Tag Archives: united-states

Why Stocks Are Getting Riskier By The Day

Borrowing costs are set to move higher. Higher borrowing costs could force American companies to curtail the debt that they’ve raised to buy back shares of their own stock. Not only would stock prices struggle to move higher if corporations are not buyers of as many shares as they have been in the past, but a lessening in stock buybacks would reduce the perception of corporate profitability. These headwinds to stock valuations as well as future returns – near-term and longer-term – are not easily dismissed. The central bank of the United States (a.k.a. the Federal Reserve) may hike its overnight lending rate in December. Committee members are also discussing plans to phase out the reinvestment of principal on balance sheet securities. Translation? Borrowing costs are set to move higher. The Fed is tightening for the first time in nearly a decade. In so doing, it is implicitly signaling faith in the U.S. economy’s ability to accelerate. The question investors might want to ask is whether or not that conviction is misplaced. For one thing, if the U.S. economy continues to expand at the same sub-par recovery rate of 2.2% per year, stock valuations will move from overvalued to insanely valued. Consider the ratio of total U.S. stock market capitalization to the broadest quantitative measure of U.S. economic activity, gross domestic product (GDP). With total market cap at nearly $21.6 trillion and GDP at at roughly $17.9 trillion, the ratio sits at 120.8%. The historical average since 1970? About 72.5%. Investors should recollect that Warren Buffett described Market-Cap-To-GDP as the “best single measure of where valuations stand at any given moment.” It follows that stocks are more expensive than they were before the financial collapse in 2008, though they are less expensive than they were prior to the tech wreck in 2000. If the ratio reverts to the historical mean of 72.5%? Then hold-n-hope advocates should prepare themselves for stock prices lose HALF of their current value. There are other concerns for investors should the economy prove less resilient than the Federal Reserve would like us to believe. Higher borrowing costs could force American companies to curtail the debt that they’ve raised to buy back shares of their own stock. Why is this so problematic? Not only would stock prices struggle to move higher if corporations are not buyers of as many shares as they have been in the past, but a lessening in stock buybacks would reduce the perception of corporate profitability. Remember, when a public corporation earning $0.70 per share (EPS) has one million shares outstanding, lowering the share count by 10% to 900,000 artificially pushes profitability per share up to $0.778. Were any additional products or services sold? Nope. The accounting wizardly plays itself out in more “reasonable” price-to-earnings (P/E) ratios that investors often use to determine valuation levels. Keep in mind, the buyback game has been happening for more than six-and-a-half years. Since 2009, debt-fueled share buybacks pushed earnings per share up 190%. Revenue from sales of products and services? Sales have increased an exceptionally modest 23%. With buybacks primarily funded by debt, higher borrowing costs sank the debt-funded buyback connection that was part and parcel of the previous market collapse (10/2007-3/2009). Is it unreasonable to suspect that this connection will follow a similar pattern? (click to enlarge) So if the Fed is wrong about the growth of GDP, and if it is wrong about the effect that higher borrowing costs will have on corporate credit expansion, stock valuations will surge. That’s true for Market-Cap-To-GDP. And that’s true for price-to-earnings (P/E). Yet there may also be an issue with the perception of a directional shift from a stimulative environment to a less stimulative one. Take a look at the relationship between the S&P 500 and the Fed’s balance sheet throughout the current bull market run. Each time that the Fed created electronic dollar credits to buy assets, expanded its balance sheet, and subsequently lowered borrowing costs, stocks rallied dramatically. In each of the three instances since the 2009 stock lows where the balance sheet remained the same? Stocks struggled to make meaningful strides. (click to enlarge) The possibility of the Fed reducing its balancing sheet. The danger of share buybacks rolling over. The unlikelihood of the U.S. economy breaking out in dramatic fashion. These headwinds to stock valuations as well as future returns – near-term and longer-term – are not easily dismissed. And that’s not even addressing the possibility that the domestic economy and/or the global economy weaken further. Is the consumer truly in great shape? Retail stocks in the SPDR S&P Retail ETF (NYSEARCA: XRT ) suggest otherwise. The exchange-traded fund hit new 52-week lows below the levels that we witnessed in the August-September sell-off. What’s more, we already know the recessionary struggles associated with manufacturers. Industrial production, which measures the amount of output from the manufacturing, mining, electric and gas industries, has fallen in nine of of the previous 10 months. There are few, if any, ways to put a positive spin on the declines in industrial production. (click to enlarge) And then we have the Fed telling us that “global market risks have diminished.” Really? How much further does copper – the metal with a Ph.D. in economics – need to fall before global market risks reignite? The iPath DJ-UBS Copper Total Return Sub-Index ETN (NYSEARCA: JJC ) has not only broken below August and September lows, it might as well have fallen off a cliff. Similarly, how much further does oil need to drop before oil producing exporters begin falling apart. The iShares MSCI Canada ETF (NYSEARCA: EWC ) is still toiling near its 52-week depths. No Virginia, global market risks have not diminished. For that matter, global economic deceleration is still the prevailing prognostication by the International Monetary Fund (NYSE: IMF ). China’s economic output is decelerating. Japan is already in recession. And European quantitative easing is not stimulating borrowing activity the way that it did in the U.S. In the end, all we have is the collective hope of voting members in the Federal Open Market Committee (FOMC). Hope that economic improvement will overcome lofty valuations and a pullback in corporate borrowing. Don’t get me wrong. Based on everything from “tax-loss harvesting” to “window dressing” to momentum investing, the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) may still represent the best diversified stock holding around. How long one should stick with those brass tacks, however, is another matter entirely. 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.

How To Pick An Emerging Market Fund

By Tim Maverick If there’s one truism I’ve found during my years in the investing field – which date back to the 1980s – it’s the fact that everything is cyclical. What runs hot will inevitably turn cold in a few years, and vice versa. This reality is beautifully illustrated in this following periodic table of asset class returns. The table appeared in The Wall Street Journal courtesy of Budros, Ruhlin & Roe in Columbus, Ohio. The firm’s advisors use it to explain to clients why diversification is necessary. It also reinforces my contrarian bent. For instance, I’m not at all interested in the red-hot biotech and tech industries right now. Instead, I’m looking at a sector everyone is avoiding like the plague… emerging markets . I’ve been investing in emerging markets since the 1980s. Today, I’d like to share some tips on how to pick the best emerging market funds – and, just as importantly, how to avoid the losers. Tip #1: DON’T Use an Index Fund Index funds seriously narrow your investing universe. That’s true here in the United States, as well, but it’s really bad in emerging markets. Data from the Institute of International Finance brings home my point. Only about $7.5 trillion of the $24.7 trillion universe of emerging market stocks is contained in the various indices run by J.P. Morgan (NYSE: JPM ), MSCI (NYSE: MSCI ), and others. The rest is simply ignored. I don’t know about you, but I don’t want to pretend that roughly 70% of emerging market stocks don’t exist. As I’ve said before, you don’t shop in just one aisle at the grocery store. Don’t do it in the stock market, either. Tip #2: Don’t Invest in Closet Indexers So now we’ve eliminated index funds. Next up is looking at the top 10 positions in any fund you’re considering. If you see the names of companies like Samsung Electronics Co. Ltd. ( OTC:SSNLF ) , Taiwan Semiconductor Manufacturing Co. Ltd. (NYSE: TSM ) , and China Mobile Ltd. (NYSE: CHL ) , move on. The fund manager is a closet indexer. They’re only interested in matching the index by which they’re judged, rather than actually making money for the fund’s shareholders. Tip #3: Avoid Funds That Over-Invest in Two Sectors Finally, it’s important to look at the sector breakdown of a fund. In far too many cases, these funds are over-invested in just two sectors. If you see 50% or more invested into financials and technology, skip over this fund. This fund manager doesn’t understand emerging markets and may be confused into thinking that they’re investing in the U.S. market. Indeed, these two sectors are loved by U.S. fund managers, and that fascination is one reason I believe most emerging market funds have performed so badly. What to Look For Now that we know what to avoid, let’s figure out what we should be looking for in an emerging market fund. I’m a great believer that people are people, no matter where they live. And all people aspire to better their lives and those of their children. For me, that means investing in funds that emphasize the growing consumer class in developing economies. Look at China, for instance. It’s moving away from an industrial economy toward a consumer economy. Just as we no longer consider U.S. Steel Corp. (NYSE: X ) a bellwether for the U.S. economy, we probably shouldn’t count on industrials to perform that role in China much longer, either. And that means you don’t want to own the usual Chinese names. Instead, you want to own something like the South Korean cosmetics company AmorePacific Corp. ( OTC:AMPCF ) . Its sales and revenues are soaring thanks to Chinese demand, which is boosting its stock. Another option is a frontier market stock like Safaricom Ltd. ( OTC:SCOM ) , Kenya’s dominant telecom firm. Kenyans have the same mobile phone addiction as everyone else, and the safety valve is that it’s 40% owned by telecom giant Vodafone Group Plc (NASDAQ: VOD ) . In closing, stick with funds that emphasize the growth of consumerism in places like China. Companies like Apple Inc. (NASDAQ: AAPL ) are benefiting, and so will the myriad number of home-grown consumer companies in the emerging world. Link to the original post on Wall Street Daily

Vanguard Extend Duration Treasury ETF: Long Duration Could Be Great In December

Summary The Vanguard Extend Duration Treasury ETF gives investors exposure to the very long end of the yield curve. The yield is material but the price swings on long duration treasuries easily dominate the yield in determining annual returns. I won’t be surprised if the Fed hikes short term rates in December, but I don’t think they can continue to push up short term rates after that. If investors buy into the Federal Reserve’s picture, there could be some great sales on long duration treasuries. The Vanguard Extend Duration Treasury ETF (NYSEARCA: EDV ) is a solid option for exposure to treasuries. The ETF has an expense ratio of only .12%. As I’ve been searching for appealing bond funds, I’ve found some of my favorites are from Vanguard. Given my distaste for high expense ratios, it should be no surprise that the Vanguard products would be appealing. After looking through the portfolio, I think the holdings are fairly reasonable for an investor wanting to regularly keep part of their portfolio in a bond fund. Quick Introduction The Vanguard Extend Duration Treasury ETF is showing a yield to maturity of 3.0% and an average effective duration of 24.6 years. This isn’t an investment that investors should take lightly when it comes to interest rate risk. In my opinion the big reason to use such long duration securities is to reduce total portfolio volatility due to the negative correlation with the market or to make a play on long term yields falling and creating substantial capital gains. Maturities I grabbed another chart to show the effective maturity on the securities: That shouldn’t be surprising given that the effective duration of the fund was running almost 25 years. December The reason I’m looking to keep an eye on the very long duration securities in December is because of the Federal Reserve’s constant pressure to try to increase rates. If they actually get the short term rates higher there may be a shift up across the entire yield curve. The greatest price volatility would come from the long duration bonds. To avoid sensitivity to credit risk, I may opt to use treasuries rather than corporate securities. The Rate Issue The Federal Reserve has been talking for years about raising rates and they finally got some ammunition in November when the “jobs report” came out and indicated that unemployment levels were lower than expected and lower than the previous measurement. The Federal Reserve has an opening and they could use this opportunity to push interest rates higher. I think there is a fairly significant chance of that happening. The latest probability numbers from the CME Group, which uses the “Fed Funds Futures” to track implied probability, is shown below: (click to enlarge) We’re expecting around a 70% chance of short term rates getting a slight boost. I don’t believe that the Federal Reserve can continue to raise rates in the manner that they would like to, but I do think that an increase in short term rates finally happening could create a serious hit in the value of long term treasuries as investors start to buy into the idea that the United States will be creating higher interest rates on treasuries while most of the developed world is showing significantly lower rates. I wouldn’t be surprised if the Federal Reserve raises rates in December and sends bond prices falling. If that happens, I would consider it more likely that they would be forced to go back down on rates in 2016 rather than being able to raise them again later in the year. If short term rates went back down, I think it would be an admission of the difficulties of raising rates in this environment and the 30 year yields would fall. A falling 30 year yield would push prices on EDV materially higher. Conclusion This is a great treasury ETF with a low expense ratio and it should be on the “watch list” for investors going into December. If the Federal Reserve manages to raise rates and the 30 year yields rise (prices fall) materially, then I think it will become a fairly attractive option. I’ll be looking at long duration treasuries in December as a possible way to reduce my portfolio volatility and capture some significant gains if rates fall back down. Over the last year, EDV has had a negative correlation with the S&P 500. This wasn’t a slightly negative correlation either, this was -.41. This serves as potentially a useful hedge against my equity positions while giving me the potential to benefit from falling yields and rising prices if the Federal Reserve is unable to follow through on their plans to raise rates. My view on price movements is a significant chance of prices going lower into December followed by attractive buying opportunities to create capital gains in 2016.