Tag Archives: opinion

Solid Holdings And Growing Dividends Are On Sale? I’d Like To Buy Those

Summary The Schwab U.S. Equity Dividend ETF offers investors very solid growth in dividends. Looking at the combination of yield and growth rate makes SCHD look like a very compelling long term investment. SCHD has been slightly less volatile than the S&P 500. I don’t want to stop buying equity when prices drop, so I’m buying the slightly less volatile equity. The holdings are a solid batch of companies with strong dividend histories and established market positions. Lately I’ve been looking for ETFs that offer investors more safety. We are seeing macroeconomic issues with corporate profits after tax making up record percentages of GDP and a stock market that, at least measured by the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) is getting quite expense when we measure price to earnings or price to sales. That creates a real problem for investors looking for investments that have respectable yields without absurd levels of risk. In my opinion, one of the better shelters for the potential volatility is the Schwab U.S. Dividend Equity ETF (NYSEARCA: SCHD ). How expensive is the market? To demonstrate the relatively high prices, I grabbed the following chart: (click to enlarge) I try not to focus too much on any single measure. However, it is worth noting that price to sales levels are fairly high and that is enough to concern me and encourage me to focus on using more conservative allocations. Some sectors such as telecommunications are seeing substantial pricing wars that will drive down both sales values and profit levels. That makes me fairly bearish about the outlook for that sector. In the same way, we have seen mining companies facing very high fixed costs. Rather than respond to lower prices by cutting production, many initially attempted to increase production so the fixed costs could be spread over more units of production. From a macroeconomic perspective, I think thinner profit margins stemming from fierce competition are very healthy for the long term economy. More intense competition drives more efficient allocation of resources and lower costs are a very material benefit for consumers. Despite those gains, I want to be careful not to overextend my portfolio in buying up companies with deteriorating earnings. I’ve had quite enough of that pain from Freeport-McMoRan (NYSE: FCX ) when I didn’t predict that copper prices would get smashed by hedge funds shorting copper futures contracts to express a bearish view on China. That was an interesting lesson to learn. It encouraged me to be more careful about firms that are susceptible to seeing declining pricing power. Why SCHD is great While SCHD offers investors some appealing characteristics, like a .07% expense ratio, I’m finding more to love than the low holding costs. SCHD is offering some pretty great dividend growth history. 2011 was an incomplete year and is not a fair comparison. The full year data begins in 2012. The impressive thing is that 2015 is also an incomplete year but it is already matching the distributions for 2013. This is a dividend ETF with a respectable yield and it is a solid choice as a core portfolio holding. Holdings The following chart shows the top 10 holdings: (click to enlarge) This is a pretty good batch. I can’t help but notice that they are putting heavy weights on some of the companies that seem to be out of favor right now. Verizon Communications (NYSE: VZ ) is an example of one of the companies that I’m concerned about as Sprint (NYSE: S ) wages a massive price war. On the other hand, I’m left wondering how long the fierce competition will last. In a market that is so heavily concentrated, it seems like a reduction in intensity of competition would immediately benefit all companies. You might wonder who would move first to calm the battle. My guess is Sprint, if they stopped battling I think Verizon and AT&T (NYSE: T ) would both quickly drop back into a more complacent strategy. I have to admit that I’m pretty big on seeing the heavy allocations to Exxon Mobil (NYSE: XOM ) and Chevron (NYSE: CVX ) because I expect those mammoths to get back on track. Investors may believe that cheaper gas is here to stay, but I think money in politics is here to stay for much longer. Don’t expect XOM and CVX to go quietly into the night. One way or another, the major gas companies will put up a fight for their shareholders. The Coca-Cola Company (NYSE: KO ) and Pepsi (NYSE: PEP ) have both trailed the S&P 500 dramatically over the last five years. I’ll take that risk because they have a great distribution system in place. While junk food may be on the way out and healthier food is on the way in, these companies still have an incredible economic moat. They can still acquire the more attractive products and utilize their system of delivery to add substantial value to the process. Remember KO wasn’t too shy about taking a major position in Monster Beverage Corp. (NASDAQ: MNST ) when they recognized that MNST had a very desirable product that needed a stronger global distribution channel. Conclusion When the volatility in the market gets ugly, I’d rather not sit on the sidelines. This great dividend ETF is just what I need to keep acquiring the kind of dividend champions I want to hold for decades. Now if the price would just drop a little further and trigger my latest buy order… Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SCHD, FCX over 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: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.

XLV: Getting Your Dose Of Pharmaceuticals And Biotechnology In A Single Source

Summary XLV is a Health Care ETF with the heaviest allocations going to Pharmaceuticals and Biotechnology. The returns figures look fairly volatile in a regression analysis which makes it substantially more difficult to diversify away the excess risk. The nice thing for shareholders is that they would be holding the very companies that are establishing the prices for the medicine they may consume. Investors should be seeking to improve their risk adjusted returns. I’m a big fan of using ETFs to achieve the risk adjusted returns relative to the portfolios that a normal investor can generate for themselves after trading costs. One of the funds I am assessing is the Health Care Select Sect SPDR ETF (NYSEARCA: XLV ). I’ll be performing a substantial portion of my analysis along the lines of modern portfolio theory, so my goal is to find ways to minimize costs while achieving diversification to reduce my risk level. Expense Ratio The expense ratio for Health Care Select Sect SPDR ETF is .15%, which isn’t too bad at all. I’d love to see the expense ratio go under .10%, but .15% is within reason and not too bad for giving investors exposure to the Health Care sector. Remember that the Biotechnology sector is also within the Health Care sector which makes it more volatile. Largest Holdings (click to enlarge) I don’t see anything to complain about here. The top holdings for the ETF almost perfectly mirror the index so investors should expect the portfolio to have very similar returns. Given the low expense ratio, a fairly passive indexing strategy is usually the result. I’m fine with that. Passive indexing is a solid strategy over the long term. Looking at the individual companies, I like seeing Johnson & Johnson (NYSE: JNJ ) at the top of the holdings. This is a strong dividend company that offers investors some stability. Their product lineup is diverse enough that they are largely protecting from minor shifts in the economy and positioned to benefit from an aging population requiring more medicine. Sector The largest weighting by sector is clearly the pharmaceuticals rather than biotechnology stocks. As a result of this sector diversification the fund is dramatically more stable than peers that are heavily invested in biotechnology companies. On the other hand, the returns for it have also been materially weaker. Building the Portfolio The sample portfolio I ran for this assessment is one that came out feeling a bit awkward. I’ve had some requests to include biotechnology ETFs and I decided it would be wise to also include a the related field of health care for a comparison. Since I wanted to create quite a bit of diversification, I put in 9 ETFs plus the S&P 500. The resulting portfolio is one that I think turned out to be too risky for most investors and certainly too risky for older investors. Despite that weakness, I opted to go with highlighting these ETFs in this manner because I think it is useful to show investors what it looks like when the allocations result in a suboptimal allocation. The weightings for each ETF in the portfolio are a simple 10% which results in 20% of the portfolio going to the combined Health Care and Biotechnology sectors. Outside of that we have one spot each for REITs, high yield bonds, TIPS, emerging market consumer staples, domestic consumer staples, foreign large capitalization firms, and long term bonds. The first thing I want to point out about these allocations are that for any older investor, running only 30% in bonds with 10% of that being high yield bonds is putting yourself in a fairly dangerous position. I will be highlighting the individual ETFs, but I would not endorse this portfolio as a whole. The portfolio assumes frequent rebalancing which would be a problem for short term trading outside of tax advantaged accounts unless the investor was going to rebalance by adding to their positions on a regular basis and allocating the majority of the capital towards whichever portions of the portfolio had been underperforming recently. Because a substantial portion of the yield from this portfolio comes from REITs and interest, I would favor this portfolio as a tax exempt strategy even if the investor was frequently rebalancing by adding new capital. The portfolio allocations can be seen below along with the dividend yields from each investment. Name Ticker Portfolio Weight Yield SPDR S&P 500 Trust ETF SPY 10.00% 2.11% Health Care Select Sect SPDR ETF XLV 10.00% 1.40% SPDR Biotech ETF XBI 10.00% 1.54% iShares U.S. Real Estate ETF IYR 10.00% 3.83% PowerShares Fundamental High Yield Corporate Bond Portfolio ETF PHB 10.00% 4.51% FlexShares iBoxx 3-Year Target Duration TIPS Index ETF TDTT 10.00% 0.16% EGShares Emerging Markets Consumer ETF ECON 10.00% 1.34% Fidelity MSCI Consumer Staples Index ETF FSTA 10.00% 2.99% iShares MSCI EAFE ETF EFA 10.00% 2.89% Vanguard Long-Term Bond ETF BLV 10.00% 4.02%   Portfolio 100.00% 2.48% The next chart shows the annualized volatility and beta of the portfolio since October of 2013. (click to enlarge) Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. You can see immediately since this is a simple “equal weight” portfolio that XBI is by far the most risky ETF from the perspective of what it does to the portfolio’s volatility. You can also see that BLV has a negative total risk impact on the portfolio. When you see negative risk contributions in this kind of assessment it generally means that there will be significantly negative correlations with other asset classes in the portfolio. The position in TDTT is also unique for having a risk contribution of almost nothing. Unfortunately, it also provides a weak yield and weak return with little opportunity for that to change unless yields on TIPS improve substantially. If that happened, it would create a significant loss before the position would start generating meaningful levels of income. A quick rundown of the portfolio I put together the following chart that really simplifies the role of each investment: Name Ticker Role in Portfolio SPDR S&P 500 Trust ETF SPY Core of Portfolio Health Care Select Sect SPDR ETF XLV Hedge Risk of Higher Costs SPDR Biotech ETF XBI Increase Expected Return iShares U.S. Real Estate ETF IYR Diversify Domestic Risk PowerShares Fundamental High Yield Corporate Bond Portfolio ETF PHB Strong Yields on Bond Investments FlexShares iBoxx 3-Year Target Duration TIPS Index ETF TDTT Very Low Volatility EGShares Emerging Markets Consumer ETF ECON Enhance Foreign Exposure Fidelity MSCI Consumer Staples Index ETF FSTA Reduce Portfolio Risk iShares MSCI EAFE ETF EFA Enhance Foreign Exposure Vanguard Long-Term Bond ETF BLV Negative Correlation, Strong Yield Correlation The chart below shows the correlation of each ETF with each other ETF in the portfolio. Blue boxes indicate positive correlations and tan box indicate negative correlations. Generally speaking lower levels of correlation are highly desirable and high levels of correlation substantially reduce the benefits from diversification. (click to enlarge) Conclusion XLV is substantially less risky than the XBI. Since XBI is almost exclusively biotechnology companies, I’m not surprised that XLV is so much safer. Of course, it is still a fairly risky investment in its own right. The ETF has a beta higher than 1.00 so it will naturally be increasing the risk level on most traditional portfolios. The correlation with the S&P 500 stands at .88 which is high enough that it may be a concern. The bigger issue, in my opinion, is that XLV has a weaker negative correlation with the kind of long term bond holdings that investors would use to reduce portfolio volatility. In this case, that is demonstrated by having a negative correlation with BLV of only -.23 compared to -.29 for the S&P 500. I would treat XLV as a fairly aggressive allocation. If investors intend to bring their portfolio volatility significantly below the S&P 500, it will be more difficult if the allocations to XLV are significant. Despite the volatility, I do like the exposure within the portfolio. A heavy exposure to the pharmaceutical companies makes sense when an investor expects to be practically forced to buy their products in the future. While the portfolio has more volatility under modern portfolio theory, it does allow investors to benefit as shareholders if prices (and profits) from the pharmaceutical and biotechnology sector increase. 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: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.

How I Created My Portfolio Over A Lifetime – Part IV

Summary Introduction and series overview. The parties involved in a flash crash. The mechanics of a flash crash and how unrelated activities can intensify the problem. Summary. How I Created My Portfolio – Part IV: Lifting The Hood on a Flash Crash Introduction and series overview The parties involved in turning a normal crash into a flash crash The mechanics of a flash crash and how unrelated activities intensify the problem Summary Back to Part III [ A] Introduction and Series Overview This series is meant to be an explanation of how I constructed my own portfolio. More importantly, I hope to explain how I learned to invest over time, mostly through trial and error, learning from both my successes and failures and those of others who chose to confide in me. Each individual investor has different needs and a different level of risk tolerance. At 66, my tolerance is pretty low. The purpose of writing this series is to provide others with an example from which each one could, if they so choose, use as a guide to develop or better organize their own approach to investing. You may not choose to follow my methods, but you may be able to understand how I developed mine and proceed to create a process more suitable for your own needs. The first article in this series is worth the time to read, in my opinion and several of the many comments made by readers, as it provides what many would consider a unique approach to investing and some very foundational concepts that I learned along my journey. Part II introduced readers to the questions that should be answered before determining assets to buy. I spent a good portion of that article explaining investing horizons, including an explanation of my own, to hopefully provoke readers to consider how they would answer those same questions. Once an individual or couple has determined the future needs for which they want to provide, he/she can quantify their goals. If the goals seem unreachable, then either the retirement age needs to be pushed further into the future or the goals need to become more attainable. In the next two articles, I then explained my approach to allocating between and within difference asset classes and summarized by listing my approximate percentage allocations as they currently stand. In this article, I will try my best to explain my understanding of a flash crash and how disparate entities, all working in their own best interests and unknowingly, enter into activities that tend to increase or decrease volatility in equities. I hope to keep things simple and easy to understand, but, this being a relatively complex subject, if my efforts to unravel the chain of events does not lift the fog as well as expected, please do not hesitate to ask questions in the comments section. Since we have experienced only two flash crashes in recent history (May 6, 2010 and August 24, 2015), there is not enough data to determine exactly what happens to create one. It is especially difficult to draw conclusions about how flash crashes start because the two instances came about quite differently. But understanding what occurs during a flash crash may explain why prices of ETFs can range so far below the respective net asset values [NAV]. The focus of my explanation will be on what happens to ETFs during a flash crash. That part seems rather apparent to me. How one starts or ends is more speculation on my part. If readers have a better explanation on these elements, please feel free to share with the rest of us in the comments section. The parties involved in turning a normal crash into a flash crash I want to point out right now that I have no intention of trying to identify who starts a flash crash or who should be blamed. That is not the focus of my explanation. Readers may reach some conclusions on their own, but they should not expect to find those answers here. Sorry, but the intent to create a flash crash is not my concern. I just want to remain out of the way and protected when occurs. That is why I chose to write this article (along with reader requests) and why I believe it belongs in this series. Building an investment portfolio is only one of the steps in successful investing; we need to guard against avoidable losses, as well. For those who want to trade mispriced ETFs should another flash crash occur, having an understanding of how ETFs are affected is imperative. While I do not recommend trading, I must admit that there were some great opportunities to be had on August 24th. But remember one thing: the next one could turn out to be different. The primary parties to a flash crash, to my feeble understanding, are: Exchanges ETF market makers High-frequency traders [HFT) Traders using stop loss orders Market orders to sell Fear/Panic I do not know if actions by any of the above parties actually starts a flash crash, but once one begins each plays a role. Exchanges try to slow it down. ETF market makers are in business to make money while performing their functions. HFTs definitely try to profit. Stop losses orders get executed automatically, because that is what they are supposed to do. Market orders get filled whatever the price, adding fuel to the fire. Fear turns to panic and more market orders hit the market by those who just want out. In the case of the recent flash crash on August 24th, I suspect that when each of the three major indices closed on or within a fraction of the day’s low on the previous Friday when the Dow Jones Industrial Average Index (DJI) was down almost 531 points, a lot of fear built up over the weekend. Many investors probably placed sell orders over the weekend and some place stop loss orders in hopes of protecting themselves if equities continue to descend on Monday. The DJI was set to open a thousand points lower on Monday when the moment finally came. Panic! The flash crash was set to occur. But how did the different parties listed above contribute to some parts of the market getting hit worse than others, especially some ETFs? It can be argued, and probably correctly, that the exchanges helped avoid a worse flash crash on that day. On December 6, 2007, the SEC approved Rule 48, which the exchanges invoke prior to the open or reopen of trading (after a halt in trading) when there is evidence of too much volatility in equities due to several factors (see this article from CNBC for more on Rule 48). Rule 48 allows exchanges to suspend the requirement that stock prices be announced at the market open. The rule was used on August 24th, but it is not apparent that this action had the intended affect. After the flash crash that occurred in May 2010, circuit breaker rules were put in place to slow down the markets when stocks or ETFs sell off by more than a certain percentage. The circuit breaker means that once a particular stock falls a specified percentage within a predetermined period of time (usually mere minutes, or even seconds) trading in the stock or ETF is halted for five minutes to let investors cool down. That day trading was halted more than 1,200 times by the exchanges (actually 1268 times according to BlackRock ) on various stocks and ETFs. The mechanics of a flash crash and how unrelated activities intensify the problem There is a saying that a picture is worth 10,000 words (it is also in a song titled “IF”) and the one below tells a very convincing story in my mind. This is a three-day chart comparing the S&P 500 ETF (NYSEARCA: SPY ) and the Guggenheim S&P 500 Equal Weight ETF (NYSEARCA: RSP ). The only difference between the two ETFs is the weighting. SPY is red and RSP is blue. (click to enlarge) Source: Google Finance As you can see at the beginning and the end of the period, these two ETFs tend to be highly correlated. Then the slight divergence occurred. SPY fell by 7.8 percent while RSP, at the worst point, fell by 42.6 percent. Since both ETFs contain the same stocks this would seem impossible. Stocks began to recover after the first half hour of trading. What happened to ETFs during that half hour and prior to the open is what I want to help us understand. Normally a market maker will keep the spread (difference between the bid and ask prices) narrowly around the NAV of the underlying assets of the fund. Under normal circumstances they will gladly buy the ETF for a little under the NAV and then sell it for a little more than the NAV when needed to keep shares trading efficiently. When trading in one of the stocks that make up the ETF is halted by an exchange, having hit its “limit” down as determined by the exchange, the market maker for that ETF must decide what the spread should be and place orders accordingly. Market makers are not in the business to lose money, so when they err it is always on the side of caution. In this case, not knowing what the NAV is (because trading in some stocks has been halted and when those stocks begin trading again the price may be different from when it was halted), the market maker most likely looked for price support levels in the stocks for which a value could not be determined and placed a bid to buy at an assumed NAV based upon those prices. When multiple stocks are halted at the same time, the market maker lowers the bid to make certain that a loss is not incurred. With the market falling so abruptly, the bids by the market makers were set significantly below actual (or the last known) NAV. Hopefully, that is clear enough to explain why some ETFs diverged significantly from the value of the underlying stocks that make up the funds. Now, why did SPY and RSP diverge so dramatically? Well, it wasn’t because a lot of the stocks in the S&P 500 traded down by that much. I checked a good number of the component stocks and found very few that were down more than 12 percent. Three of the four largest components by market cap were Johnson & Johnson (NYSE: JNJ ) down 12.6 percent, Apple (NASDAQ: AAPL ) down by as much as 10.3 percent and General Electric (NYSE: GE ) down by 10.6 percent. So, what did happen? My best guess is that the market maker for RSP considered its position to contain more risk since it did not have the protection of the weighting for the stable companies at the top. Thus, when several of the stocks that make up the S&P experienced a halt in trading at the same time, especially when many of those issues were of lesser capitalization, the market maker simply chose a technical support level for those shares that it could expect to hold up and set a bid based upon the much lower assumed NAV. In addition, the HFTs, sensing a rout and recognizing a thinly traded ETF in RSP, probably hit the sell button with bids even lower and then probably cancelled those orders before being filled. The HFTs could then place buy orders even lower and pick up shares at deep discounts when there were no other bids if sellers placed market orders. The HFT trading systems are automated so there are rarely humans involved. The programs are set to identify unusual market activity and to predict potential outcomes. They place thousands of orders and can cancel within a few thousandths of a second with the objective to move the price. They move with incredible speed and usually take pennies or fractions of a penny from many thousands or millions of transaction per day. On August 24, 2015, I suspect some HFTs made chunks instead of pennies. Volatility is the friend of HFTs. Summary Once the divergence was created, the HFTs and others were able to arbitrage the difference away in mere minutes. I cannot prove any of this, but I suspect that the halts in individual stocks created wider spreads as market makers attempted to keep from losing money while facilitating trading. With 1,268 halts that day, the spreads just kept getting larger and larger. At the same time the HFTs were taking advantage of stop loss orders and market orders that were flooding the exchanges. But the trading halts may also have kept the market from falling much further than it did. The problem was not the overall market drop, but the divergence from NAV that occurred in many ETFs that day. Market makers want to make money. HFTs want to make money. Traders were running for the exits in droves just trying to keep from losing any more money. Once again we witnessed a great redistribution of wealth from main street investors to the wealthy folks on Wall Street. This is my opinion and one that you may not share, but the divergence that can occur during a panic is why I do not use ETFs for long-term holdings, especially those that do not trade in large volumes. Thinly-traded ETFs have a higher probability of divergence than those that trade large volumes regularly. After the dust settles it may work out fine, but the turmoil during a crash is more than I want to experience. On the flip side, if one has the propensity to watch the markets throughout the day (which I do not) and can do so on days such as August 24th, one could conceivably identify the divergences and buy the laggard (in the example RSP would be the laggard). Eventually, the divergence will always converge again and either the lower priced ETF will rise or the higher one will fall. Assuming one buys the laggard, the risk of loss is relatively small and the potential gain can be very significant. Not my cup of tea, day trading, but for those who relish such activities, this is one of the better ones. Unfortunately, it is not one we can depend on to happen when we are ready to act. ETFs were supposed to add liquidity to the market and, thus, lessen volatility. I don’t think we’re there yet. As always I welcome comments and questions and will do my best to provide details and answers. This is one of the best aspects of the SA community. We can learn from each other and share our perspectives so that other readers can benefit from the comprehensive knowledge and experience represented here. Disclosure: I am/we are long AAPL, JNJ. (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.