Playing the Field For Yield (Tucker)

Friday, May 31st, 2013

by Matt Tucker, iShares

Lately it feels like all I talk about here on the blog is the potential for rising interest rates – when it might happen, signs that a rate rise may be imminent, how to position bond portfolios in advance.  While this is definitely a worthy subject – and one that spurs a great number of questions from our clients – I think it’s important to take a step back every so often to remember that interest rates today are still hovering at rock bottom.  Rising rates may be a future challenge that investors need to prepare for, but the fact of the matter is, low interest rates are a challenge many investors are facing today.

It was with this challenge in mind that we launched the iShares Multi-Asset Income ETF (IYLD) a little over a year ago.  IYLD is an ETF comprised of other ETFs, tracking an index that seeks to deliver high current income while seeking long-term capital appreciation.  The objective:  to deliver yield and balance risk through diversified asset allocation.  Now that IYLD has been around for a year, and recently passed the milestone of $100 million in assets under management, it’s a good time to revisit this ETF to see how it’s doing.

First, a quick review of how the fund works.  The asset allocation of IYLD is set at 60% fixed income, 20% equity and 20% “alternative” income sources, such as preferred stocks and REITs.  While those numbers remain static, the weights of the underlying ETFs that make up each asset class are rebalanced on a quarterly basis and are chosen based on historical correlations, returns, yields and volatilities.  Only iShares ETFs that meet size, liquidity and income objectives are considered as potential holdings.  Here’s a snapshot of the fund’s current holdings (as of 4/30/13)*:

A few discerning clients have asked us why a fund that targets “income” would have an allocation to the iShares 20+ Year Treasury Bond ETF (TLT), which is currently yielding a rather unimpressive 2.7%. The answer is that US Treasuries provide a diversifying exposure to the portfolio and, while they do add some yield, they’re actually included here primarily to reduce price risk and bring relative stability to the fund’s performance through varying market environments.

So how is IYLD doing today?  With a current SEC yield of 5.43% and a one-year total return of 13.73% through the end of April, it appears IYLD has delivered on its objectives.  As a comparison, the S&P 500 Index has returned 16.89% and the Barclays Aggregate Bond Index has returned 3.68% over the same timeframe – both with current yields around 2%.  The upshot: Investors who are struggling to find yield but also want to balance risk might find IYLD to be an intriguing solution.

As for the inevitable question about rising rates, IYLD may be an interesting solution for that environment as well.  While we would generally not expect a rising rate environment to be a tailwind for the fund (remember that it’s 60% fixed income), the benefits of diversification across asset classes could help it outperform a pure fixed income portfolio.

Source: Bloomberg, BlackRock

Matt Tucker, CFA, is the iShares Head of Fixed Income Strategy and a regular contributor to the iShares Blog.  You can find more of his posts here.

The performance quoted represents past performance and does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than the original cost. Current performance may be lower or higher than the performance quoted. Performance data current to the most recent month end may be obtained by calling toll-free 1-800-iShares (1-800-474-2737) or by visiting www.iShares.com.

Index returns are for illustrative purposes only and do not represent actual iShares Fund performance. Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

Asset allocation models and diversification do not promise any level of performance or guarantee against loss of principal. Investment in the Fund is subject to the risks of the underlying funds. There is no guarantee that the Fund will generate high income.

*Holdings are subject to change. Full fund names are as follows: PFF – iShares US Preferred Stock ETF; HYG – iShares High Yield Corporate Bond ETF; TLT – iShares 20+ Year Treasury Bond ETF; EMB – iShares Emerging Markets USD Bond ETF; TLH – iShares 10-20 Year Treasury Bond ETF; CLY – iShares 10+ Year Credit Bond ETF; DVY – iShares Select Dividend ETF; HDV – iShares High Dividend ETF; IGF – iShares Global Infrastructure ETF; REM – iShares Mortgage REIT Capped ETF

Tags: ETF, ETFs, Fixed Income, yield
Posted in Bonds, ETFs, Fixed Income, ideas, Insight, Outlook, REITs, Stocks | Comments Off

Defensives Continue to Get Whacked

Thursday, May 30th, 2013

by Bespoke Investment Group

After a rough day yesterday, defensive sectors continue to get sold off this morning.  Below is a snapshot of where the ten S&P 500 sectors are currently trading within their normal trading ranges.  In the table, the black vertical line represents the sector’s 50-day moving average.  The white zone represents between one standard deviation above and below the 50-day, and moves into the red or green zone are considered overbought or oversold.  As shown, Utilities and Telecom are now well into oversold territory, while Consumer Staples is quickly approaching its 50-day moving average.  Health Care has also now moved out of overbought territory into the neutral zone.

Investors typically move into more defensive sectors if they think the market is due for a pullback.  If you have done that recently, it has done anything but pay off.

Copyright © Bespoke Investment Group

Tags: defensives, Fixed Income, utilities
Posted in Bonds, ETFs, Fixed Income, US Stocks | Comments Off

REITs, Utilities, and Treasuries Fall Off a Cliff

Thursday, May 30th, 2013

by Stockcharts.com

The Utilities SPDR (XLU) and the 20+ Year T-Bond ETF (TLT) both peaked in early May and declined sharply the last four weeks. The Real Estate iShares (IYR) continued higher into mid May, but peaked last week and fell sharply the last four days. Interest rate sensitive issues are not having a good time right now.

Click this image for a live chart.

Tags: ETF, ETFs, Fixed Income, yield
Posted in Bonds, ETFs, REITs | Comments Off

Fixed Income = Broken Sentiment? (Bradley)

Friday, April 26th, 2013

By Tom Bradley, Steadyhand Investment Funds

My last post on gold spoke to the impact of investor sentiment on security prices. In the case of the shiny metal, sentiment is everything. As for other securities, such as bonds and stocks, it’s a secondary factor – economic fundamentals (profits) and valuation drive the boat.

Having said that, I find the market sentiment in the fixed income markets to be remarkable. I say that because the consensus around interest rates has two elements to it. One speaks to valuation (rates are unsustainably low) and the other to timing (rates won’t rise for a few years to come). In other words, the market thinks bonds are expensive now, but because of macro-economic factors, they’re going to stay that way for a few more years.

I bring this topic up again (and again and again) because investors have to be careful when valuation and sentiment are at extremes. Betting with the consensus is a hard way to make money at the best of times, but when it lines up with valuations being out of line, it can set the stage for a wild ride … in the wrong direction.

Hopefully, gold has served as a wakeup call when it comes to investor sentiment and strong consensus. That is: it will change; we won’t see it coming; and we won’t know why until after the fact.

The catalyst for higher interest rates could be any number of things – higher inflation, a better economy, rising stock markets. When long-term Government of Canada bonds lose 15% of their value, we’ll be saying, “What were we thinking … bonds were ridiculously expensive and everyone loved them!”

So beware of complacency. We are in unprecedented times when it comes to government finances and monetary stimulation. Other than the Leafs making the playoffs, we shouldn’t be too confident about anything right now.

Note: In response to the interest rate complacency, and valuations for the bonds and stocks, we have positioned the Founders Fund (and advised clients in relation to their long-term asset mixes) to carry a minimum weighting in bonds and hold some cash and short-term investments instead (10-15%). As for the bonds we hold, our manager, Connor, Clark & Lunn, is heavily tilted towards corporates, with little or no exposure to Government of Canada bonds. We’re recommending a regular allocation to stocks, but with a tilt towards foreign stocks over domestic.

Copyright © Steadyhand Investment Funds

Tags: Bonds, Fixed Income, Tom Bradley
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2 Popular Minimum Volatility ETF Strategies

Tuesday, August 21st, 2012

by Del Stafford, iShares

By now, you’ve probably heard about the benefits of a minimum volatility (or, “min vol”) strategy and the ETFs that seek to deliver it, but you might still be wondering how to use these funds in a portfolio. One common misconception is that min vol ETFs are a tool designed for volatile markets specifically, but this simply isn’t the case. In fact, the two minimum volatility ETF strategies we see our clients using most often are both strategic, long-term plays that have nothing to do with current market volatility. These two strategies are: 1) lowering overall portfolio risk or 2) increasing allocation to equities without increasing overall portfolio risk.

Lower overall portfolio risk
Investors who are trying lower their overall portfolio risk can simply replace their existing market capitalization based equity investment with the corresponding minimum volatility ETF. For example, let’s say a client’s portfolio consists of 60% equity and 40% fixed income. Let’s use the MSCI USA Index to represent “equity” and the Barclays US Aggregate Bond Index to represent “fixed income”. The client would replace the 60% allocation to the MSCI USA Index with a 60% allocation to the MSCI USA Minimum Volatility Index.

This strategy would result in a ~20% reduction in portfolio risk since inception of the analysis (June 2008) and an even greater reduction in risk in the nearer term (see below).

Increase allocation to equities without increasing overall portfolio risk
Like the example above, an investor looking to employ this strategy would start by replacing their existing market capitalization based equity investment with the corresponding minimum volatility ETF, but then they would also increase their allocation to the minimum volatility ETF while decreasing their allocation to fixed income. After replacing the MSCI USA Index with the MSCI USA Minimum Volatility Index, the investor would increase their allocation to the MSCI USA Minimum Volatility Index and decrease their allocation to the Barclays US Agg Bond Index until the total portfolio risk reaches the level they desire. For example, they may seek a level of portfolio risk that is just below the since inception risk of the Original Portfolio, which is 12.15%.

This strategy allows the investor to increase their allocation to equity by 17% while obtaining a consistently lower level of risk than the Original Portfolio (see below).

While there are certainly other ways to employ minimum volatility ETFs in a portfolio, our team has found that these two strategies are the most commonly used among our clients.

Source: Markov Processes International (MPI)

Del Stafford, CFA is the iShares Head of Product & Investment Consulting and a regular contributor to the iShares Blog. You can find more of his posts here.

The iShares Minimum Volatility Funds may experience more than minimum volatility as there is no guarantee that the underlying index’s strategy of seeking to lower volatility will be successful.

Copyright © iShares

Tags: Barclays, Bond Index, Case In Fact, Common Misconception, Current Market, Equity Investment, ETF, ETFs, Fixed Income, Inception, Investor, Investors, Ishares, Market Capitalization, Market Volatility, Msci, Portfolio Risk, Risk 2, Usa Index, Volatile Markets, Volatility Index
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Some Numbers Worth Thinking About

Thursday, August 16th, 2012

What Are Investors Thinking About Coming Into the Home Stretch?

Whether it is right or wrong, many still think of investing on a calendar year basis. So as we crawl through this period of incredibly low volatility and low volume it is time to start thinking about the home stretch. Coming into year end there are some striking numbers that investors and money managers must be thinking of and are likely to influence their decisions for here on out.

Equities

The S&P 500 is up 11.8% for the year. The Nasdaq is up 16.3%. Had you been lazy and just bought AAPL (which is allegedly the most owned stock by hedge funds), you would be up 55.8%. Had you “tried to lose client money” by buying banks, you would have failed there too. XLF is up 16.4% and even JPM, with the whale trade and LIBOR is still up 11.5% this year (remember how bearish everyone was on banks at the start of the year?).

Okay, what about Europe? Well an investment in the STOX 50 would be down 1% in USD, but still up 4.9% in Euro. The Nikkei is up 7.5% in Yen terms and 4% in dollars.

China, with all of its problems and daily headlines of various types of landings, is down only 4% in local terms and 5% in USD.

In many ways it would have been hard to lose money investing in equities. Just simple equity investments and that’s without timing any of the bigger moves. Yet the composite hedge fund ytd return is only about 3%.

Fixed Income

The fixed income case is even more depressing for hedge funds. It has been almost impossible to find a losing investment here. The 10 year treasury return is over 2.5%, Investment Grade bond index is 7.9%, High Yield bond index is 8.6% and even boring, senior secured, floating rate leveraged loans have generated 7.1%. The Municipal bond index is up only 5% but some of that income is tax-free. Emerging markets have been stellar with core dollar denominated debt up 11.9% and even local currency debt now up 4.4%.

Even an investment in a 5 year Italian bond would be up 8.8% so far. I haven’t converted that to dollars where it is less, but this number is worth thinking about. Close your eyes, but Italian 5 year bonds at the start of the year, and you would be up 8.8% so far in Euros. At least Spain has had the decency to be down. Had you bought 5 year Spanish bonds at the start of the year you would have a 2.1% loss in Euros (slightly less in dollars). All the time and focus spent on how bad Spain is and you would only be down 2.1% on a five year bond, strikes me as surprising.

On fixed income, I continue to believe that specific credit and bond selection is necessary here, as the “go go” bonds have gone about all they can. The ETF’s are underperforming the benchmarks in many cases now, at least in part because the “beta” has been played out.

Others

The dollar has done well this year. Investing in DXY would have produced a 3.2% return. Investing in commodities would have lost 3.3% based on the CRB index. That surprised me, given how much talk there is about inflation.

Can You Sell Sharpe Ratio?

At a glance, the hedge fund composite index returns are pretty lackluster. Obviously some funds have done a great job, some are designed for low volatility or tail risk environments, etc., but some are designed to generate total returns for their investors. It must be getting hard for some investors to wonder why they are paying 2 and 20 to get returns that just aren’t that good. So many investments have outperformed, and there are so few losers, some investors will question how it was possible to achieve such low returns.

That is the key game that is getting played out now. The weaker hedge funds, those without long track records and good relationships with their investors are racking their brain on how to outperform coming into year end. Clients may say they want steady returns, especially in bad times, but we all know that many of them are as likely to chase returns as stick with that philosophy.

These weak funds need returns, not sharpe ratio. They need to keep assets under management. They need to justify their existence. It is reasonably safe to assume that many of the laggards have been short the market, since so much has gone up. They can add to that position, or they can decide not to fight the Fed and ECB and go long chasing returns that way. I think every day now that we continue in this low volume, low volatility environment, these funds will become more and more tempted to chase returns from the long end and will scrounge the world for the highest beta assets that they can buy and push up in this low liquidity environment.

Clearly the good funds remain in the driver seat, but they have the luxury of being patient and figuring out what they want to do. It is those most desperate for returns into year-end that are likely to swing for the fences, and I think it is becoming more likely that means another big push higher in risk assets.

I wouldn’t do it if I was them. I remain between 0% and 50% now and continue to be tempted to set shorts (I’m now eyeing the S&P Sept 1,370 puts since they are cheaper than when I started watching the 1,350′s). For now I remain long and biased towards Spain, Italy, banks, and continue to think CDS can have a capitulation tighter (low trading volumes will turn the big banks into net income hogs again, reducing their desire to hedge).

Tags: Aapl, Client Money, Currency Debt, Emerging Markets, Equity Investments, Fixed Income, Hedge Fund, Hedge Funds, High Yield Bond, High Yield Bond Index, Home Stretch, Investing In Equities, Landings, Leveraged Loans, Libor, Money Managers, Municipal Bond, Nasdaq, Stox, Whale Trade
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Mythbusting: Emerging Market High Yield Bond Risk

Friday, August 3rd, 2012

by Del Stafford, iShares

Emerging market high yield bonds – about as risky as an asset class can get, right? After all, emerging markets are known for carrying a significant amount of risk, and high yield bonds are one of the more speculative sectors within fixed income. Put the two together, and aren’t you doubling down on risk? I thought the same myself before researching this very topic, but to my surprise I found that is not [always/necessarily] the case.

First, most investable emerging market high yield indices contain bonds that are issued in US dollars (USD), so with these indices there isn’t additional risk from owning other currencies. Also, emerging market high yield generally includes sovereign bonds (issued by a government) and quasi-sovereign bonds (issued by an agency backed by a government), while US high yield generally only includes corporate bonds.

Corporate bonds are typically viewed as riskier than government bonds, even when they have the same credit quality rating. In times of market volatility and stress, you can see that play out in what is commonly referred to as a “flight to quality”. For example, we saw this happen during the credit crisis of 2008 when the market largely sold out of corporate bonds and bought US Treasuries.

The sovereign and quasi-sovereign exposure in emerging market high yield caused it to behave differently from other risk assets during 2007-2009. The below chart shows correlations of emerging market high yield (Barclays EM High Yield Index), US corporate high yield (Barclays US Corporate High Yield Index), emerging market equities (MSCI Emerging Markets Index) and developed international equities (MSCI EAFE Index) to US equities (S&P 500 Index) during this time period. You can see that developed international equities, emerging market equities, and US high yield increased in correlation but emerging market high yield decreased in correlation.

In addition, when you look at historical volatility in the below chart, emerging market high yield has experienced comparable levels of risk to US high yield over the past seven years.

Now, the intent here isn’t to say that emerging market high yield bonds are for everyone, but rather to challenge investor assumptions about the investment’s risk profile. Investors interested in emerging market high yield debt should still consider whether it suits their portfolio needs (Matt Tucker’s recent post may be helpful).

Source: Markov Processes International (MPI)

Del Stafford, CFA is the iShares Head of Product & Investment Consulting and a regular contributor to the iShares Blog. You can find more of his posts here.
Correlation is a statistical measure that captures the degree of the historical relationship between the returns of a pair of investments or indexes.

Correlation ranges between +1 and -1. A correlation of +1 indicates returns moved in tandem, -1 indicates returns moved in opposite directions, and 0 indicates no correlation.

Standard deviation is the statistical measure of the degree to which an individual value in a probability distribution tends to vary from the mean of the distribution. It is widely applied in modern portfolio theory, where the past performance of securities is used to determine the range of possible future performance, and a probability is attached to each performance.

Bonds and bond funds will decrease in value as interest rates rise. High yield securities may be more volatile, be subject to greater levels of credit or default risk, and may be less liquid and more difficult to sell at an advantageous time or price to value than higher-rated securities of similar maturity.

Copyright © iShares

Tags: asset class, Barclays, Corporate Bonds, Correlation, Correlations, Credit Crisis, Credit Quality, Emerging Market, Emerging Markets, Fixed Income, Government Bonds, High Yield Bond, High Yield Bonds, International Equities, Ishares, Market Volatility, Markets Index, Sovereign Bonds, Time Period, Treasuries
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Oh Canada… 3 Reasons to Consider International Preferreds

Monday, July 9th, 2012

by Jessie Symanski, iShares

Hi there. I’m Jessie Szymanski, the newest guest contributor for the iShares Blog.

My job is all about making your life easier. I mean, I won’t do your laundry, but my role at iShares is to make your investments easier to understand and easier to implement. As a Messaging and Communications Strategist, I write about anything from new products to investment strategies to the essentials of fixed income ETFs.

So I thought I’d take my mission of making your life easier to the (blog) streets, starting with a topic we’ve been hearing a lot about lately: preferred stock.

Preferreds are attracting a lot of attention now for two reasons. First, a persistently low interest rate environment has pushed many investors to seek yield in places other than fixed income. Preferreds are subordinate to bonds, but senior to common stock. That means that they generally offer higher yields than bonds, but less return potential than common stock. They’re often referred to as “hybrid” securities because they offer some characteristics of bonds and some characteristics of common stocks.

The second reason for the recent focus on preferreds is that a provision of the Dodd-Frank Act may affect the way that US banks classify their preferred offerings. (The majority of preferred securities are issued by financial companies.) So investors who traditionally look to the United States for preferreds have started to look internationally.

What’s interesting about the international preferred market is that it’s dominated by Canada. Fully 73% of the iShares S&P International Preferred Stock Index Fund (IPFF) is dedicated to Canadian securities.

Why is that important? Three reasons:

• Canadian banks are strong. Some investors shy away from US preferreds because they’re typically issued by financial companies (and are then linked to sometimes-shaky US banks). According to a recent World Economic Forum study on 150+ countries, Canada’s banking system was the most sound of them all (the United States ranked #111). While the United States relaxed underwriting standards a few years back, Canada did not, so Canadian bank balances sheets are seen as stronger.
• Investors can diversify internationally, without those pesky PIIGS. You might be worried about a little something called the continent of Europe. While IPFF has exposure to the UK and Sweden, it’s dominated by Canada and has no exposure to the PIIGS (Portugal, Italy, Ireland, Greece, and Spain), Germany or France. The result? Investors can use IPFF to diversify internationally, without undue exposure to the most problematic European countries.
• Potential for additional income versus common stock. Because IPFF consists of preferred stock, it offers the potential for additional income versus Canadian common stock (but lower return potential). For investors who prioritize income, the difference in yield (5.36% for IPFF’s index as of May 31 versus 3.11% for broad Canadian common stock, as measured by the MSCI Canada Index) may be worth a closer look.

Income-seeking investors can consider IPFF an interesting alternative to common stocks, or a natural complement to traditional preferred stock investments.

How else can I make your life easier? What investment-related concerns are keeping you up at night? Comment below and I’ll answer your other questions.

Now if I could only get someone to do my laundry….

In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Securities focusing on a single country may be subject to higher volatility. Narrowly focused investments typically exhibit higher volatility. Preferred stocks are not necessarily correlated with securities markets generally. Rising interest rates may cause the value of the Fund’s investments to decline significantly. Payment of dividends is not guaranteed. Removal of stocks from the index due to maturity, redemption, call features or conversion may cause a decrease in the yield of the index and the Fund.
Index returns and yield are for illustrative purposes only and do not represent actual iShares Fund performance. Index and yield performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

Tags: Canadian Banks, Canadian Securities, Common Stock, Common Stocks, Dodd, Fixed Income, Guest Contributor, Hybrid Securities, Interest Rate Environment, Investment Strategies, Ishares, Jessie, Preferred Market, Preferred Offerings, Preferred Securities, Preferred Stock, Stock Index Fund, Strategist, Szymanski, World Economic Forum
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Why Investors Persist Hanging on to Long Treasuries at Such Low Yields

Monday, July 2nd, 2012

Some readers have asked if other fixed income asset classes could be just as effective as long term treasuries for an equities portfolio in hedging an equities book (discussed here). Here the comparison is made to municipal bonds, investment grade corporate bonds, and HY corporate bonds. Long term treasuries are still superior in reducing the portfolio volatility – at least based on the last couple of years. That’s because muni and corporate spreads tend to be inversely correlated to equities, reducing the hedge effectiveness of these instruments.

Again, the x-axis is the percent of the portfolio invested in the S&P500, with the rest of the portfolio being in one of the fixed income asset classes. The y-axis is the combined portfolio daily volatility over the past two years.

That is the reason investors are willing to take asymmetric risk and dismal current yield to hold long term treasuries. Whether this relationship holds going forward remains unclear. A scenario in which both treasuries and equities sell off some time in the future is not unrealistic.

SoberLook.com

Tags: Amp, Asset Classes, Axis, Bonds Investment, Corporate Bonds, Current Yield, Fixed Income, Investors, Municipal Bonds, P500, Portfolio, Reason, Relationship, risk, Treasuries, Volatility
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It’s All Relative (Sonders)

Monday, June 4th, 2012

June 1, 2012

by Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc., and
and Brad Sorensen, CFA, Director of Market and Sector Analysis, Schwab Center for Financial Research, and
and Michelle Gibley, CFA, Director of International Research, Schwab Center for Financial Research

Key Points

• Equities have pulled back and are flirting with correction (-10%) territory. We believed this was a needed process, and remain modestly optimistic that economic data will rebound and the market will eventually resume its move higher over the next several months.
• The Federal Reserve has made clear that it stands ready to act should the US economy deteriorate, or the European debt crisis escalate, but we remain skeptical. The more important issue in our view is how the coming “fiscal cliff” is addressed.
• The European crisis continues to escalate and we are recommending that investors underweight European equities. Hopes of a sustainable solution in the near term are virtually nonexistent, while contagion fears are rising. China’s growth has slowed but the country has tools at its disposal and we believe a soft-landing is the most likely scenario.

Frustrating! That’s one of the most common words we hear from investors as they look at the current environment. Fixed income yields remain historically low, money market returns are nonexistent, international markets have various ills, and the domestic economy is muddling along—not a great list to choose from.

As uncertainty has grown, we are again reminded how important having a diversified portfolio can be. Day-to-day moves can be influenced by innumerable factors that are rarely predictable, and even over several months, markets can be influenced by exogenous events that are nearly impossible to appropriately factor into pricing models. For example, at what discount should equity markets trade if Greece exits the eurozone? We don’t know if it will happen, when it might happen, how it will happen, or what the ultimate financial impacts may be. We don’t know if there will be a relief rally or a sharp downturn on further uncertainty—both arguments can be made. And, of course, the market could move in the exact opposite direction if an agreement to keep Greece in the coalition is reached and viewed as credible by investors. As detailed below, risks in the eurozone have risen to the point that we are now recommending investors underweight European equities, which results in an underweighting of developed international, and use that cash to move to a potentially more defensive posture by investing in highly-rated US equities.

We continue to see signs, however, that many investors are overexposed to investments viewed as “safe.” Highly-rated fixed income instruments continue to see near-record inflows and cash appears to be heavily weighted in many investors’ portfolios. This “return of capital rather than return on capital” mentality, however, has its own dangers. By holding an outsized amount of a portfolio in these instruments that are paying next-to-nothing in yield, investors are virtually locking in losses of purchasing power at even a low inflation rate of 2-3%. To achieve investing goals over the longer-term, we believe investors need to be appropriately allocated among various asset classes, which may mean moving into areas that are not exactly comfortable and where clarity is lacking.

US looks good—relatively speaking

We believe that domestic equities are among the most attractive assets currently. We’ve seen a pullback that has come close to correction territory (down 10% from the top), which has helped to alleviate some of the overly optimistic sentiment indicators that we highlighted in early April. The American Association of Individual Investors (AAII) recently noted that its bullish reading is now at the lowest level in 20 months. The pullback has also helped to bolster the valuation picture as earnings remain healthy. In fact, on a forward-earnings basis, the multiple on the S&P 500, at 12, is four points lower than the long-term average of 16.

Economically, domestic data has been a bit soft, but several areas—notably autos and housing—have improved; and US growth is decidedly stronger that in many other areas of the world. The mild winter likely had an impact on data, and we are likely seeing a little give-back recently; but we think the risk of another recession in the near-term is low. Although unemployment claims are no longer descending at the same pace as earlier this year, the labor market continues to heal. The May labor report was disappointing but we don’t want to panic over one or two weak numbers from a lagging indicator. However, the mere 69,000 jobs gained in May along with a tick up in the unemployment rate to 8.2% is certainly concerning and the next several weeks of data will be key to watch.

Claims have shown strength after soft patch

Source: FactSet, U.S. Dept. of Labor. As of May 31, 2012.

As noted, we’ve seen increasing signs that the housing market is slowly starting to heal. While its impact on the economy has dramatically fallen over the past several years, an even modestly improving market should help to bolster confidence and stimulate activity in various areas of the economy. The National Association of Home Builders confidence reading rose to 29 recently, still quite low, but the highest reading since May 2007. Additionally, we saw housing starts rise 2.6% month-over-month (m/m), new home sales gain 3.3% m/m, and existing home sales advance by 3.4%. Perhaps even more encouragingly, the median price of those existing homes rose 10.1% year-over-year. Finally, housing affordability remains at an all-time high thanks to still-low prices and record-low mortgage rates.

Tags: Brazil, BRICs, Charles Schwab, Chief Investment Strategist, Contagion, Debt Crisis, Diversified Portfolio, Domestic Economy, Economic Data, energy, European Equities, Eurozone, Exogenous Events, Federal Reserve, Fixed Income, Ills, India, International Markets, Liz Ann, Money Market, Pricing Models, Sector Analysis, Senior Vice President, Sustainable Solution
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