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.
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%.
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)
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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Tuesday, August 21st, 2012
by Russ Koesterich, Chief Investment Strategist, iShares
Come September investors might feel as if they are trapped in their own version of Groundhog Day. Last year, the Dow dropped 6% in September. Given the month’s consistently negative bias and lingering headline risks, there is a reasonable chance markets will come under pressure again this year.
While investors often pay too much attention to the calendar, September is the notable exception. Looking at data on the Dow Jones Industrial Average, which stretches back to 1896, September has historically been the worst month of the year, with an average return of slightly worse than negative 1%. This is the only month of the year for which the seasonal bias is so great as to be considered statistically significant.
The tendency for markets to fall in September is also evident when you look at the win rate – how often equities move higher. The win rate in September is barely 40%, versus nearly 60% for the other 11-months. Finally, this phenomenon is not limited to the United States. September has historically been the worst month of the year in a number of European markets – including Germany and the United Kingdom, as well as in Japan.
In addition to a negative seasonal bias, there are three other reasons to be concerned about the headline risk to the markets in the coming weeks:
- On September 12, the German Constitutional Court will rule on the constitutionality of the European Stability Mechanism (ESM). Investors currently expect a favorable ruling, so any other outcome is likely to be disruptive.
- The Netherlands holds an election, also on September 12. This is risky for markets as the outcome may very well be a fragmented government, which will call into question the commitment of the Dutch to further fiscal integration and their support for the southern European countries.
- Closer to home, the US Federal Reserve will begin two days of deliberation on September 12 about the economy and monetary policy. Many investors are still expecting, or at least hoping for, an extension of the Fed’s quantitative easing program, but there is considerable scope for disappointment should the central bank stand pat.
In addition to headline risk, there has been a growing complacency in global equity markets. This trend is particularly evident when looking at implied volatility, or the VIX Index. In mid-August the VIX went below 15, well below its long-term average. While there are several technical reasons that the VIX is this low, it should still concern investors. A low VIX reading indicates weak demand for put protection, suggesting that investors are not particularly concerned with downside protection. Previous readings in this vicinity – in March of 2012 and the spring of 2011 – coincided with short-term tops.
How should investors position their portfolios? While I still prefer equities over the long-term, this is probably a reasonable time to consider trimming back on positions and looking for instruments that offer the potential for downside protection. One way to achieve this is to re-allocate from a cap-weighted exposure into a minimum volatility fund, or other instruments which tend to have a lower market beta.
For investors looking for global exposure, I like the iShares MSCI ACWI Index Fund (NYSEARCA:ACWI), the iShares MSCI All Country World Minimum Volatility Index Fund (NYSEARCA:ACWV), or the iShares S&P Global 100 Index Fund (NYSEARCA:IOO).
The author is long IOO.
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. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. 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.
Index returns are for illustrative purposes only. Indexes are unmanaged and one cannot invest directly in an index.
Tags: Chief Investment Strategist, Constitutionality, Deliberation, Dow Jones, Dow Jones Industrial, Dow Jones Industrial Average, European Markets, European Stability, Federal Reserve, German Constitutional Court, Groundhog Day, Investors, Koesterich, Month Of The Year, Negative Bias, Netherlands, Phenomenon, Russ, Southern European Countries, Tendency, Us Federal Reserve
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Monday, August 20th, 2012
The fact that the S&P 500 is back near multi-year highs is certainly enough to make bulls happy. That being said, the rally has hardly been broad. As one example, the Utilities sector, which is comprised of 31 stocks in the S&P 500, was down every day this week. Earlier in the week, we also noted that in the most recent leg higher, the Russell 2000 has been underperforming the S&P 500.
In terms of new highs, we have also seen a narrowing of the rally. Back in late March and early April when the S&P 500 made a new bull market high, the number of stocks in the S&P 500 hitting new highs got as high as 78, or 15.6% of the index. Today, however, the number of new highs was just a little more than half the peak reading we saw in the Spring. Of the 500 stocks in the S&P 500, there were 42 stocks that hit a new high (8.4% of the index).
The reason for the smaller number of new highs stems from the fact that the rally is being led by megacaps (like AAPL), which stocks with smaller market caps have lagged. This doesn’t necessarily mean that the rally is doomed. Rather, the less broad based nature of the rally means that it is imperative for investors to be in the right stocks. For a lot of us, just summoning up the courage to get into the market is hard enough. Now, we also have to worry about picking the right stocks!
Copyright © Bespoke Investment Group
Monday, August 20th, 2012
by Michael ‘Mish’ Shedlock, Global Economic Analysis
Economic Times reports European Central Bank mulls caps on borrowing costs
The European Central Bank is considering buying the bonds of crisis-wracked eurozone countries to ensure borrowing costs do not rise beyond a pre-determined level, German newsweekly Der Spiegel said Sunday.
The bank will define an upper limit for borrowing costs in countries such as Spain and Italy and intervene in the markets to ensure it is not breached, Spiegel said, without citing its sources.
At the end of trade on Friday, Spain was paying 6.39 per cent to borrow for 10 years and Italy 5.76 per cent. In contrast, Germany was paying 1.49 per cent, as investors trust Europe’s top economy to repay them.
The so-called spread, or difference, between benchmark German bonds and the debt-wracked countries would be decisive for the proposed rate cap, Spiegel said.
ECB President Mario Draghi announced earlier in August that his institution “may” buy bonds of struggling countries if they first apply for EU bailout funds and accept tough conditions in return.
He said the details would be worked out before the next meeting of the ECB, scheduled for September 6. Spiegel said that ECB governors would decide then whether to implement the proposed borrowing cost cap.
Here is a link to a translated article in Der Spiegel: ECB is planning to challenge interest rate speculation
The European Central Bank (ECB) is considering to establish in its future bond purchases interest rate levels for each country. Thus, they would state papers of the crisis countries always buy when interest rates exceed a certain impact on their yields German Bunds. Sun investors would get a signal that interest rates, the ECB considers appropriate.
Because the Fed has unlimited funds – they can even print the money eventually – it would not succeed even more speculators to drive the returns of the targeted rate also. Thus, the ECB wants to keep not only the financial costs of ailing countries in check, but also to ensure that the general level of interest rates in the euro zone is not too much drifting apart.
At its next meeting in early September, the Governing Council will decide whether the interest rate target is actually installed. One thing is certain, that the ECB will continue to practice their bond purchases more transparent. In the future, they will announce each country, in which capacity she has taken the bonds from the market. This information should be released immediately after the purchases. So far, the ECB had only ever made known Monday how much money she spent on purchases in the previous week as a whole.
Can This Work?
It depends on the definition of “work”. In general, if central planners (and it is important to understand that is what we are talking about here) set prices too high there will be unlimited supply.
Likewise, if central planners set prices too low, there will be shortages.
When it comes to money, recall that Switzerland capped the rate of the Swiss Franc vs. the euro. To defend that cap the Swiss National Bank has to offer unlimited money at the target exchange rate.
When it comes to interest rates, the ECB must be willing to buy an unlimited number of bonds (up to the total supply of all bonds).
Theory vs. Practice
So yes, the ECB can “in theory” defend a price target on bonds, but only at the risk of owning every bond.
What about an exit mechanism? How will the ECB get rid of all those bonds down the road? To who, at what price?
Will Germany go along with this ridiculous scheme? For how long?
As is always the case, interference in the free market by central planning fools always fails in the long run.
Tags: Article In Der Spiegel, Bailout, Borrowing Cost, Crisis Countries, Ecb President, Economic Times, German Bonds, Global Economic Analysis, Governors, India, Interest Rate Caps, interest rates, Investors, Mario Draghi, Michael Mish, Mish Shedlock, Rate Cap, Speculation, Speculators, Spiegel
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Wednesday, July 25th, 2012
by Russ Koesterich, Chief Investment Strategist, iShares
As short-term interest rates remain at or close to zero, investors starved for income should be wary of overpaying for yield, particularly when it comes to US utilities.
As I write in my new Investment Directions monthly commentary, I continue to prefer dividend funds and the global telecommunications sector for investors searching for yield. But some segments of the market – such as US utilities — are looking expensive and should likely be avoided.
I continue to hold an underweight view of US utilities for two reasons:
1.) Valuation: Investors have pushed US utility stocks up too far as US utilities currently look even more expensive than they were back in January. US Utilities are currently trading at nearly 15x earnings, versus an average since 1995 of around 14.5x. And the stocks are even more expensive when you compare their valuation to the broader market. As a regulated industry, utilities typically trade at a discount to the broader market. Since 1995, US utilities have traded at an average discount of roughly 25% to the S&P 500. Today, however, US utilities are currently trading at a more than 8% premium, the largest since late 2007.
2.) Profitability: The premium can’t be justified by US utilities being more profitable than in the past. In fact, the US utilities industry is currently less profitable than its long-term average. Return on earnings for US large cap utility companies is currently 10.5%, the lowest level since 2004.
So why are investors paying a near 10% premium to invest in a sector whose profitability is close to an eight-year low? The answer: US utilities have benefited from investors’ flight to safety and flight to yield. To be sure, if the market experiences a major correction, US utilities would likely outperform given their low beta (a measure of the tendency of securities to move with the market at large). However, absent a major correction, I believe a combination of stretched valuations and lackluster profitability suggests that US utilities are likely to continue to trail the market, even in a slow growth environment.
As I wrote in a recent post, my preferred vehicles for seeking yield are dividend paying equities, such as the iShares High Dividend Equity Fund (NYSEARCA: HDV), given its low beta and quality screen; the iShares Dow Jones International Select Dividend Index Fund (NYSEARCA: IDV) and the iShares Emerging Markets Dividend Index Fund (NYSEARCA: DVYE). For investors willing to take the added risk of sector exposure, I like the iShares S&P Global Telecommunications Sector Index Fund (NYSEARCA: IXP).
And for investors still looking for exposure to utilities, I continue to hold a neutral view of global utilities, particularly international ones available through the iShares S&P Global Utilities Index Fund (NYSEARCA: JXI).
The author is long HDV, IXP, IDV
Investing involves risk, including possible loss of principal. In addition to the normal risks associated with investing, narrowly focused investments typically exhibit higher volatility. 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. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume.
There is no guarantee that dividends will be paid.
Tags: Amp, Beta, Cap, Chief Investment Strategist, Dividend Funds, Earnings, Global Telecommunications Sector, interest rates, Investment Directions, Investors, Ishares, Nbsp, Profitability, Russ, Segments, Tendency, Term Interest, Utilities Industry, Utility Stocks
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Monday, July 23rd, 2012
David Rosenberg discusses how the 3 D’s (Deleveraging, Deflation, and Demographics) are hurting markets, and where investors can go for positive returns, with Wealthtrack’s Consuelo Mack.
Here is the full transcript:
CONSUELO MACK: This week on WealthTrack, the influential economist whose projections have been right on target. Financial Thought Leader David Rosenberg shows how the 3 D’s of deleveraging, deflation and demographics are hurting economies and markets and where investors can go for positive returns, next on Consuelo Mack WealthTrack.
Hello and welcome to this edition of WealthTrack. I’m Consuelo Mack. This week, we are sitting down for an in-depth interview with one of the handful of prognosticators who has gotten it right going into and through the rolling global financial crisis we are experiencing to this day. He is Financial Thought Leader David Rosenberg, chief economist and strategist at Toronto-based wealth management firm Gluskin Sheff. Dave returned to his native Canada in 2009 after spending many years as Chief North American Economist at Merrill Lynch, where Institutional Investor magazine placed him on their coveted “All American All Star Team” from 2005-2008.
Rosenberg took on the bullish Wall Street herd as early as 2004, when he started warning about the developing housing and credit bubble which, as he predicted throughout, would wreak havoc on the financial system and many world economies. Well he hit the nail on the head again last year, forecasting the global economy would slow and that treasury bond yields would fall- another homerun. In his influential and widely read daily “Breakfast With Dave” reports, he ranges across the globe covering everything from Europe and how “it is rather incredible that this rolling crisis is now going on 2-1/2 years and policy makers have yet to find a viable solution”; to emerging markets and “why the once mighty BRIC currencies are depreciating of late at their fastest pace since the 1998 Asian crisis”; to the financial markets and “how the “pattern of the past three years is unmistakable as each spring, the equity market corrected as stimulus measures wore off, to only then prompt more incursions by the fall.”
What other patterns are unmistakable to Dave Rosenberg and why did he write in a recent report that “the future is brighter than you think”? I asked him all of the above and more, starting with what he thinks the most important patterns for the economy and markets.
DAVID ROSENBERG: I think the primary trend is still one of deleveraging. It hasn’t really changed much from the last time that the two of us spoke; it’s become much more global in nature. So it started off in the U.S. four or five years ago, in the American mortgage market, the housing market, consumer loans in general, but now we’re seeing how it’s morphed into the survival of the welfare state and all the debt finance to prop up these peripheral countries in Europe, and even now there’s questions about whether China is going to have a hard or soft landing because of a perceived property bubble there.
So we’re still in this deleveraging cycle, still dealing with the impact of too much debt relative to the size of the global economy, and this is what’s creating all this market angst and instability that we’re still living with; notwithstanding the fact that the economy, the U.S. economy is three years in a recovery, we’re still stuck in a very slow growth mode, but recurring financial market instability at the same time.
CONSUELO MACK: So is there any way of knowing whether the second half is going to be worse, better, or the same as the first half? Because, I mean, I’m thinking of my audience out there, and myself included, and saying, “I don’t want to live through another three or four years like this.” So what’s it going to look like, do you think the second half?
DAVID ROSENBERG: Well, I’m going to sound like a classic economist here and say it’s going to be somewhere in between, and this is what I mean. Are we going to get another gut wrenching, you know, 7% decline in GDP, and lose another 8 million jobs? I don’t think we’re going to go through anything close to what we endured in ’08 and ’09.
CONSUELO MACK: And to back-to-back kind of 50% decline in the stock market?
DAVID ROSENBERG: It’s not going to be that bad. But then again, you have to take a look at the contours of the recovery. I actually think the recovery tells you a lot more than the actual gut-wrenching recession did, because normally when you do this with the economy, you do that.
CONSUELO MACK: You get to a V, right?
DAVID ROSENBERG: Well, even in that 1933-’36 period, you got a huge recovery, much bigger than we had this time around, and this time around we had basically a checkmark of left-hand person, that’s what we had. It was not a V-shaped recovery; it was a very meager recovery, especially when you consider everything that the government threw at this thing. Consider the Fed took rates to 0 in December of ’08, they’ve tripled the size of their balance sheet $3 trillion. We’ve had, what, $4 trillion, four years of trillion-dollar deficits, and…
CONSUELO MACK: The fiscal stimulus…
DAVID ROSENBERG: …and more foreclosure moratoria. We’ve tried everything. So we’ve had modest economic growth, but very unacceptable. And now what’s happening is the Fed is left now with all these uncreative tools. Like Ben Bernanke certainly believes that he can do more but, you know, in Economics 101 you learn about the law of diminishing returns, and it’s basically that you end up getting less and less and less incremental impact from the same policies over time. And so that was the same with QE1, QE2, with the LTRO that we had out of Europe. We were getting just a smaller incremental impact on the economy with each individual policy proposal.
CONSUELO MACK: So therefore three years into a quote, unquote “recovery”, so are we on the cusp of another recession?
DAVID ROSENBERG: Cusp or precipice, I don’t know if I’m quite there yet. The economy is extremely fragile. The underlying trend in the economy is barely 2%, it’s barely 2%. So when you have a trade shock that can wipe out 2 percentage points of growth, you’re left with 0. Now, maybe that’s not a recession in the classical sense because we’re not actually going in reverse, but the unemployment rate is going up in a no-growth environment. And then you talk about this so-called fiscal drag, this fiscal cliff that we’re going to see next year- it’s because, you know, we’re probably not in as bad as shape as the Europeans, but here in America, we’ve kicked the can down the road a lot in terms of the Bush tax cuts getting extended, in terms of payroll tax relief, extended unemployment insurance benefits, all these provisions expire December 31st. So just by the government taking back the parking permit from everybody, we have a drag on the economy next year from fiscal restraint, 4 percentage points of GDP, percentage points.
CONSUELO MACK: Which we don’t have. So listening to you, Dave, quite honestly, I do want to kind of bury my head in the sand and I’m thinking to myself, you know, that I want to be in incredibly safe assets, that this is no time to put risk on. And yet, you know, one of the things that you follow, as well, is investor sentiment and the fact that there is a growing despair out there that people are very frightened and worried. And as we know traditionally, that’s in fact, the time when it’s actually best to buy risk.
DAVID ROSENBERG: I mean, there are always opportunities. In a fat-tail world, you’ve got to be very cognizant of the risks. So it’s as much not just focusing on the gross returns, but we have to – and this is what we’re doing every day at my shop at Gluskin Sheff- is we are assessing the risk, identifying it, managing it, and pricing it. And frankly it’s not about, you know, being risk averse. You know, people think that somehow, you know, when you talk about risk all the time you’re risk averse. It’s always important to make sure as an investor that you’re getting paid to take on the risk, that you’re not paying…
CONSUELO MACK: Right, so it’s price is really…
DAVID ROSENBERG: Right. Like, for example, I would say, you know, the high-yield bond market right now is actually, I would argue, priced for a bad economic outcome. You want to buy the assets that you think have already discounted. What’s embedded, what’s the story in this particular asset class, what’s it telling you? So I’m taking a look at the high-yield market right now. I think it’s actually very attractive. We have a core portfolio of high-yield bonds, and the reason I say that is because ultimately when you’re buying corporate bonds, you’re staking a claim in the corporate balance sheet. And the one thing that’s not changed, despite the fact that we’ve got all this angst overseas, the fact that the U.S. economy has hit stall speed, corporate default rates are barely more than 2%, you’ve got corporate balance sheets in great shape whether you look at debt equity ratios, or interest coverage ratios- the fact that treasurers companies both Canada in the U.S. have locked in their maturity schedules, 80% of corporate debt is locked in. In some sense, the corporate sector is in better financial shape than the government sector is. So I like corporate bonds.
CONSUELO MACK: One of the things that you’ve told clients is that reliance and deriving a stable income stream while preserving capital is paramount right now. So in these uncertain times, stability of income stream is one of your major investment focuses.
DAVID ROSENBERG: Right. And it comes down to what my overall theme is called: the macro and market outlook in 3D. So I’m talking about the 3Ds. What are the 3Ds? Well, they’re deflation, there’s demographics, and there is deleveraging and we talked about the deleveraging. There’s also this demographic overlay because the first of the Boomers are 55 going on 56, that’s the median age. The first of the Boomers are in their mid-60s, and so they control the wealth. They’re in a different part of their investment life cycle right now, and so accumulating cash flows as opposed to relying on strictly capital appreciation for the Boomer class, the life cycles as far as investments are concerned, that’s altered. And we’re seeing it in our own business in terms of what our clients are telling us, how they would like their money managed.
So you’ve got the demographics talking about the deleveraging, but the deflation. And so people will say to me, “Well, I thought in a deflation, cash is king in a deflation.” And the answer is well, you know, historically that’s true. That’s the ultimate capital preservation- cash is king in deflationary environment except when interest rates are 0. And so then it’s not cash is king, cash flow is king. So it’s imperative. It’s not just about preservation of capital, which of course in the fat-tail world, which is the deleveraging world, capital preservation is key; but you have to overlay that with preservation of cash flows. That’s why MLPs have been so popular.
CONSUELO MACK: Right, Master Limited Partnerships.
DAVID ROSENBERG: That’s why muni funds. That’s right, and that’s why REITs, and that’s why dividend growth, dividend yield have been so popular now. People come back and say to me, “But these things look so expensive.” Well, they look expensive because that’s what’s in demand, you know? And it doesn’t mean because it’s expensive you don’t want to buy it. You know, the perfume I bought is expensive, yeah, but is it good? Yes. Well, okay, that’s why it’s expensive because it’s a good thing to buy. These are good strategies right now, and that’s why their prices have been up as much as they have.
CONSUELO MACK: So as far as this pattern that we’ve seen for the past three years in the stock market, and where it rallies until the spring and then it basically sells off. That has been very disheartening for investors. Are we locked into that for the foreseeable future?
DAVID ROSENBERG: I think what we have is this battle going on, got this battle. We have the secular forces of deflation coming from all this deleveraging and the deleveraging, of course, takes demand out of the global economy, you’ve got the deflation, and then you’ve got these governments fighting it hard. So the secular forces of deflation in the market place, and then the tug-of-war as governments come in and reflate- whether it’s China, or whether it’s the U.S. government, or whether it’s the ECB. And so what this does is creates tremendous volatility, tremendous volatility.
But once again, the question is for an investor, what do I do with this volatility? How can I sleep at night? And that’s why in conjunction with say income equity over here, and corporate bonds over there, there should be a slice in the portfolio in hedge funds that really hedge long-short strategies that can actually be…
CONSUELO MACK: And they exist? There really are hedge funds that really hedge?
DAVID ROSENBERG: Well, you know, hedge funds have been around for 50 years. They got a bad name in the last cycle because they weren’t hedge funds, they were leverage long-only funds. But there are firms out there that are either hedge funds. You know, Gluskin Sheff is not a hedge fund, but 20% of our business is managing these long-short strategies, and it’s actually a very effective way to be nimble in the market place when you get these dislocations.
It’s really just taking sectors and companies that you think are bad businesses, are going to cut their dividends, and you put a short position on them, and you couple that with long position of the companies that you think are going to grow the dividends over time.
CONSUELO MACK: So let’s talk about earnings, because I know that you’ve said that the E in the price earnings ratio, the earnings, they are problematical. So what is your outlook for corporate earnings? And again, what does that mean for the stock market?
DAVID ROSENBERG: Well, corporate earnings right now have hit an inflection point, and it’s not just that they’re slowing, they’re actually starting to contract. Earnings are actually, after a three-year period of steady increases off those lows in 2009, corporate profits are actually now starting to decline outright.
CONSUELO MACK: And you’re talking about the S&P 500?
DAVID ROSENBERG: S&P 500 and even bigger picture. When we got the GDP numbers a couple of weeks ago- the GDP numbers give you corporate earnings for all of America, not just for the large-cap companies- and corporate earnings are coming down. And my sense is that the earnings estimates by the analysts on Wall Street is still far too high. Earnings estimates are important. I’m noticing that fewer companies are giving guidance. Fewer companies are giving guidance. What’s that telling you? That corporate CEOs, very similarly, they have a very clouded crystal ball right now. Fewer companies are giving guidance, and then the ones that are giving guidance, for every one that’s saying something positive about their business, two to three are saying something negative about what the outlook is. And on top of that, the estimates are starting to come down. I don’t think they’ve come down enough.
What does it mean for the stock market? You know, I think that if we were to go into a recession, normally the market corrects 20%. I’m not going to say that we’re going into a recession, but my sense is that the stock market is going to remain at best in the range that it’s been in for the past several months. We have to respect the range, but we’re going to be still in for a lot of volatility, which is why I was saying before that hedge funds, they really hedged, totally appropriate. On top of that, you have to be nimble and as tactical as you possibly can be, but if you’re going to ask me do I think that there’s more downside pressure given the risks out there, and especially to corporate earnings, the answer is yes. I think at this stage, without getting into, you know, what’s your call on where we can get to, I think the balance of risks is at that the market goes down over the near term and then goes up. And if it does, I think it will be a great buying opportunity down the road.
CONSUELO MACK: Let me ask you just about another macro issue, which is what about Europe? And you’ve said, you wrote recently that, you know, you’re two and a half years in, you know, these rolling problems keep coming up in Europe, and there are no viable solutions.
DAVID ROSENBERG: Well, I mean, there are solutions. I don’t know how viable they are. I think it’s a matter of just looking at it realistically. The European Union was working just fine. You know, the whole notion that we were going to try and avoid another World War, another European war at all costs. I don’t think that we needed to have a currency union to achieve that. You can’t have a monetary union and not have the fiscal union, and an integrated banking union. You can’t have it.
CONSUELO MACK: So realistically, I mean, are the 17 countries going to sacrifice their sovereignty?
DAVID ROSENBERG: Hardly likely. I had breakfast recently with a CEO of a major Canadian bank, and he told me that they have a Eurozone breakup committee. And he said this is happening around the world. Any major multinational corporation, any business that is doing business in Europe has one of these Eurozone breakup committees, not unlike the pre-Y2K committees that you had in the late 1990s. So you can bet your bottom Euro that if that’s what they’re doing, the Eurocrats in Brussels are trying to come up with some sort of… you talk about viable, what’s a viable exit strategy? Unless the ECB steps up en masse and rapidly expands its balance sheet, and starts buying the bonds of Italy and Spain en masse at auction, you know, that’s pretty radical. I don’t know what the quick fix is. So I think that the end game will ultimately be that the Eurozone breaks up.
CONSUELO MACK: One of your investment themes that we’ve talked about basically has been capital preservation and income orientation, as well, and one of the themes that you and I have talked about in the past is what you call “SIRP”, which is Safety and Income at a Reasonable Price. Are you looking for SIRP investments? Is that still a major strategy theme?
DAVID ROSENBERG: I would say that SIRP has its thumbprints across all the portfolios we’re running at Gluskin Sheff. In fact, what’s interesting is that we, for years, since 2001 we’re running this one particular strategy that’s called “premium income”, which it’s a hybrid, it’s got dividends, and it could have REITs, it could have preferred, convertible bonds; it’s really a portfolio aimed at distribution, a portfolio aimed at generating monthly cash flows for our clients.
CONSUELO MACK: And that’s Safety and Income at a Reasonable Price.
DAVID ROSENBERG: Right. Well, when we say… for example, when I talked about corporate bonds, and we’re talking about “safety” in quotes; I mean, safety, it’s relative. When talking about corporate bonds, it’s because of the quality of the balance sheets are very strong. Because that’s inherently when you’re buying corporate bonds, it’s mostly about default risk. You want to minimize that strong balance sheets. When I talk about on the equity side, we’re talking about running portfolios that have a low beta, which means low correlations with the overall market direction.
CONSUELO MACK: Right. The overall stock market direction.
DAVID ROSENBERG: The overall stock market direction, so we’re talking about, so it’s not just about, you know, does this company have a consistent history of paying off dividends, and we like the business. It’s also how does it move relative to the overall market? So in a period like this where it’s very tumultuous, and where the market is more prone to go down than up, you want to run your portfolios with very low betas. And so that’s the safety part, that’s the “S” part of the SIRP.
CONSUELO MACK: And the low correlations of the markets, in a highly correlated market, which is what we’ve been in for the last several years, so what are the areas that aren’t correlated that have low betas?
DAVID ROSENBERG: Well, for example, one of the themes that we liked has been the consumer frugality theme. So it means consignment stores, it means private label, it means do-it-yourselfers. I mean, for example, you could actually say, wow, because a Home Depot, does it fall under that category as an example. I’m not going to go sell my home, I’m not going to move, I’m underwater in my mortgage, but you know what? I still want to have a fun life, so instead of buying a new home, I’ll spruce up my existing home. And so home repair, a do-it-yourselfer, and so you can find…
CONSUELO MACK: So can you match a name or two to, you know, the frugality theme? So, for instance, frugality, what’s a–
DAVID ROSENBERG: Well, I’ll tell you one area where we have been long, and it’s worked out well has been the dollar stores. And they’ve been phenomenal investments, and by the way, it’s not just because low income households shop there, you’d find… and what the studies are showing is that a greater share of middle income households are actually going to dollar stores. And that’s an area where we have focused on in terms of our consumer exposure.
CONSUELO MACK: Let me run down a couple of the other investment themes, noncyclical. So give me, you know, what’s the theory behind the noncyclical emphasis? And give me an idea.
DAVID ROSENBERG: Well, it’s all about generating stable cash flows. In an uncertain environment, what do you want in an uncertain environment? You want stability. What about utilities, regulated utilities? Regulated utilities. They have regulated pricing power. What about telecom? And it might not just be the stock, you might want to buy the bonds of these companies. Once again, if you have a single A telecom company that’s giving you a triple B yield, you know, I will be happy to take that all day long in terms of looking at the risk and reward. So telecom, utilities, consumer staples, these are the areas that will tend to outperform in the environment that I’m describing right now.
CONSUELO MACK: And one other category that you had was hard assets. So what are we talking about when you’re emphasizing hard assets?
DAVID ROSENBERG: Resources are not a bad place to be. They’re already corrected quite a bit, so resources, whether it’s raw food, or whether it’s, I would say energy, which is corrected quite a bit. ]If you’re a long-term investor, these are complements. They’re not going to generate a yield for you, but they are what you want to own, things you can see, touch and feel in a very uncertain world, and these things have cheapened up quite a bit, as a hedge against the income part of the portfolio.
CONSUELO MACK: So one question is One Investment for long-term to diversify portfolio, what is it that you would recommend that we all own some of?
DAVID ROSENBERG: Well, I’m still a big advocate of corporate bonds. As I said, I think balance sheets are in great shape, default rates are low, there is too much default risk priced in, and so I would say I would focus on, let’s try and generate equity-like returns without taking on the equity risk. And there is a part of the capital structure that can accomplish that, and it’s called “corporate credit”. That is still to me a happy medium between 0 percent treasury bills and going out in the riskiest part of the equity structure. So corporate bonds to me are a solid investment.
CONSUELO MACK: And Dave Rosenberg, you know, you have a reputation of being a permabear, which is not fair, because you were also known as a permabull in the ‘80s and the ‘90s, and in a recent report you said” the future is brighter than you think.” Why when others are despairing are you getting enthusiastic about the future?
DAVID ROSENBERG: Well, I’m not going to say I’m getting enthusiastic about the future. What I am willing to do is put out some checkmarks as to what can cause me to turn more optimistic. And so I see a flicker of light, and it’s realization that politics will lead the financial markets, which will lead the economy, and what leads the politics is the grassroots level, and so what happened last month, for example, I think in Wisconsin with the recall in San Jose, San Diego, and there seems to be this growing realization at the grassroots level that we have to get our public sector balance sheets in better shape; that these underfunded liabilities have to come under control. So we’re starting to see more of a groundswell of support.
What I’m thinking about is how things will change politically on November the 6th, understanding, coming from Canada; Canada went through what Europe is going through right now. Canada is going through what the U.S. was going through back in the early 1990s. You could never have predicted that Canada ten years later would be the poster child for fiscal integrity globally. But it took tremendous political courage.
CONSUELO MACK: We’ll see what happens, and that’s what you’re going to be watching, Dave Rosenberg.
DAVID ROSENBERG: I’m more than willing to reclaim my status of a permabull that I had in the ‘80s and ‘90s if I see those clouds part come November.
CONSUELO MACK: All right, Dave Rosenberg, so great to have you here from Canada, Gluskin Sheff. It always a pleasure to have you on WealthTrack.
DAVID ROSENBERG: Thank you.
CONSUELO MACK: At the conclusion of every WealthTrack, we try to leave you with one suggestion to help you build and protect your wealth over the long term. This week’s reiterates one we just talked about- Dave Rosenberg’s long-time income generating strategies which is S.I.R.P.: safety and income at a reasonable price. So this week’s Action Point is: seek safety and income at a reasonable price, or S.I.R.P.!
Everything we know about the financial markets right now points to ongoing volatility and headwinds for stock price appreciation. Among the areas Rosenberg recommends where you can find reliable dividend growth and dividend yields are: Canadian and U.S. preferred stock shares, which are senior to common stocks; energy infrastructure investments, such as natural gas pipelines; and utilities. All S.I.R.P. vehicles.
And that concludes this edition of WealthTrack. I hope you can join us next week. We are going to sit down with an investment professional who combines two disciplines: overall investment strategy and actual fund management. BlackRock consultant Bob Doll will join us to discuss macro trends and micro strategies. Until then, to see this program again, or others and read my Action Points and our guests’ One Investment recommendations, please visit our website, wealthtrack.com Have a great weekend and make the week ahead a productive one.
Tags: American Economist, Chief Economist, Consuelo Mack, Credit Bubble, David Rosenberg, Deflation, Demographics, Depth Interview, Global Economy, Global Financial Crisis, Institutional Investor Magazine, Investors, Merrill Lynch, Native Canada, Prognosticators, Sheff, Target, Treasury Bond Yields, Viable Solution, Wealth Management Firm, Wealthtrack, World Economies
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Wednesday, July 18th, 2012
In the hunt for income, high yield bonds continue to be of interest to investors willing to take on the extra risk. However, there are more ways to play this asset class than simply US high yield bonds. In this short video, Matt Tucker explores the pieces that make up the high yield puzzle and how they might fit in a portfolio.
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.
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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Sunday, June 10th, 2012
by Guy Lerner, The Technical Take
The “dumb money” indicator is now showing that investors are extremely bearish, and this is a bull signal. On average, the best time to buy is 1 week after the signal. Several caveats are worth noting.
First, about 80% of the signals will produce positive results within a reasonable draw down. What is meant by “reasonable”? The SP500 should bottom within 6% of next week’s buy point. If the SP500 drops below next week’s buy signal by more than 6%, then this is a failed signal. A failed signal is the market’s way of saying that what we expect to happen has not happened, and failed signals can lead to very strong moves opposite to those expectations.
Second, the current extreme reading in the “dumb money” indicator is not supported by other measures of investor sentiment. For example, the Rydex market timers are still showing extremes in bullishness and in some sense, they have been unwinding their bullish positions over the past several months. By no means are they bearish, and this data series is looking more like a market top than a market bottom. Corporate insiders did hit extremes in buying 2 weeks ago, but like the current “dumb money” indicator reading, these were only “mild” extremes. So what does it mean? The resulting snap back rally is likely to be weak and unlikely to carry as far as a rally that begins when all of our measures of investor sentiment are showing much greater extremes of bearishness.
The market has bottomed where one would expect it to have bottomed — near its 200 day moving average. I am sure this has brought a sense of order and relief to the bulls and to those investors who were buying the kool-aid only 2 short months ago. Ahh, this is how bull markets function. Now that this temporary blip (mis-pricing) is over, we can get back to the business of being bullish. I am not trying to discount the current bull signal. A bottom is being forged. It would be nicer to have seen greater extremes in bearish sentiment at the bottom as this leads to stronger future returns. I could just as easily make the case that this is the last gasp of an aging bull market.
The “Dumb Money” indicator (see figure 1) looks for extremes in the data from 4 different groups of investors who historically have been wrong on the market: 1) Investors Intelligence; 2) MarketVane; 3) American Association of Individual Investors; and 4) the put call ratio. This indicator is showing extreme bearishness.
Figure 1. “Dumb Money”/ weekly
Figure 2 is a weekly chart of the SP500 with the InsiderScore “entire market” value in the lower panel. From the InsiderScore weekly report: “S&P 500: Sentiment Remains Positive But Volume Declines…. Russell 2000: Number of Buyers Drops But Sentiment Remains Positive. ”
Figure 2. InsiderScore “Entire Market” value/ weekly
Figure 3 is a weekly chart of the SP500. The indicator in the lower panel measures all the assets in the Rydex bullish oriented equity funds divided by the sum of assets in the bullish oriented equity funds plus the assets in the bearish oriented equity funds. When the indicator is green, the value is low and there is fear in the market; this is where market bottoms are forged. When the indicator is red, there is complacency in the market. There are too many bulls and this is when market advances stall. Currently, the value of the indicator is 62.78%. Values less than 50% are associated with market bottoms. Values greater than 58% are associated with market tops. It should be noted that the market topped out in 2011 with this indicator between 70% and 71%.
Figure 3. Rydex Total Bull v. Total Bear/ weekly
Tags: Bearish Sentiment, Best Time, Blip, Bull Markets, Bulls, Caveats, Corporate Insiders, Dumb Money, Extremes, Guy Lerner, Investor Sentiment, Investors, Kool Aid, Market Bottom, Market Timers, Measures, Moving Average, Rally, S&P500, Signals, Snap Back
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Monday, June 4th, 2012
by Jeffrey Saut, Chief Investment Strategist, Raymond James
June 4, 2012
The “S” word makes most investors uneasy. They find the “B” word, “buying,” much more pleasant. Why is perhaps best explained in a book written by Justin and Robert Mamis titled “When to Sell.” Following are several poignant excerpts from that book:
“Stocks are bought not in fear but in hope. No matter what the stock did in the past it assumes a new life once a purchaser owns it, and he looks forward to a rosy future – after all, that’s why he singled it out in the first place. But these simple expectations become complicated by what actually happens. The stock acquires a new past, beginning from the moment of purchase, and with that past comes new doubts, new concerns, and conflicts. The purchaser’s stock portfolio quickly becomes a portfolio of psychic dilemmas, with ego, id, superego, and reality in a state of constant battle.”
“The public is most comfortable when they are sitting with losses. Because if their stocks are down from where they bought them, they don’t have to worry about them. Once he’s got a loss, the typical investor is sure he isn’t going to sell. He bears the lower price because in his mind it is temporary and ridiculous; it’ll eventually go away if he doesn’t worry about it. So selling at a loss becomes absolutely out of the question. And since it is out of the question, and his mind is made up for him, the struggle of any potential decision vanishes and he is able to sit comfortably with the loss.”
“To the public mind, selling is never sound. It always conveys the possibility of being wrong twice: first, admitting that they’ve made a buying error; second, admitting that they might be wrong in selling out. And if the stock has actually gone up, they are tormented; should they take a profit or hold for a bigger one? That creates anxiety, and anxiety breeds mistakes. But as long as they’ve got losses, and never have to decide, they can sit back comfortably and dream instead.”
“Through the entire market cycle lurks the fear of finalizing the deed, of taking it from dream to reality by selling. By not selling, by tightly holding on to his stocks, the investor never has to face reality.”
Yet, “selling” seemed to be on the market’s mind late last week punctuated by Friday’s Dow Dive of ~275 points. Said decline left the senior index down 8.74% from its May 1st closing high (13279.32) into Friday’s close (12118.57). While not all that big of a decline, it brought back memories of the past two years’ May – July corrections of 17% and 20%, respectively. Yet, investors should keep in mind that since 1928 there have been 294 pullbacks of 5% or more. Ninety four of them have been moderate (>10%), 43 have been severe (>15%) and 25 have been bear markets (>20%). What is interesting to me is that since last October 4th’s “undercut low” the chant from most investors has been, “We want a pullback to become more fully invested.” Now that we have the pullback everyone is in panic mode (again). To borrow a line from George Bernard Shaw – There are two tragedies in life; one is not to get your heart’s desire, the other is to get it! The “heart’s desire” for the bulls since last October has been the fact the markets have ignored all of the bad news. Verily, the senior index has turned a deaf ear to the worsening Euroquake situation, Iran, softening economic trends, deflationary dives in commodities, etc. Of course that “deaf ear” stance has changed over the past four weeks.
Indeed, the Dow’s decline is now 22 sessions long. Such “selling stampedes” typically last 17 – 25 sessions before they exhaust themselves; it just seems to be the rhythm of the thing. This has been my observation over the years in that it takes this long to get participants bearish enough to finally panic and throw in the towel by selling their stocks. While it is true some stampedes have lasted more than 25 sessions, it is rare to have one run more than 30 sessions. Today is session 23 on the downside. Obviously Friday’s Fade took out my failsafe point of 1290 on the S&P 500 (SPX/1278.04), leaving the DJIA (INDU/12118.57), the S&P 500, and the NASDAQ Composite (COMP/2747.48) all below their respective 200-day moving averages (DMAs). The bears will be quick to point out this is what happened right before the crashes of 1929 and 1987. However, the bullish argument is that over the past 20 years a break below the 200-DMA by the SPX, after it has stayed above it for three months, has typically led to a rally. Also worth noting is the decline has left most of the oversold indicators I rely on pretty oversold. Nevertheless, I told “callers” on Friday that when markets get into one of these selling squalls they rarely bottom on a Friday. What tends to happen is participants go home and brood about their losses over the weekend and “show up” on Monday in selling mode, which often leads to “turning Tuesday” (read: recoil rebound). Accordingly, the SPX needs to quickly recapture 1290, and stay above that level, if a rally is to commence. On the other hand, if the SPX merely bounces back up to 1290, and then falls sharply back, I would view that as a bearish sign requiring more downside hedging and/or the raising of some more cash. Fortunately, we recommended raising cash in February – April. Unfortunately, we recommended judiciously putting some of the cash back to work (but not much of it) into somewhat more defensive names like 3.8%-yielding Rayonier (RYN/$42.18), which has a Strong Buy rating from our fundamental analyst.
While Euroquake has been on center stage for weeks, Friday’s shockingly weak employment report brought the focus back to the economy and jobs. The 69,000 private sector payroll growth figure was well below the estimate of 150,000 and just to add pain to injury the unemployment rate ticked up to 8.2% from 8.1%. Still, investors should remember unadjusted private-sector payrolls have risen by 1.983 million over the trailing 12 months for roughly a 165,000 monthly average jobs gain. As our economist, Dr. Scott Brown, notes, “That’s not bad, but it is far short of what’s needed to make up ground lost during the economic downturn.” Now for weeks I have been discussing the weakening economic reports. That string of weakness continued last week given that of the 21 economic releases, 18 were weaker than expected, two were in line, and only one exceeded the estimate (that would be Continuing Claims). This softening trend could still just be a weather-related issue combined with skewed seasonal adjustments; the next few months will decide.
The call for this week: Friday was the first day of hurricane season here in Florida, yet the storm didn’t hit our beaches but rather blew onto the Street of Dreams with a 275-point “storm surge.” The media attributed Friday’s Flop entirely to the disappointing employment numbers, but the truth was the market was already headed down before the release of those numbers. And when the SPX’s 1290 level was breached, the rout was on. The result left all of the indexes we monitor near their lows of the day and the three major market indices (INDU, SPX, COMP) below their respective 200-DMAs for the first time in about five months. The bears will be quick to point out this is what happened right before the crashes of 1929 and 1987. However, the bullish argument is that over the past 20 years a break below the 200-DMA by the SPX, after it has stayed above it for three months, has typically led to a rally. And despite the break below my 1290 pivot point I can’t shake the feeling that all of this is just part of the bottoming process.
P.S. – I am on the road again this week seeing accounts and speaking at conferences.
Copyright © Raymond James
Tags: Anxiety, Book Stocks, Chief Investment Strategist, Conflicts, Doubts, Ego Id Superego, Excerpts, Fear, Investors, jeffrey saut, Losses, Purchaser, Raymond James, Saut, Stock Portfolio, Struggle, Typical Investor
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