Tag Archives: opinion

A Cure May Be In Store For The SPDR S&P 500 Trust ETF

When I warned about market correction in mid-August, I also discussed what factors would eventually cure what ails us. One of those factors is presenting itself Thursday, as the Federal Reserve offers clarity on an uncertainty weighing on investors’ minds and weighing down stocks. The probability of Fed inaction on interest rates or the possibility of a minor action with the removal of concern about October should serve stocks immediately. I expect such a scenario should provide immediate & significant upside to the SPDR S&P 500 Trust ETF, returning it toward its highs above $210 and higher as longer term factors. Risk to this thesis could come from a Fed rate action of 0.25% or if the Fed does not clear away concern about a potential action in October. When I authored my warnings about market correction in early to mid-August, I also indicated what the cure for stocks would eventually be. One of those factors appears to be about ready to help out, and that is clarification from the Fed. No matter what happens Thursday afternoon, the Federal Open Market Committee (FOMC) will provide some clarity to investors. Stocks should benefit from the removal of some uncertainty, and I see immediate upside of 2.5% to 5.0% probable for the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) post the Fed meeting. But any gains and the length of duration of upward direction will depend on the specifics of what the Fed does and says. The longer term for stocks and the SPY will continue to depend on the U.S. economy, energy sector issues, emerging market implications, seasonal capital flow factors and the Fed path and accuracy moving forward. 1-Year Chart of SPY at Seeking Alpha In my early to mid-August warnings of imminent market correction (see several links within the summary piece), I suggested the eventual cure for stocks would require a cocktail of medicines. I discussed the implications of seasonal capital flows and that the passing of time toward November 1st and a more welcoming capital flow environment would serve stocks then. I also suggested the U.S. economy mattered far more than the Federal Reserve, and that we would need to see health in the economy to gain traction. That means that the U.S. energy sector must heal or at least not meaningfully infect the rest of the economy. It also means that China only stumbles and does not fall, and that growth recovers in that important sector of the global economy. Finally, I said we needed Fed clarity, and that uncertainty about the Fed’s path was not serving stocks. Thursday, we will receive some clarity on the Fed’s path. Most likely, the Fed will succumb to market pressures and refrain from raising rates at this meeting. However, I’m not sure that is the best case scenario. Rather, I believe a minor rate hike of less than a quarter of a percentage point would serve to satisfy expectations that Fed action is happening this year while also easing concern that the Fed could act prematurely. If the Fed makes a minor move and indicates it is not likely to act in October, pushing expectations for the next hike to possibly December or March, it will serve stocks well. It is also likely to reiterate its data dependence and to note risks to the U.S. economy including China and emerging markets, the U.S. energy sector, and the strength of the dollar. But I also anticipate the Fed will note the strength of U.S. labor and the lack of inflation, which are positives. I suggest such an outcome would be just what the doctor ordered for the stock market. The result, in my view, would be a surge in stocks and a marching of the SPDR S&P 500 Trust ETF back towards previous highs certainly above $205, and probably to $210 or higher without much disturbance. Much depends on the specifics of the very complex data set we will get from the Fed. A risk lies in the possibility that the Fed raises rates by a quarter of a point. Such a scenario, I believe, would send a shock through the market and spur a selloff back to correction lows. That is not perfectly clear, given that investors would like to see the Fed finally get started at some point. However, I expect that given the latest poor indications from China and emerging markets, the Fed will refrain from further disturbing the global economy and the U.S. economy as a result. Despite the likelihood of inaction, in my opinion, the FOMC vote could be closer than in previous meetings. Investors will need to have some indication that October is not a threat as well, or this period of volatility will simply extend to the next Fed meeting. So if the Fed does not act, but leaves the possibility of an October action on the table for investors to worry and debate about, stocks could see their upside limited or completely erased. Over the long-term, what matters far more than the Fed are the health of the U.S. economy and the health of sectors of the global economy that threaten the U.S. economy. That means, not only must U.S. data continue to reflect progress, especially in the labor market and GDP data, but weakness in the U.S. energy sector and manufacturing (relative to it) must dissipate. Also, China must stabilize rather than deteriorate; if this occurs, expect global stocks to rally significantly. Finally, as September and October pass, significant capital flow pressure from institutions ending their fiscal years will dissipate and likely offer support to stocks as the institutions look forward with many securities trading at relative value. We are in a complex period now, where the market is supersensitive to news flow. It is the worst possible time for the Fed to be contemplating action, but it is our situation. Long-term investors should be patient now, but remain focused on the matters discussed herein. I cover the market closely, and invite relative interests in the SPY security and the market to follow my column here at Seeking Alpha . Disclosure: I am/we are long SPY. (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.

Equity CEFs: A No Brainer In The Nuveen Dow 30 Dynamic Overwrite Fund

Summary The Dow Jones Industrial Average has been the worst performer of the three major US indices so far in 2015, down -5.8% through September 16th. However, a rebound in the global markets could help the DJIA the most since the index represents 30 of the largest multi-national blue chip companies in the US. One CEF that correlates with the DJIA has seen its market price also suffer even as its NAV outperforms the DJIA. This has created a no-brainer opportunity in my opinion. Four months ago I wrote this article, How To Buy The DJIA At A 10% Discount And A 6.9% Yield . Well, guess what? Now you can own that same fund, the Nuveen Dow 30 Dynamic Overwrite fund (NYSE: DIAX ) , $13.66 market price, $15.45 NAV, -11.6% discount, 7.8% current market yield, at an even bigger discount and yield. And if four months from now the fund is at a -13% discount and an even higher yield, I would tell you to buy more. But to me this already is a no brainer. Why? Because I believe institutional investors have got to take notice when an arbitrage opportunity this obvious presents itself. When you know you’re dealing with a pretty straightforward fund like DIAX, which only owns 30 large cap stocks and sells options against 50% of its positions, you can take a fairly large position even with limited liquidity if you know you can hedge the downside in more liquid ETFs. And when the spread is this large and involves index funds, I believe this becomes too juicy to ignore. Note: DIAX also owns a couple popular index ETFs, DIA and SPY , in which options are used as well. Index-based CEFs are the easiest funds to understand and more importantly the easiest to hedge if you want to have an arbitrage position. For this reason and the fact that index CEFs are so predictable in their NAV moves, their market prices usually don’t stray too far from their NAVs. But that hasn’t been the case with DIAX or really any of the four new Nuveen option income CEFs this year. Note: For some background on the four Nuveen option income CEFs, please read the above article link. All of the new Nuveen option income CEFs are index based and they all got started in late December 2014. Three out of the four new funds were the result of mergers between previous option income CEFs from Nuveen. However, DIAX has suffered the worst as it’s the only one tied to the DJIA as its benchmark. So a poor performing Dow Jones Industrial Average this year has just been amplified in a less liquid CEF that correlates to it. This is shown in the following Premium/Discount graph in which DIAX’s discount has continued to widen. So despite a defensive option strategy, DIAX has seen a continued valuation drop in its market price and the reasons for the widening discount I believe are two fold. One is because DIAX was the result of the merger between two old Nuveen option CEFs correlated to the DJIA and if you owned both funds (DPO) and (DPD) prior to the merger, which a lot of investors did including myself, you probably didn’t want to own all of the shares of the new fund simply because that would have given you a much larger exposure in just one fund. This, I believe, resulted in the initial steep drop in valuation shown. The second reason is that DIAX’s market price has fallen pretty substantially since the beginning of the year due to weakness in the Dow Jones Industrial Average, the increased market price discount of DIAX and then also because of the quarterly distributions which totals $0.80/share so far this year. So from a pure depreciation basis, i.e. not including distributions, DIAX’s market price has dropped from $16.38 when it started trading in late December to $13.66 today. As a result, I believe tax-loss selling has now further exacerbated DIAX’s discount as investors lock in a loss with perhaps the expectation that the Dow Jones Industrial Average might be even lower in mid October or later in the year when they could buy the fund back. This is all speculation of course but I can’t think of any other reason why anyone would be so shortsighted to sell DIAX now at a -11.6% discount, particularly when the DJIA is starting to look firmer as some of its weakest components, i.e. Exxon Mobil Corp (NYSE: XOM ) and Chevron (NYSE: CVX ) , show some life. But there’s another reason why this doesn’t make any sense. As an option income CEF, DIAX’s NAV will hold up better than the DJIA in a weak market environment. This is part of DIAX’s strategy to reduce volatility while paying an enhanced yield, something you generally don’t get with ETFs. In other words, the weaker the DJIA stays, the better DIAX looks even if it’s not showing up in the market price for the above mentioned reasons. This is reflected in DIAX’s NAV performance so far this year which is off only -3.5% on a total return basis compared to the DJIA being off -5.8%. That may not sound like a big percentage difference but in the eyes of an institutional investor who might take a larger position in DIAX if they knew they could arbitrage the position with a more liquid ETF that performance difference is compelling in a down market. But then there’s also just the common sense factor. Who would sell a fund that owns nothing but the 30 bluest chip companies in America at $13.66 when its liquidation value is a bona fide $15.45 per share currently? Unlike a fixed-income or leveraged CEF in which you can’t entirely be sure that the NAV would represent the liquidation value (certainly a lot closer than book value however), a $500 million CEF that only owns 30 heavily traded positions could be liquidated in a day at pretty close to its NAV. Now some people could argue that what good is the discount if you never get to realize the step up value? That is true, the liquidation of a CEF is a rare event that you certainly shouldn’t count on. But that’s not the reason you invest in heavily discounted CEFs even though it would be reason enough in a worst case scenario. No, the biggest reason why you invest in heavily discounted CEFs is simply because you receive a larger yield than what the fund is responsible for paying. In other words, the NAV yield of a CEF is what it has to cover. But funds at discounted market prices means you receive a higher yield than what the fund is paying. So in a case like DIAX, its NAV yield is a very reasonable 6.9% but its current market price yield is 7.8% because of the discount. Again, maybe not such a big deal to an individual investor but to an institutional investor, that’s a big difference if you have a large position. Conclusion So what could go wrong? Well, certainly if the global economy takes another leg down that’s probably not going to help the US multi-national companies that dominate the DJIA. And though DIAX’s NAV would continue to outperform the Dow Jones Industrial Average in such a scenario, investors could still drive down DIAX’s market price based on emotional selling and a lack of buyers. This has been happening a lot to CEFs over the summer, i.e. not heavy selling but just a lack of buyers. Nonetheless, I believe this is one of the more compelling opportunities I’ve seen in a while, especially if the Dow Jones Industrial Average component stocks start to perform better since you know DIAX’s NAV will perform close to that of the index, holding up better during flat to moderately down periods and lagging a bit during up periods. But you won’t get any surprises with DIAX and you can lock in a nice windfall yield to boot. On a market price basis, I suppose tax-loss selling could continue and that might keep a lid on the market price for awhile no matter what the DJIA index does but I’ve also got to believe that institutional investors would step up and take advantage of an arbitrage opportunity at these levels. An -11.6% discount to the Dow Jones Industrial Average is huge, comparatively like going back to 2013 when the DJIA was below 15,000. It also gives institutional investors an opportunity to play both sides in a more volatile market environment in which both arbitrage positions will probably be profitable at one time or another. For individual investors, I would not recommend an arbitrage and I believe the current discount and yield is opportunity enough. But if you did want to hedge a position, you could either short the SPDR Dow Jones Industrial Average ETF (NYSEARCA: DIA ) (though you would be responsible for paying a monthly dividend) or you could buy an inverse fund like the ProShares Short Dow 30 fund (NYSEARCA: DOG ) which is a 1X the inverse of the DJIA. Disclosure: I am/we are long DIAX, DIA. (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.

VTWNX: This Is A Great Option For The Investor Nearing Retirement

Summary The Vanguard Target Retirement 2020 Fund has a simple construction and a low expense ratio. Despite being a very simple portfolio, they have covered exposure to most of the important asset classes to reach the efficient frontier. I would like a very slight modification to increase the allocation to higher credit quality bonds at the expense of lower quality bonds. This is quite simply one of the best constructed portfolios I’ve seen for a worker nearing retirement. Lately I have been doing some research on target date retirement funds. Despite the concept of a target date retirement fund being fairly simple, the investment options appear to vary quite dramatically in quality. Some of the funds have dramatically more complex holdings consisting with a high volume of various funds while others use only a few funds and yet achieve excellent diversification. My goal is help investors recognize which funds are the most useful tools for planning for retirement. In this article I’m focusing on the Vanguard Target Retirement 2020 Fund Inv (MUTF: VTWNX ). What do funds like VTWNX do? They establish a portfolio based on a hypothetical start to retirement period. The portfolios are generally going to be designed under Modern Portfolio Theory so the goal is to maximize the expected return relative to the amount of risk the portfolio takes on. As investors are approaching retirement it is assumed that their risk tolerance will be decreasing and thus the holdings of the fund should become more conservative over time. That won’t be the case for every investor, but it is a reasonable starting place for creating a retirement option when each investor cannot be surveyed about their own unique risk tolerances. Therefore, the holdings of VTWNX should be more aggressive now than they would be 3 years from now, but at all points we would expect the fund to be more conservative than a fund designed for investors that are expected to retire 5 years later. What Must Investors Know? The most important things to know about the funds are the expenses and either the individual holdings or the volatility of the portfolio as a whole. Regardless of the planned retirement date, high expense ratios are a problem. Depending on the individual, they may wish to modify their portfolio to be more or less aggressive than the holdings of VTWNX. Expense Ratio The expense ratio of Vanguard Target Retirement 2020 Fund Inv is .16%. That is higher than some of the underlying funds, but overall this is a very reasonable expense ratio for a fund that is creating an exceptionally efficient portfolio for investors and rebalancing it over time to reflect a reduced risk tolerance as investors get closer to retirement. In short, this is a very solid value for investors that don’t want to be constantly actively management their portfolio. This is the kind of portfolio I would want my wife to use if I died prematurely. That is a ringing endorsement of Vanguard’s high quality target date funds. Holdings / Composition The following chart demonstrates the holdings of the Vanguard Target Retirement 2020 Fund: This is a fairly simple portfolio. Only five total tickers are included so the fund can gradually be shifted to more conservative allocations by making small decreases in equity weightings and increases in bond weightings. The funds included are the kind of funds you would expect from Vanguard. The top 4 which carry almost all of the value are extremely diversified funds. The Vanguard Total Stock Market Index Fund is also available as an ETF under the ticker VTI . I have a significant position in VTI because it carries an extremely low expense ratio and offers excellent diversification across the U.S. economy. Volatility An investor may choose to use VTWNX in an employer sponsored account (if their employer has it on the approved list) while creating their own portfolio in separate accounts. Since I can’t predict what investors will choose to combine with the fund, I analyze it as being an entire portfolio. Since the fund includes domestic and international exposure to both equity and bonds, that seems like a fair way to analyze it. (click to enlarge) When we look at the volatility on VTWNX, it is dramatically lower than the volatility on SPY. That shouldn’t be surprising since the portfolio has some large bond positions. Over the last five years it has significantly underperformed SPY, but that should be expected given the much lower beta and volatility of the fund. Investors should expect this fund to retain dramatically more value in a bear market and to fall behind in a prolonged bull market. Opinions I find this to be a very solid fund, but if I could make two adjustments it would be to slightly increase the amount of domestic equity at the expense of international equity and to increase the percentage of long term government debt by adding a small position in the Vanguard Long-Term Government Bond Index Fund (MUTF: VLGSX ). The long term government bonds have a negative correlation to equity markets and a high level of volatility. Due to the strong negative correlation they make the resulting portfolio less volatile than it would be without them. The ideal allocation would be fairly small, but I would prefer to a small inclusion of that (say 5%, maybe as high as 10%) at the cost of total bond index funds that will hold more corporate debt. Corporate debt can be a great investment, but because it is has more credit sensitivity the diversification benefits are weaker. This inclusion would be expected to drop the annualized volatility a little further. Conclusion VTWNX is a great mutual fund for investors looking for a simple “set it and forget it” option for their employer sponsored retirement accounts. It is ideally designed for investors planning to retire around 2020, but can also be used by younger employees with lower risk tolerances or older workers with higher risk tolerances. Disclosure: I am/we are long VTI. (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.