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Abengoa Yield PLC: Diversified Global YieldCo With Attractive Dividend And Upside Potential

Summary Attractive sustainable current dividend yield of over 8 percent; expected to increase by 31 percent next year. YieldCo sponsored by global engineering giant with a substantial pipeline of attractive acquisition opportunities. Solid diversified asset portfolio with stable cash flow and global exposure. Last week we brought readers an interesting opportunity with a renewable energy focused YieldCo in NextEra Energy Partners (NYSE: NEP ). With this article, we’re focusing on another YieldCo with substantial upside potential, along with a strong sustainable high yield dividend. This time, however, the company is more nuanced and has, in our view, a different risk profile than NextEra Energy Partners. However, we believe the potential upside with this company is significant and offers a great source of low cost diversification to an income focused portfolio. Abengoa Yield PLC (NASDAQ: ABY ) is a United Kingdom registered company that trades primarily on the NASDAQ. Abengoa Yield follows the typical YieldCo model for project developers: its sponsor, Abengoa SA (NASDAQ: ABGB ), wins contracts, develops projects and then the Yieldco has the opportunity to be the first bidder on these projects as they’re sold. The sponsor benefits by freeing up capital to pursue more development opportunities and investors in the Yieldco benefit by holding onto long-term stable cash flow generating assets that can be levered to produce a high dividend yield. The sponsor, Abengoa SA, is a global engineering company based in Spain whose expertise is primarily in the development of power projects. Its market capitalization is approximately $1 billion, with 2014 revenues of over €7 billion. As of the second quarter of 2015, the sponsor held a 51.1 percent interest in Abengoa Yield, though the company is targeting this to be reduced over time to a 40 percent interest. Unfortunately for Abengoa Yield, there are conflicting views on the financial health of the sponsor, with a recent upgrade by Standard & Poor’s in July offset by the news that Moody’s has put the company on credit watch in early August. Abengoa Yield PLC does enjoy a higher credit rating from Moody’s than the sponsor, indicating limited concern about the impact of a default or bankruptcy of Abengoa SA on the YieldCo’s immediate financial situation. However, there is no doubt that a default of the sponsor would have a considerable impact on the future project pipeline that the YieldCo has access to, and we believe that this risk is captured in Abengoa Yield’s lower valuation and higher yield. With the YieldCo business model, questions around governance are common. In the case of Abengoa Yield, we believe there are adequate governance controls in place to protect the interests of its shareholders. First, a majority of its Board of Directors are independent directors, independent of both management and of the sponsor company. The board must vote on any acquisition of assets from the sponsor and determine that the terms are set “no less favorable than terms generally available to an unaffiliated third-party under the same or similar circumstances.” These terms would be determined based on a market analysis of what similar projects would be priced at in the market. While the risk remains that the board could be swayed by influence of the sponsor, it would be at great legal risk to the independent directors and so we believe that this level of control is adequate. Further, there is an inherent control in the business model as the sustained ability for the YieldCo to raise equity in the market is based upon its ability to generate attractive cash flow returns. A poorly priced deal could hamper the YieldCo’s ability to attract equity financing in the future, harming the very purpose of the fund for the sponsor. Finally, in the case of Abengoa Yield, the sponsor does plan to dilute its interest over time to only 40 percent of the outstanding shares, handing majority shareholder ownership over to the public. In terms of its asset portfolio, Abengoa Yield is a highly diversified YieldCo, with assets ranging beyond just renewable energy on long-term contracts. In addition to solar and wind generation assets, the company also owns a conventional 300 megawatt gas plant, 1,100 miles of electric transmission lines and two water treatment facilities, along with a financial interest in a Brazilian electricity transmission project. The diversified nature of its assets is attractive, with many other YieldCo type models more focused on generation specific projects. All of these assets are backed by long-term contracts, most with investment grade counterparties, allowing Abengoa Yield to apply a significant degree of leverage through project financing. The average remaining contract life for the assets is 23 years. (click to enlarge) Source: Abengoa Yield PLC’s June 2015 Investor Presentation Along with the long-term, stable cash flow contracts, Abengoa Yield has also locked down O&M costs for all of its assets. This has generally been done through long-term inflation linked O&M agreements, primarily with Abengoa SA as the contractor. This provides cost certainty not only on the revenue side but also on the cost side, offloading operating and maintenance risks to the O&M services provider. This is a common practice in the YieldCo space, and Abengoa SA certainly has the skills and global reputation to be a strong operator of these assets. Abengoa Yield is still exposed to capital maintenance expenditures for its assets, however, and increasing capital maintenance costs could pose a risk down the line. In the medium term, however, we review this risk as small as most of the assets are fairly new in vintage and won’t be facing substantial overhauls for decades. In many cases, much of the return on and return of capital for a project is captured in its initial contract term, making maintenance and renewal of future contracts an option that the company can decide, or not, to exploit down the road depending on market conditions. Beyond the diversification in the types of assets of the company, the firm is also significantly geographically diversified. Its solar projects are split between the United States, Spain and South Africa, while its wind generation is located in Uruguay, its gas generation is in Mexico and its transmission assets are in Peru and Chile. Finally, the firm’s water treatment projects are in Algeria. Some of these jurisdictions certainly add risk to the company’s profile, but we also find the diversification to be encouraging in an industry where political and regulatory risk threaten companies with over-concentrated positions. We would expect further diversification of the company’s assets geographically due to the nature of potential push down projects from the parent, which truly operates in every corner of the globe. The firm’s assets are generally supported by long-term contracted cash flow arrangements. This enables the company to pay both a high dividend and maintain a significant amount of leverage. The firm’s cash flows are based 61 percent on availability, rather than production, and 93 percent of the cash flows are in US dollars, or hedged to US dollars through a swap arrangement with the sponsor. Further, less than 4 percent of contracted cash flow is from counterparties that have less than an investment grade rating. The combination of these factors provides a very stable cash flow base from which the company can support its high payout ratio dividend. In terms of future projections, the company has published some attractive but well supported numbers, with a projected 2016 exit dividend of $2.10-2.15 per share annualized. This would be a significant increase from the $1.60 per share paid today. The company then projects ongoing growth at 12-15 percent per year based primarily upon further acquisitions of Abengoa SA projects, potential third-party acquisitions and efficiencies. We think the long-term trend might be on the aggressive side of attainable and we reflect that in our valuation analysis further on this report. Source: Abengoa Yield PLC’s June 2015 Investor Presentation The YieldCo’s primary source of expansion projects is completed projects with contracted cash flows purchased from the sponsor. The firm has a Right of First Offer on all projects that Abengoa SA offers for sale, giving it the opportunity to participate in any potential acquisition from Abengoa’s substantial project list. The sponsor had a backlog of €8.8 billion, according to its first half 2015 presentation, with significant power and infrastructure projects under development that would be ideal assets for inclusion in Abengoa Yield PLC’s portfolio down the road. Previous asset sales occurred at a 15 percent IRR, which is a significant discount to Abengoa Yield PLC’s current return on equity as calculated in our valuation, offering the potential for accretive acquisitions at its current price. Positives Diversified Geographical Exposure: The variety of geographical locations represented in Abengoa Yield’s holdings is an attractive feature for a company of this nature. Having a variety of jurisdictional exposure limits the impact of any one country’s political or regulatory changes, which can have a significant impact on these types of assets. Despite the geographic diversification, the contracted cash flows for the company are primarily in US dollars or are hedged to US dollars and therefore the firm has limited foreign exchange exposure risk. Diversified Portfolio of Asset Types: The variety of assets held by Abengoa Yield is attractive for investors. We believe that the lower risk conventional gas generation and electric transmission assets act to reduce required equity returns for the firm overall and underpin the company’s stable cash flow profile. The renewable assets are well diversified themselves with a split between solar and wind projects of varying sizes. ROFO Agreement with Abengoa SA: The firm’s Right of First Offer arrangement with Abengoa SA is highly attractive on the basis that the sponsor has a significant pipeline of developed and in development projects that could be sold down to the YieldCo at an attractive price. We expect that Abengoa SA will overcome its liquidity crunch in the medium term and this project pipeline will be realized at its full value for the YieldCo. Conservative Leverage at Hold Co Level: The firm currently reports a net debt to cash flow available for distribution of 1.8x versus its target level of 3x. This offers some ability for the company to finance future acquisitions through additional debt, rather than the dilutive equity offerings which are too common in the YieldCo space. Risks Many Assets in Higher Risk Jurisdictions: Many of Abengoa Yield PLC’s assets are located in jurisdictions that pose higher business risks than assets in North America or Western Europe. While a concentration of assets in any one high-risk jurisdiction may pose a concern for us, having small exposures to numerous jurisdictions seems to offer a higher potential return, with minimal incremental risk on a portfolio basis. That said, if future acquisitions continue to build exposure in an existing asset location, or if the risk profile of future asset locations was significantly higher, this would materially impact our required equity return and valuation. Financial Health of the Sponsor: The conflicting views on the financial health of the sponsor, Abengoa SA, are certainly weighing on this stock. We believe that Abengoa SA has taken steps to address its financial situation but the outcome of this is uncertain. Further deterioration in the financial health of the sponsor may have a material impact on the availability of projects for Abengoa Yield to acquire through the ROFO agreement. Valuation One attractive aspect of a company that is primarily driven by its dividend and distributes nearly all available cash to shareholders is the ease in analyzing and comparing its relative value along with assessing its implied cost of equity capital. In the case of Abengoa Yield, our baseline assumptions are the lower end of 2016 dividend guidance of $2.10 per share, a 90 percent payout ratio and an 11 percent annual growth rate. Why do we reduce the expected growth rate below the guidance provided by the company? Our concerns about the sponsor’s financial health are not insignificant and any major liquidity crunches at the sponsor could impact the available project pipeline for future acquisitions by the YieldCo. We do believe that the higher growth rate could be obtainable, as demonstrated by the company’s ability to beat that growth rate in 2016, if the sponsor company can maintain an adequate pipeline of projects at a reasonable cost. Into the details of the valuation, based on the September 18 share price of $19.34, these dividend, payout ratio and growth assumptions produce an implied cost of equity of 23 percent on a free cash flow to equity basis, nearly on par with the equity cost of capital determined in our analysis of NextEra Energy Partners, but still significantly higher than Brookfield Renewable’s (NYSE: BEP ) 16 percent cost of equity. Importantly, this is also a significant discount to the typical sale price of these types of assets, with the recent purchases from the sponsor occurring at a 15 percent IRR. This is reflected in Abengoa Yield PLC’s current price to book of 0.88. Arguably, the lower risk transmission assets held by this YieldCo should reduce its cost of equity compared to a firm like NextEra Energy Partners, who has a more concentrated asset exposure. Over the longer term, we believe that these YieldCos will trend towards a more reasonable 15-18 percent return on equity. This is the basis of our base case scenario for Abengoa Yield PLC of $30.00 per share (at an 18 percent return on equity). This would represent an even 7 percent dividend yield in 2016, which is much more generous than the yield on the firm’s stock earlier in 2015, illustrating significant upside potential beyond our projection. Summary Overall, we believe that Abengoa Yield offers an attractive valuation and potential upside for a set of high quality power and infrastructure assets located in geographically diverse locations. Current drag from the financial situation of its sponsor has weighed on this price but we do believe that this simply offers an attractive entry point for long-term investors. We view Abengoa Yield as having a unique risk and return profile and offsetting highly attractive qualities that together make for a bargain priced addition to a diversified portfolio. Disclosure: I am/we are long ABY, NEP. (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.

Fragile Five EMs Redefined? ETFs To Watch

Taper tantrums were heard all over the emerging markets in 2013, especially in the “Fragile Five” countries. These countries – Brazil, Turkey, India, Indonesia and South Africa – were then hugely reliant on foreign capital to finance their external deficits, which put these at risk post QE exit by the Fed. This was because the end of the cheap-dollar era had led to an uproar in these markets, with their currencies plunging to multi-year lows. The widening current account deficit and worsening external debt conditions were the main headaches of the pack. Moreover, most of these nations had some structural problems of their own, which added to this turbulence. However, more than two years have passed since then, and several changes – mainly political – have taken place in those countries. While a shift in political power and pro-growth reformative changes boosted India in the mean time, the changes in Indonesia are yet to reap returns. Meanwhile, India and Brazil managed to shrug off these risks to a large extent, while Colombia and Mexico have entered this vulnerable bunch. These two have joined other three laggards, namely Indonesia, Turkey and South Africa, to form a new Fragile Five emerging market bloc, per JPMorgan Asset Management. What Pushed India and Brazil Out of the Fragile League? India has been able to reduce its current account deficit to 1.4% of GDP from 5% in 2013, the steepest cutback by any major emerging market, per Bloomberg . While Brazil has not been successful on this front, as the commodity market crash restrained the economy to excel on this current account metric, the country offers foreign investors the highest interest rates. Notably, foreign investors park their money in the riskier emerging market bloc for higher yields. Brazil’s real cost of borrowing is the highest among the world’s leading emerging markets. This might keep the flair for Brazil investing still alive among some yield-hungry investors, despite the fast-deteriorating fundamentals of the economy. Coming to the ETF exposure, all Brazil ETFs were in deep red this year, losing more or less 30% each. Only one fund, the Deutsche X-trackers MSCI Brazil Hedged Equity ETF (NYSEARCA: DBBR ), lost 10% due to its currency-hedged technique. However, India ETFs appear steadier, with exchange-traded products swinging between profits and losses. Highest gains of 7.6% were accumulated this year by the EGShares India Consumer ETF (NYSEARCA: INCO ). DBBR has a Zacks ETF Rank #3 (Hold), while INCO has a Zacks ETF Rank #1 (Strong Buy). What Brought Mexico and Colombia In? The second-largest economy of Latin America, Mexico was fated for a downtrend mainly due to the oil price rout. Oil revenue makes up about a third of the Mexican government’s revenues. This, coupled with the recent strength in the greenback caused an extreme upheaval in Mexican peso recently and led the currency toward its lowest close on record in early August. The Mexican peso fell about 3.7% in the last one month (as of August 13, 2015). On August 12, the country’s central bank lowered its 2015 economic growth outlook to the range of 1.7-2.5% from 2-3% to reflect lower-than-expected export and reduced oil output. Due to the low inflation, Mexico’s interest rate is also low at 3%, way low from an EM perspective. As per J.P. Morgan, the economy’s real interest rate hovers around zero which leaves no way out for the government to ease the monetary policy further and quicken the economy. In short, low yield opportunity fails to lure investors toward Mexico. Mexico ETFs were moderately beaten up in the early part of this year, but crashed in the last one-month phase, with the Deutsche X-trackers MSCI Mexico Hedged Equity ETF (NYSEARCA: DBMX ), the iShares MSCI Mexico Capped ETF (NYSEARCA: EWW ) and the SPDR MSCI Mexico Quality Mix ETF (NYSEARCA: QMEX ) all losing in the range of 3.5-6%. Thanks to the currency-hedged approach, DBMX lost the least. DBMX has a Zacks ETF Rank #2 (Buy), while EWW has a Zacks ETF Rank #3. Colombia was another victim of the oil crash. Oil accounts for more than half of its exports. As a result, Latin America’s fourth-largest economy was hard hit by a drop in foreign direct investment in the oil sector, which continues to widen the current account deficit. The country’s currency tumbled 25% against the greenback in the last one month. The Colombian peso’s 37% fall in the last one year was the third-worst performance among 151 currencies tracked by Bloomberg . The economy’s 2015 growth will mark the most sluggish pace in six years, and its current account deficit will likely be the widest in three decades, per Bloomberg. Two Colombia ETFs, the Global X MSCI Colombia ETF (NYSEARCA: GXG ) and the iShares MSCI Colombia Capped ETF (NYSEARCA: ICOL ), have lost 30% so far this year, while around 12% losses were incurred in the last one month. Both GXG and ICOL have a Zacks ETF Rank #5 (Strong Sell). Original Post

A Market Top? 15 Warning Signs

Summary Signs of a market top are evident in corporate data, respected valuation methods, economic facts, overall U.S. market price movement and investor sentiment. 15 indications that the S&P 500 is near a market top. For those who may find the evidence presented convincing, consider lowering your overall allocation to risk assets. Some investors like to take advantage of multi-asset stock hedging. The FTSE Multi-Asset Stock Hedge (MASH) Index that my colleague and I created incorporates a variety of these asset types, including zero-coupon bonds, long-duration treasuries, German bunds, gold and the Swiss Franc. Stocks are tumbling in Russia, Brazil, Chile, South Africa, Australia and Canada due to economic weakness in China. Meanwhile, the Vanguard Europe ETF (NYSEARCA: VGK ) remains roughly 5.5% off of its May high, as the feel-good effect of $1.3 trillion in European Central Bank stimulus subsides. In truth, risk assets from across the spectrum are fading . Exchange-traded vehicles as diverse as iShares High Yield Corporate Bond (NYSEARCA: HYG ), iShares Russell 2000 (NYSEARCA: IWM ), iPath Commodity (NYSEARCA: DJP ) and Vanguard FTSE Emerging Markets (NYSEARCA: VWO ) are all battling downtrends. Historically, there is a strong correlation between sharp declines in a wide variety of riskier assets and the S&P 500. Here in 2015, however, the S&P 500 has been nearly as defiant as those investors who have placed all of their eggs in the benchmark’s basket. How defiant? The S&P 500 SPDR Trust (NYSEARCA: SPY ) is a mere percentage point off of its all-time record. The popular S&P 500 benchmark has several sub-components (e.g., energy, materials, industrials, etc.) that have already succumbed to downtrends. Still, the large-cap U.S. stock proxy has held firm. On the flip side, however, a cornucopia of warning signs suggest caution. Signs of a market top are evident in corporate data, respected valuation methods, economic facts, overall U.S. market price movement and investor sentiment. Here are 15 indications that the S&P 500 is near a market top: Corporate 1. Dividends are Decreasing . According to S&P, there were 696 reported dividend increases in the second quarter of 2014. In the second quarter of 2015? Only 562. That represents a 19.3% decrease. Equally disconcerting, 57 corporations decreased their dividends in the first quarter whereas 85 companies dropped the bomb in the second quarter. Dividend decreases have now reached their highest point since 2009. 2. Questionable Accounting . Thomson Reuters is reporting that second-quarter earnings growth should come in at 1.2%. That’s relatively flat, but it is not necessarily the end of corporate profitability. Or is it? According to data from S&P Dow Jones Indices, Q2 profits should chime in at $22.85 a share. That’s down a dramatic 15.8% from one year earlier. Accounting shenanigans? That depends upon who you ask. S&P’s data employs generally accepted accounting principles (GAAP) were all expenditures are included. Thomson Reuters? They get their numbers from the analysts who often pull out costs when the corporations themselves exclude those costs. 3. Buybacks may be the Only Support . Stock buyback programs have never been about identifying attractive valuations. They’re about the short-term allocation of inexpensively borrowed capital to reduce share count, improve perceived profitability per share and gloss over revenue declines. Unfortunately, when revenue shortfall meets with higher corporate borrowing costs (a la wider credit spreads), those price-insensitive repurchase programs wind up becoming the only support for the market itself. Bank of America/Merrill Lynch recently broke down net stock acquisitions/dispositions by client type and found that corporations are the only net buyers. 4. Corporate Debt Levels Are Hitting Extremes . Are companies sitting on stockpiles of cash? Borrowed cash, and probably not as much as many folks think since so much of that cash went into buying back stock shares. Corporations are highly indebted. They’ve even increased their debt obligations by 25% since 2009. In fact, non-financial corporations are more leveraged at 37% than they were in 2007 at 34%. What happens when the borrowing costs rise on the 7-year corporate credit bonds that have been issued? Too much leverage is a probable warning sign. 5. IPOs Oh No? The last time that the S&P 500 experienced a meaningful correction of 19%-plus occurred during the eurozone crisis of 2011. Yet they battled back to end the year at the break-even point. Conversely, IPOs in the Bloomberg IPO Index fell 23.3% in the calendar year 2011. So far in 2015, the Bloomberg IPO Index has already hit a correction with declines of more than 10% year-to-date. Depreciation from the November 2014 highs is even greater. Valuation 6. Exorbitant P/Es, Forward Or Backward . Goldman Sachs recently dispelled the myth that low interest rates alone justify higher price-to-earnings ratios. According to their data, the forward 12-month P/E averaged 11.2 when real interest rates were between 0% and 1%. Forward P/E today? 16.7. Stocks would need to drop by 1/3 in value to revert to the mean. 12-month trailing P/Es, you ask? According to S&P, the index is pushing 22.2 with the recent decline in S&P’s estimates of earnings. Reversion to the mean here would also require a 33% decline in current pricing. 7. Unsustainable P/S Ratios . Ed Yardeni pegs the S&P 500 at 1.85. That’s the second-highest in history when the P/S surpassed 2.0 in 2000. With two consecutive quarters of declining sales (a.k.a. “a revenue recession”), it is difficult to see how that ratio does not get more out of whack. 8. Market Cap-to-GDP is Scary . Scores of analysts as well as investing oracles like Warren Buffett revere this valuation methodology. And why not? According to fund manager John Hussman, the indicator boasts an impressive track record of 92% accuracy with respect to subsequent 10-year total returns for the total U.S. stock market. As of this moment, the Wilshire Total Market Index market cap is roughly $21.85 trillion. That’s 125% of GDP. By this metric, the US stock market is only expected to annualize at about 0.3% with returns from dividends over the next decade. (Note: Market cap uses the Wilshire 5000 rather than the S&P 500.) Economic 9. Manufacturer Recession? We often here that the consumer represents two-thirds of the U.S. economy. It seems that many believe this renders the other one-third irrelevant. The U.S. factory sector experienced a six-month drop in its output (adjusted for inflation) as it failed to increase between November (2014) and May (2015). Meanwhile, New York-area manufacturing conditions fell so deeply in August, the -14.9 reading on the Empire State Manufacturing Survey is as poor as April of 2009. The Philly Fed’s survey’s most recent readings are consistent with the findings in the New York area, while ISM data is only representing a slowdown. 10. The Consumer Isn’t Spending Enough . Gallup data found that July was the third consecutive month when Americans spent less than they had in the same month in the year earlier. Similarly, year-over-year declines occurred in five out of the seven initial months of 2015. One would be hard-pressed to say that consumers were opening their wallets, let alone spending their gas savings windfalls. Moreover, to the extent that consumer confidence reflects purchasing habits, Gallup’s Economic Confidence Index is near 10-month lows. 11. Fed Tightening in a Weak Economic Environment? For the last three decades, every time that the Fed has tightened monetary policy, an economic slowdown or recession has come to fruition. Then, to stimulate economic confidence, the central bank of the United States resorted to conventional and unconventional tools for lowering interest rates. Bear markets were often involved. More importantly, there are two occasions in history when annualized GDP was lower than 2.5% and the Fed still decided to tighten overnight lending rates. In both instances, recessionary pressures quickened and stock bears occurred within 6-15 months. Contrarian 12. “Fear Index” Shows Little Fear . The CBOE S&P 500 VIX Volatility (VIX) demonstrates that the investing community simply does not anticipate a mammoth fall from grace. At 13.8, investors are only buying protection associated with a 6.5% drop in the next 30 days. And with the exception of a bit of concern related to Greece back in July, VIX Volatility has remained near its lows throughout the summertime. Market 13. Half of the S&P 500 Components are in Downtrends . In a healthy bull market, 75%-85% of S&P 500 stocks are above long-term trendlines and/or demonstrating upward price movement. In 2013 and in the first half of 2014, 85% of S&P 500 stocks exhibited these characteristics as shown in the S&P 500 Bullish Percentage Index. By the second half of 2014 and the early part of 2015, 75% became the new high water mark. Clearly, 3/4 participation would likely suffice in bolstering the U.S. large cap space. Since May, however, the deterioration in market breadth has meant that 1/2 the market is “bearish” and 1/2 the market is “bullish.” Historically, a breakdown in participation tends to foreshadow more severe price pullbacks for key indices. 14. Credit Spreads are Widening . Narrowing credit spreads demonstrate greater confidence in the creditworthiness of borrowers. In contrast, widening credit spreads indicate trepidation concerning the ability of corporate borrowers to service their debts. Near market tops, credit spreads are still relatively low, but they begin to rise. And this is precisely the case with respect to the 1.75% spread with BBB junk in May as opposed to the the 2.16% that we see today. Investors in lower quality junk are demanding 2.16% more over quality corporate bonds — a spread that is higher than we have seen in more than two years. 15. Flat Market Or Flat Market Plus All of the Other Stuff . According to perma-bulls, the flatness in the S&P 500 cannot tell you anything. After all, when markets were flat this far into a calendar year, they finished the year flat on one occasion, down on three occasions and higher on eight others. Batting .666 then? Perhaps not. For one thing, calendar years are not particularly instructive when it comes to bulls, bears, market tops or market bottoms. We could just as easily be talking about a July to June period or a drawn out two-and-a-half year bear (3/2000 to 9/2002). Second, and more critically, perma-bulls are explaining away market flatness as though it exists in a vacuum. It does not. It is occurring alongside plummeting commodities, plunging foreign market stocks, deteriorating small-caps, high yield bond distress, a weak economy, a less accommodating Fed, abysmal market breadth, revenue declines, earnings deceleration, extreme U.S. stock valuations and widening credit spreads. It follows that market flatness prior to 1930’s 28.5% collapse or 1941’s 17.5% correction should not be dismissed because of the Great Depression or the Pearl Harbor attack. Granted, the flatness of the market by itself may not tell us anything about what the market is likely to do. Nevertheless, when U.S. large caps are single-handedly holding on for dear life, and virtually every other indication is flashing yellow or red, market flatness is more likely indicative of the calm before the storm. For those who may find the evidence presented convincing, consider lowering your overall allocation to risk assets. As I have indicated on previous occasions, if your asset allocation target is typically 65% stock (e.g., domestic, foreign, large, small, etc.) and 35% bond (e.g, short, long, investment grade, higher yielding, etc.), you might choose to downshift. Perhaps it would be 50% stock (mostly large-cap domestic), 25% income (mostly investment grade) and 25% cash/cash equivalents. Raising the cash level and modifying the type of stock and bond risk will help in a market sell-off as well as offer opportunity to purchase risk assets at better prices in the future. In a similar vein, some investors like to take advantage of multi-asset stock hedging . Rather than using leverage, options or shorting, you consider a basket of non-stock assets that tend to do well when stocks are falling apart. The FTSE Multi-Asset Stock Hedge (MASH) Index that my colleague and I created incorporates a variety of these asset types, including zero-coupon bonds, long-duration treasuries, German bunds, gold and the Swiss Franc. For Gary’s latest podcast, click here . Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.