small-cap firms, 11% to micro-cap companies, and another 21.5% to mid-cap retailers. PMR’s performance has lagged that of RTH in the trailing one- and three-year periods ending Jan. 16, 2015 (RTH has not traded for five years), and while it has nicely outperformed XRT in the trailing one-year period, it’s underperformed XRT in the trailing three- and five-year periods. It’s not clear whether investors can count on outperformance from this fund going forward. PMR charges a relatively high expense ratio of 0.63%. What the Economic Outlook for 2015 Means for Retail ETFs In general, Morningstar’s analysts anticipate a healthier and stronger U.S. consumer in 2015 and beyond, which portends well for retail ETFs. A strengthening consumer in particular would favor ETFs with small- and mid-cap tilts, as they hold fewer defensive names and more discretionary, higher-beta firms. So that dynamic could make XRT and PMR more appealing options. At the same time, investors should pay close attention to some retail trends that are less favorable for smaller players. Some of these include the need for retailers to have both a brick-and-mortar business and an e-commerce presence–a requirement that in general requires firms to be larger and have more scale–and a broader trend of the millennial generation spending less money on high-priced items found at specialty retailers offering apparel or luxury goods and instead spending more on experiential items and more expensive places to live. Although any generational shift plays out over a much longer-term time horizon, it’s worth watching closely. E-Commerce Growth Continuing Unabated In addition to disappointing December results, traditional bricks-and-mortar retailers continue to face challenges from online shopping. Many traditional retailers have struggled to keep up with Amazon’s strong fulfillment capabilities and price competition. Although Amazon continues to grow and take share from traditional retailers, it also has problems of its own, as it continues to search for ways to grow its business profitably. In the first few weeks of 2015, the firm’s share price is down sharply. Over the longer term, we have some concerns about smaller retailers’ ability to compete with Amazon from a fulfillment standpoint. Morningstar’s equity analysts note that a variety of retailers have increased their emphasis on logistics and delivery speeds, but even so, only a few retailers at this time can match Amazon’s capacity and geographic reach. The transition to e-commerce is continuing slowly for bricks-and-mortar retailers, as many of their fulfillment centers were not designed for e-commerce. For investors, what this means is that smaller-cap retail names–which are found more in XRT and PMR–may well find themselves more susceptible to the growth in online shopping. So while broader macroeconomic trends–a stronger consumer with more disposable income–could benefit those funds, e-commerce growth could come at the expense of some, if not many, of the smaller firms in those ETFs. Other Options Because retail makes up a large chunk of the consumer discretionary industry, investors seeking broad exposure to the retail space also could consider a consumer discretionary ETF. Consumer Discretionary Select Sector SPDR (NYSEARCA: XLY ) , which charges 0.16% and holds about 85 companies, is a large and liquid fund that devotes about one third of its assets to retailers. Similarly, Vanguard Consumer Discretionary ETF (NYSEARCA: VCR ) costs just 0.12%, holds a broader portfolio of 382 firms, and also invests about a third of its assets in retail firms. Investors interested in ETFs with meaningful exposures to Amazon can consider one of two Internet ETFs, both of which devote between 7% and 8% of assets to Amazon: First Trust Dow Jones Internet (NYSEARCA: FDN ) (0.60% expense ratio) and PowerShares NASDAQ Internet (NASDAQ: PNQI ) (0.60% expense ratio). Internet and catalog retailers like Amazon make up between 20% and 25% of the assets of each ETF. Disclosure: Morningstar, Inc. licenses its indexes to institutions for a variety of reasons, including the creation of investment products and the benchmarking of existing products. When licensing indexes for the creation or benchmarking of investment products, Morningstar receives fees that are mainly based on fund assets under management. As of Sept. 30, 2012, AlphaPro Management, BlackRock Asset Management, First Asset, First Trust, Invesco, Merrill Lynch, Northern Trust, Nuveen, and Van Eck license one or more Morningstar indexes for this purpose. These investment products are not sponsored, issued, marketed, or sold by Morningstar. Morningstar does not make any representation regarding the advisability of investing in any investment product based on or benchmarked against a Morningstar index.

What Is Driving Up SLV Besides Gold?

The fall in the U.S. treasuries yields keeps up the price of SLV. The rally of gold is only partly related to the recovery of silver. Despite the recovery in silver prices, SLV’s silver holdings didn’t pick up. The silver market has started off the year on a positive note as shares of iShares Silver Trust (NYSEARCA: SLV ) added nearly 14% to their value (up to date). Is most of this recovery related to the rise in gold? Let’s reexamine the relation between silver and gold and further explore other factors that drive up SLV. Despite the progress of SLV in the past few weeks, its rally seems, at first glance, less related to the rise in gold prices. The chart below shows the linear correlation of gold and silver on a month-to-month basis (daily percent changes). Source: Bloomberg In the past month the linear correlation was around 0.615; even though this is still a significant and strong correlation, it’s also well below the levels recorded in the preceding months. Moreover, the ratio between SPDR Gold Trust (NYSEARCA: GLD ) and SLV has zigzagged with an unclear trend in recent weeks, as indicated in the chart below. Source: Google finance The ratio is still at a high level of around 7.2, which means GLD has still outperformed SLV in the past year. Some investors, however, might consider the high level of the GLD-to-SLV ratio as an indication that the latter is actually cheaper than the former. I put less faith in this assessment. This ratio could keep going up or remain at this level for a long time. After all, back in the early 90s the ratio between gold and silver started off at around 70 – this is the current ratio – and kept rising up to the low 90s and remained in the 70s and 80s range up to 1997. This doesn’t negate the fact that SLV’s recovery in the past few weeks was driven, in part, by the rise in gold. It only goes to show that other factors may have come into play in pushing up silver prices. One other factor to consider is the ongoing drop in long- and mid-term U.S. treasuries yields – they may have also contributed to the rise in SLV prices. The chart below shows the progress in the 7-year U.S. treasury yield and the price of SLV in the past several months. During the period presented below, the linear correlation between the two was around -0.3 – a mid-strong correlation. Source: Bloomberg and U.S Department of the Treasury Even though the FOMC is still expected to raise its interest rates, which are likely to bring back up the U.S. treasury yields in the second half of 2015, the recent developments in the markets including low inflation – mainly due the fall in oil prices – and higher economic uncertainty drove down U.S. treasuries yields. If yields continue to come down in the short term, this could keep pushing up the price of SLV. The recent developments in Europe including the Swiss National Bank’s decision to stop pegging its currency and ECB’s upcoming announcement of its QE program also seem to drive the demand for precious metals. In terms of growth of physical metal, this seems to play a secondary role, at best, in moving the price of silver. After all, China is one of the leading silver importers. The country recently published its fourth-quarter growth rate update; it showed a 7.4% growth in annual terms. This is slightly higher than market expectations of 7.3%. But this is still lower than its growth rate of 7.7%, which was recorded in the same quarter in 2013. This year, the World Bank estimates China’s GDP will expand by only 7.1% – this is 0.4 percentage points below its previous estimate back in June 2014. The IMF also revised down the global economic growth from 3.8% to 3.5% this year. A slower growth rate for China could suggest, at face value, a slower rise in the demand for silver. Lower growth in the world economy isn’t expected to increase the industrial demand for silver but it’s likely to drive more investors towards silver. This only serves as another indication that the demand for silver on paper leads the way for the price of SLV. But is the demand actually picking up for SLV? The chart below presents the changes in SLV’s silver holdings in the past few months. Source: SLV’s website Since the beginning of the year, silver holdings have actually slightly come down by 1.4% to 325 million ounces of silver. This could be an indication that some SLV investors have taken money off the table after the price of silver rallied. Looking forward, however, the recovery of silver is likely to slowly bring more people back to SLV. The silver market has seen a recovery in recent weeks. Over the short term, silver could keep rising especially if the global economy keeps showing slower growth. For more see: 3 Reasons to Prefer Silver Wheaton

The Rise Of Factor Investing And The Implications For Asset Allocation

Once upon a time there was only one factor-the market, a la the capital asset pricing model. But after a half century of crunching the numbers since CAPM was born, “now we have a zoo of new factors,” as Professor John Cochrane observed a few years ago. In theory, identifying more factors opens the door for building superior risk-adjusted portfolios. But some practitioners worry that “the proliferation of factors is deeply troubling,” as Research Affiliates explained recently. Why? Because not all factors are created equal and securitizing what looks like a productive risk premium on paper is tricky when it comes to real-world results. Finding success in the factor zoo, in other words, is quite a bit more challenging than it appears when reading finance journals. But for those who are willing to try, there are numerous ETFs and mutual funds to choose from in the new world order. Taking the marketing material at face value tells us that clever strategists can build smart-beta portfolios that leave their standard-beta counterparts in the dust. That’s certainly possible, but the pernicious rumor promoted by some folks that happy outcomes are inevitable is misleading at best. The main problem is that quite a lot of what some see as compelling evidence in favor of going off the deep end with smart beta funds is really just cherry-picking the strongest performers. You can certainly find ETFs and mutual funds that deliver encouraging results in the art/science of mining smart beta. But there are plenty of dogs as well. The real question is whether there’s any evidence that, all else equal, an asset allocation strategy populated with smart-beta funds reliably outperforms its conventional-beta counterparts in a convincing degree on a risk-adjusted basis? Coming up with an answer is tougher than it sounds, in part because there aren’t a lot of smart-beta ETFs and mutual funds with sufficiently long records to run a robust test. The original factor strategies-i.e., small-cap and value-have been around for a few decades and so there’s a relatively deep and wide empirical record to study on this front. And the results are encouraging, particularly when it comes to value. But there’s a bigger mystery with the newer generation of factor funds that target an array of risk premiums, such as momentum, quality, and volatility. And more are on the way. Some of this is little more than data mining. Looking for relatively strong relationships in the cross section of security returns is child’s play at this point, thanks to the rise of inexpensive computing power. But the transition from encouraging in-sample results to out-of-sample confirmations using real-world funds is a slippery affair. Most of the studies to date focus on a single asset class; kicking the tires when it comes to asset allocation is still in its infancy with regards to smart beta analysis. As a preliminary test, I recently ran a test using a set of smart-beta funds that track indexes designed by one of the more respected names in the business. The analysis is compelling because the smart-beta funds I review have been around for at least five years and hug benchmarks designed by a single firm. Meanwhile, there are low-cost alternatives that track conventional cap-weighted indexes. In short, we have the ingredients for a robust test of real-world results. It’s hardly definitive, but it offers some perspective on how smart beta fares in asset allocation. I created two sets of equity portfolios-a smart-beta strategy and its standard-beta counterpart for a U.S./foreign equity allocation using five allocation buckets (U.S. broad, U.S. small cap, U.S. value, foreign developed, foreign Asia ex-Japan). The initial portfolio weights are identical. I ran the numbers with a year-end rebalancing strategy vs. a buy-and-hold portfolio. In both cases the results are the virtually the same, namely: there’s not a lot of difference between smart-beta and conventional-beta portfolios over the past five-year period. In a future post, I’ll lay out the details with a review of the numbers, at which point I’ll name names. For now, let’s just say that the data suggests that building portfolios with smart-beta funds may not be a silver-bullet solution that reliably outperforms a comparable strategy using conventional index funds. Why? Several reasons. First, smart-beta funds have higher expense ratios, although for the test I ran the funds under scrutiny charged only moderately higher fees vs. the traditional index funds. Another challenge is the simple fact that smart beta doesn’t always outperform, at least not reliably so across all asset classes at all times. This is a major challenge for analysis in this corner because there’s a growing number of vendors using a wide set of criteria for designing funds. Ideally, investors will select only those products that will deliver superior results and otherwise use standard index funds. But this is harder than it sounds, particularly for time horizons over, say, one to three years. In my test, some of the smart-beta funds outperformed (some of the time), but others stumbled. The result: the wins cancelled out the gains and the overall results tracked the portfolios built with conventional index funds. Selecting one or two smart-beta funds and earning superior results over standard index products is one thing, but it’s a tougher game when applied to a broad asset allocation strategy over a longer-term horizon. Some of this is due to the variation in the design quality of products, but there’s also lots of debate about what’s likely to work in the smart-beta zoo vs. what’s an anomaly that won’t survive beyond the realm of backtesting. As a recent paper (“Facts and Fantasies About Factor Investing”) by researchers at Lyxor Asset Management explains: From a professional point of view, only a few number of risk factors and anomalies are reliable. Among these relevant factors, we find for example [small-cap, value and momentum]. But, even with a reduced set of less than 10 factors, there are again a lot of questions to answer in order to understand what the nature, the behavior and the risk of these factors are. Academics have done extensive studies on these questions and their work can help to find the answers, but some questions still remain open, in particular the level of the risk premia. That last point, about the level of risk premia, is critical. Indeed, after adjusting for commissions, taxes and various real-world frictions, there’s a high bar for arguing that a given factor is a viable candidate for use in real-world portfolios. The bottom line is that the evolution from conventional-beta products to smart-beta funds comes with a number of hazards. By contrast, the transition from conventional active management to plain-vanilla indexing over the past generation has been and remains a more reliable process, particularly in the context of designing and managing multi-asset class portfolios. That doesn’t mean that smart beta isn’t a productive development in assert pricing and money management. But it turns out that there’s a lot more art than science in the next generation of indexing than some folks would have you believe. As a result, beating Mr. Market’s asset allocation over the long run will likely remain as challenging as ever.