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Why Good News And Bad News Are Not Helping Stocks Anymore

Since the Great Recession’s inception, whenever the stock market dropped like a steel anvil or the U.S. economy showed signs of weakness, the Federal Reserve acted to inspire investor confidence. For example, in November of 2008, when the Fed announced its first quantitative easing (QE1) program to buy mortgage-backed securities (MBS), stocks rocketed 10% in two weeks. The enthusiasm wore off quickly. In March of 2009, the central bank of the United States “doubled down” on the MBS dollar amount and simultaneously expanded its reach with a decision to acquire $300 billion of longer-term Treasury bonds. The 1-year program correlated with stock market gains of 70%. Could the Fed have stopped there? At the end of the first quarter in 2010? The Fed could have. However, when the S&P 500 lost 16% over the next few months, committee members began hinting at a second tidal wave of bond buying (QE2). From summertime rumor through QE2 completion in the second quarter of 2011, the S&P 500 pole vaulted approximately 29%. Might the monetary policy authorities have decided, at that juncture, to let financial markets operate without additional interference? At the conclusion of the second quarter of 2011? They might have. Perhaps unfortunately, the S&P 500 responded unfavorably to the end of another Federal Reserve program and the absence of a European bank bailout. A 19% price collapse over a brief span of time compelled the Fed to invoke “Operation Twist” – a program to push borrowing costs even lower through using the proceeds of short-dated Treasury bond maturities to acquire intermediate- and long-dated maturities. The Federal Reserve also orchestrated dollar liquidity swap arrangements that aided European financial institutions with raising capital. Not surprisingly, the Fed-inspired activities helped push U.S. stocks 27% off of the 2011 bottom. “Operation Twist” was scheduled to end in the second quarter of 2012. What could possibly go wrong? This time, investors did not even wait for another Fed program to end, sending stocks down nearly 10% over 8 weeks in April-May. The Fed did not wait either. They extended “Operation Twist” through year-end 2012. And there was more. In an effort to break the cycle of start-stop stimulus dates, and to stimulate a U.S. economy that showed definitive signs of deceleration, the Fed served up hints of its largest quantitative easing experiment yet. The third round of asset purchases (QE3) was not only larger than its predecessors at $85 billion per month, it was open-ended in nature; that is, it came without a formal termination date. Over the next three years, the S&P 500 catapulted roughly 57% with little resistance. Since the last asset purchase by the Fed in mid-December of 2014, however, investors have not been able to rely on the Fed to “ride to the rescue.” On the contrary. Investors have lived with the persistent headwind of overnight lending rate tightening. Granted, the Fed did everything it could to prepare financial markets for an exceptionally slow path to rate normalization. Monetary policy leaders even pushed its first move – a 0.25% increase in the Fed Funds rate – out from the first quarter of 2015 to the 4th quarter of 2015. Nevertheless, once market participants began to fear that the Fed would cease serving as a backstop for falling equity prices, return OF capital supplanted return ON capital. Unless the Fed reverses course back toward zero percent rate policy, and perhaps another round of QE, overexposed investors are likely to sell the bounces. Consider the overexposed participants who leveraged their portfolios on margin. Those who bought stock on margin have leveraged themselves 2:1, having borrowed money to acquire twice as many shares of stock than they would have been able to do otherwise. And while that increased demand for stock shares pushed prices higher on the way up, the need to deleverage accelerates price declines on the way down. How out of whack did margin debt become over the last few years? Margin debt peaks went hand in hand with the stock market tops in 2000 and 2007. Similarly, the margin debt pinnacle in April of 2015 is not far from the nominal high for the S&P 500 in May of 2015. Keep in mind, prominent members of the Federal Reserve like Richard Fisher, have acknowledged front-loading an enormous stock rally to create a wealth effect. What Mr. Fisher did not acknowledge, however, are the back-end issues associated with wealth effect intentions. For instance, stocks that move to exorbitant valuation levels offer less hope for future returns. In the same vein, one should be able to anticipate a wealth effect reversal when a front-loading Federal Reserve subsequently removes its support for ever-increasing equity prices. Don’t be fooled by CNBC’s focus on China or the ticker tape on crude oil. China’s slowing economy may be relevant to U.S. corporate revenue and profitability, but it’s the Fed’s perceived unwillingness to “save stocks” from the volatile sell-off that exacerbates the panic. Oil depreciation may be signaling global recessionary pressures and domestic manufacturer retrenchment. Again, however, it is the direction of the Fed’s rate normalization path, albeit gradual, that has poked the grisly bear in its eyes. Perhaps ironically, the Fed ignored its own projections on economic deceleration in the final quarter of 2015. It raised its benchmark overnight interest rate by 25 basis points to between 0.25 percent and 0.50 percent, even as the Atlanta Fed’s “GDP Now” currently projects 0.6% 4th quarter economic growth. That’s well below the 2.0% annualized growth in the six-and-a-half year economic recovery, where 2.0% had been deemed too anemic for the Fed to fully remove itself from the QE/zero percent rate game. In sum, the U.S. stock market is likely to see little more than bounces and rallies in a bearish downtrend, until and unless the Fed reverses course. In the past, “bad news was good news” because poor economic data solidified ongoing central bank involvement. “Good news was good news” because, well, that meant things were getting better. Today, on the other hand, “good news is bad news” because it might encourage the Fed to tighten rates more quickly. And bad news? That’s the worst of both worlds for risk assets because the Fed is not currently expressing a willingness to head back toward quantitative easing or zero percent rate policy. There have been some safer havens over the last six months, ever since the August-September meltdown for stocks. The PowerShares DB USD Bull ETF (NYSEARCA: UUP ), the iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ), the iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ), the SPDR Gold Trust ETF (NYSEARCA: GLD ), the CurrencyShares Japanese Yen Trust ETF (NYSEARCA: FXY ) and the iShares National AMT-Free Muni Bond ETF (NYSEARCA: MUB ) have all gained ground over the last six months. In fact, most of the asset classes in the FTSE Multi-Asset Stock Hedge Index (MASH) – zero-coupon bonds, munis, longer-term treasuries, the yen, the greenback, gold – have appreciated in value. The SPDR S&P 500 (NYSEARCA: SPY ) has not been quite as fortunate. Click to enlarge 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.

Oil Hits 12-Year Low: Short Energy Stocks With ETFs

No doubt, last year’s chaos in the energy sector has spilled over into this year with many stocks piling up heavy losses in the first couple of weeks of 2016. In fact, the worries have deepened this year with renewed concerns over the slowdown in the world’s second-largest economy and the Iran sanctions’ lift off. This is especially true, as the relaxation in sanctions would add a fresh stock of oil in the global market, which is already facing a supply glut. Iran, a member of the Organization of the Petroleum Exporting Countries (OPEC), is expected to increase its crude oil exports by half a million barrels a day immediately and a million barrels a day within a year of lifting the ban. Though the Iran sanctions were widely expected and the development of oil in the country will take some time to fully ramp up after 40 years, the move unnerved investors, spreading panic among them. That being said, oil price tumbled to a level not seen in more than 12 years with U.S. crude plunging below $29 per barrel and Brent slumping to below $28 per barrel. From a year-to-date look, oil price has lost more than 20% this year, representing the worst two-week decline since the 2008 financial crisis (read: 4 Country ETFs to Gain from Oil Price Crash ). Trend Remains Weak Currently, the outlook for oil and energy sector seems gloomy. This is because oil production has risen worldwide with the OPEC continuing to pump near-record levels, and higher output from the likes of U.S., Iran and Libya. Additionally, a strengthening U.S. dollar backed by a rate hike is making dollar-denominated assets more expensive for foreign investors and thus dampening the appeal for oil. In particular, it will make the borrowings for high-yield firms costlier and result in less money flows into capital-intensive shale oil and gas drilling projects. This in turn will lead to higher bankruptcies, which would hit the already battered energy sector. On the other hand, demand for oil across the globe looks tepid given slower growth in most developed and developing economies. In particular, persistent weakness in the world’s biggest consumer of energy – China – will continue to weigh on the demand outlook. The negative demand/supply imbalance would push oil prices and the stocks further down at least in the short term. Moreover, the ultra-popular United States Oil Fund (NYSEARCA: USO ) , tracking the price of US light crude with an asset base of around $2.2 billion and average daily volume of around 32.3 million shares, has hit new all-time lows several times this year. Given the continued sell-off and the bearish outlook, the appeal for energy ETFs is dulling (read: Oil and Energy ETFs That Hit All-Time Lows ). As a result, investors who are bearish on oil right now may want to consider a near-term short on the energy sector. Fortunately, with ETFs, this is quite easy as there are many options to accomplish this task. Below we highlight them and state how each stands out among the rest: ProShares Short Oil & Gas ETF (NYSEARCA: DDG ) This fund provides unleveraged inverse (or opposite) exposure to the daily performance of the Dow Jones U.S. Oil & Gas Index. The ETF makes a profit when the energy stocks decline and is suitable for hedging purposes against the fall of these stocks. The product has amassed $14.1 million in AUM while volume is light at under 10,000 shares. Expense ratio comes in at 0.95%. It has added nearly 10% so far this year. ProShares UltraShort Oil & Gas ETF (NYSEARCA: DUG ) This fund seeks two times (2x) leveraged inverse exposure to the Dow Jones U.S. Oil & Gas Index, charging 95 bps in fees. It has amassed $46.1 million in its asset base and trades in good volume of more than 183,000 shares per day on average. DUG returned 19.8% in the first couple of weeks of 2016. Direxion Daily Energy Bear 3x Shares ETF (NYSEARCA: ERY ) This product provides three times (3x) inverse exposure to the Energy Select Sector Index. Though it charges the same annual fee of 95 bps, it is extremely popular and trades in heavy volume nearly 1.7 million shares. The fund has a decent AUM of $74 million and has gained 32% so far this year. Direxion Daily S&P Oil & Gas Exp. & Prod. Bear 3x Shares ETF (NYSEARCA: DRIP ) This ETF provides three times bearish exposure to the oil & gas exploration and production corner of the broad energy space tracking the S&P Oil & Gas Exploration & Production Select Industry Index. It has accumulated $6.1 million in its asset base while trades in a lower volume of 32,000 shares per day on average. The fund charges 95 bps in annual fees and has gained 62.9% since the start of the year. ProShares UltraShort Oil & Gas Exploration & Production ETF (NYSEARCA: SOP ) This fund seeks two times inverse exposure to the S&P Oil & Gas Exploration & Production Select Industry Index, charging 95 bps in fees. It failed to garner enough investor interest with AUM of just $4.6 million and sees a paltry volume of about 3,000 shares a day. SOP is up 40.6% in the year-to-date timeframe. Bottom Line As a caveat, investors should note that such products are suitable only for short-term traders as these are rebalanced on a daily basis. Still, for ETF investors who are bearish on the energy sector for the near term, either of the above products could make an interesting choice. Clearly, a near-term short could be intriguing for those with high-risk tolerance, and a belief that the “trend is the friend” in this corner of the investing world. Link to the original post on Zacks.com

What Determines A Stock’s Value?

The biggest question in investing is whether the stock market-or a sector, industry, or specific stock-is going to go up or down in the months ahead. “I don’t blame anyone for asking that question,” says Brad Sorensen, Director of Market and Sector Analysis at the Schwab Center for Financial Research. “It’s the one we all want answered.” Of course, no one knows for sure which direction the stock market will go-especially in the short term. That’s because a wide number of variables, many of which can’t be predicted, can make the markets move in one direction or the other and render useless even the best research and analysis. These variables can include regulatory changes, extreme weather or natural disasters, changes in management-the list goes on. That doesn’t mean investors can’t make intelligent, informed guesses . While no one can predict the market’s exact ups and downs, investors have the potential to boost their investment returns over the long term if they can identify sectors or stocks that are undervalued or overvalued. Valuing the Market At any given point in time, the stock market’s value is the sum of all of the shares outstanding multiplied by their prices. If we all agreed that this value was fair, then stock prices would be static, stuck in place until an outside variable-say, the release of new economic data-changed investors’ minds. But the reality is that we don’t all agree, and that’s why there are so many ways to value the market. One is to compute the value of the entire stock market (total market capitalization) relative to U.S. gross national product. Another way is the Q ratio. It starts with total market capitalization and divides that number by the replacement cost, or the amount of money a company would have to spend to replace an asset, added up across all companies and industries. A third method, used by Morningstar, calculates fair value assumptions using a proprietary discounted cash flow model. The model assumes that each stock’s value is equal to the total of the free cash flows the company is expected to generate in the future, discounted back to the present. Tallied up, these individual valuations help determine whether the market as a whole is over- or undervalued. Evaluating Individual Stocks Many investors look at common, well-known metrics to determine how a stock is likely to perform. One of investors’ most widely used tools in this respect is the price-to-earnings (P/E) ratio-the measure of a stock price compared to its per-share earnings. “The P/E ratio is a familiar metric for many investors, as there tends to be a lot of information out there about earnings,” Brad says. “But it’s far from being a perfect measure, and it’s only one piece of the puzzle.” For example, many P/E ratios are retroactive measures-meaning they reflect a current price against a trailing 12-month profit. That’s useful, but investors generally aren’t buying a company’s past. Instead, they are investing in the future, trying to capture growth. Price-to-book (P/B) ratio is another popular tool for measuring the price of a stock or index against its per-share book value (total assets minus intangible assets and liabilities). A low P/B ratio-typically less than 1-could indicate that a stock is undervalued. This metric is popular among value investors, who search for securities that trade below their intrinsic net worth. But, like P/E ratios, P/B ratios have their limitations. For instance, a P/B ratio tends to be more useful for companies with a lot of hard assets on their books, such as factories or equipment. The ratio says less about companies with significant non-physical assets, such as intellectual property and brands. Brad says that it’s not wrong for investors to consider P/E or P/B ratios as part of their research, but that they shouldn’t rely on this data alone. There are plenty of metrics-such as cash flow and debt ratios-that an investor can use to measure value. Brad also recommends that investors pay close attention to sales growth-especially in today’s market. “Many companies stayed afloat during the recent market downturn by cutting costs everywhere they could,” Brad says. “Going forward, companies will have to rely on sales growth in order to maintain viability and profitability.” Analyzing Sectors For sector analysis-the area that Brad focuses on-determining trends means incorporating macro-economic data points and other factors that might impact a particular industry. When analyzing the technology sector, for example, Brad and his team track the age of current equipment and whether companies have the cash to invest in new technology. They also examine whether the environment is favorable for financing purchases. Some sectors-such as financials, which include banks, investment firms, mortgage companies, and insurers-are more complicated than others to analyze. “These businesses are vulnerable to regulatory and interest rate changes, and even natural disasters,” Brad says. “There are hundreds of data points to consider.” Historical Insights While it’s important to look ahead in an attempt to gain insight into where a company or sector is heading, Brad suggests investors pay attention to historical valuation levels. “It’s critical to look at investments relative to how they have traded and performed at different points during economic cycles,” he says. “An investment’s past performance doesn’t guarantee its future returns, but historical data can provide clues as to what might happen.” As a result, Brad and his team constantly update valuation models and forecasts based on incoming economic data, and-at least monthly-look back in time to see if a stock or sector is trading in a pattern that could help inform future movement. “It’s a juggling act-looking back and evaluating possible future scenarios simultaneously, and taking in as much information as possible to help make informed decisions down the road,” he says. Making Sense of the Data With so many different data points to consider, some investors might find it difficult to track down and synthesize information about a specific investment or a particular area of the market. Brad Sorensen and his colleagues at the Schwab Center for Financial Research spend much of their time evaluating and rating stocks and sectors in order to provide Schwab clients with objective, comprehensive research to help them make informed decisions. One result of their efforts is the collection of approximately 3,000 Schwab Equity Ratings® . Available to Schwab clients, these A-F grades can help condense and simplify large amounts of data based on a 12-month outlook. Conclusion Though no one can consistently and accurately predict what the market does next, knowing how stocks are valued can help you find opportunities. By identifying sectors or stocks that are undervalued or overvalued, you may be able to boost investment returns over the long term. Important Disclosures The information here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. Investing involves risk, including loss of principal. Sector investing may involve a greater degree of risk than an investment with broader diversification. Schwab Equity Ratings use a scale of A, B, C, D and F, and are assigned to approximately 3,200 U.S.-traded stocks headquartered in the United States and certain foreign nations where companies typically locate or incorporate for operational or tax reasons. Schwab’s research outlook is that A-rated stocks, on average, will strongly outperform, and F-rated stocks, on average, will strongly underperform the equities market during the next 12 months. Schwab Equity Ratings are not personal recommendations for any particular investor. Before buying, investors should consider whether the investment is suitable for themselves and their portfolio. Schwab Equity Ratings should only constitute one component in your own research to evaluate stocks and investment opportunities. From time to time, Schwab may update the Schwab Equity Ratings methodology. Schwab Equity Ratings and the general buy/hold/sell guidance are not personal recommendations for any particular investor or client and do not take into account the financial, investment or other objectives or needs of, and may not be suitable for, any particular investor or client. Investors and clients should consider Schwab Equity Ratings as only a single factor in making their investment decision while taking into account the current market environment. Schwab Industry Ratings provide Schwab’s outlook for industries based on Global Industry Classification Standard (GICS®) groupings, such as Beverages, Pharmaceuticals and Software. Schwab Industry Ratings are assigned using an A, B, C, D and F rating scale and can be particularly helpful in evaluating which industries investors may want to emphasize within a specific sector. They can also be used in conjunction with Schwab Equity Ratings to help fill in gaps in a portfolio. See Schwab.com for more information. The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc. Morningstar, Inc., is not affiliated with Charles Schwab & Co., Inc. ©2015 Charles Schwab & Co., Inc. ( Member SIPC ) All rights reserved. (0214-0042)