While U.S.-based stock funds continued to witness significant outflows, real estate funds emerged as one of the few bright spots in terms of inflows, according to Lipper. The stock funds registered an outflow of $3.9 billion for the week ending May 18, raising the total withdrawals in the year-to-date frame to $45 billion. Moreover, stock funds have not seen inflows for two consecutive weeks since November. However, real estate funds are the ones that emerged as one of the few sectors that attracted significant investor sentiment during the week. These funds registered an inflow of $750 million, the biggest inflow witnessed since November 2015. Encouraging data related to the sector and a bright outlook may have boosted investor sentiment. Against this backdrop, investing in mutual funds and ETFs from this sector may prove profitable for investors in the coming months. Concerns Affecting Stocks Weak first-quarter earnings and intensified rate hike fears affected financial markets. As of May 18, total earnings for 466 S&P 500 members were down 7.0% from the same period last year on 1.2% lower revenues. Like the last few quarters, disappointing results from energy companies marred the first-quarter earnings season. Without energy earnings results, total earnings of the S&P 500 members would have been down 1.3% from the year-ago quarter. Also, minutes of the Federal Reserve’s two-day policy meeting in April indicated that most of its officials remain optimist for a rate hike in the June meeting. Moreover, New York Fed President William Dudley said that he is “quite pleased” to see strong possibilities of a rate hike in June-July. Dudley also said that the Fed is “on track to satisfy a lot of the conditions” for a rate rise. Also, Richmond Fed President Jeffrey Lacker pointed to a June rate hike, after “risks from global and financial developments having virtually entirely dissipated.” Lacker previously wanted a rate hike in April, and now agrees that “the case would be very strong for raising rates in June.” These have intensified rate hike fears among investors, which in turn affected the major benchmarks recently. What is Boosting Real Estate Funds? Despite these concerns, real estate mutual funds registered a return of 8.5% over the past three months, banking on optimism in the sector, according to Morningstar. While most of the broader sector found it difficult to post encouraging first-quarter earnings results, total earnings for S&P 500 construction companies jumped 27.5% from the same period last year on 3.9% higher revenues. Encouraging first-quarter results from the sector indicated that it is on a track for impressive growth at least in the near future. Along with the upbeat earnings results, the sector also got a boost from recently released housing data and a positive outlook. Encouraging Housing Data Among the recent encouraging data, a 1.5% uptick in residential construction spending led expenditure on construction to rise 0.3% from February to a seasonally adjusted annual rate of $1,137.5 billion in March. Over the last 12 months, construction spending has gained 8%. During this period, non-residential construction has increased by 8.3%. Also, the National Association of Home Builders (NAHB) reported that the home builder sentiment index (HMI) remained flat at 58 in May for the fourth consecutive month. This also indicates that the sector continues to experience steady growth, fueled by an improving job market and low mortgage rates. Moreover, the National Association of Realtors reported that existing homes sales gained 1.7% last month to a seasonally adjusted annual rate of 5.45 million, higher than the consensus estimate of 5.38 million. Existing homes sales rose for the second consecutive month. Meanwhile, housing starts increased 6.6% from March to an annual rate of 1,172,000 in April. Housing starts increased by 10.2% during the first four months of 2016, compared with the year-ago period. Significantly, single-family housing starts increased 16.8% year over year during this period. Also, building permits increased 3.6% from March to 1,116,000 last month. Bright Outlook Recently, economists in the NAHB Spring Construction Forecast Webinar predicted that single-family construction may jump 14% from 2015 to 812,000 units this year. Moreover, single-family construction is expected to surge another 19% next year. They also projected 3.3% and 1.3% gains in residential remodeling activity in 2016 and 2017, respectively. Separately, as per the Freddie Mac forecast, total home sales may hit the highest level of 5.9 million units in 2016 in nearly a decade. Sales were estimated to increase further to 6.2 million units next year. Mutual Funds and ETFs to Buy Banking on this encouraging scenario, we have highlighted three mutual funds and three ETFs from the real estate sector that carry favorable Zacks Ranks. Mutual Funds Each of these real estate mutual funds carries a Zacks Mutual Fund Rank #1 (Strong Buy). We expect these funds to outperform their peers in the future. Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but also on the likely future success of the fund. Moreover, these funds have encouraging year-to-date and one-year returns. The minimum initial investment is within $5000. Also, these funds have a low expense ratio and carry no sales load. Fidelity Real Estate Investment Portfolio No Load (MUTF: FRESX ) primarily focuses on acquiring common stocks of companies involved in operations related to the real estate domain. FRESX has year-to-date and one-year returns of 3.6% and 9.5%, respectively. Its annual expense ratio of 0.78% is lower than the category average of 1.29%. John Hancock II Real Estate Securities Fund (MUTF: JIREX ) invests a large chunk of its assets in equity securities of companies from the real estate sector and REITs. JIREX has year-to-date and one-year returns of 2.8% and 6.5%, respectively. The annual expense ratio of 0.79% is lower than the category average of 1.29%. VY Clarion Real Estate Portfolio S (MUTF: IVRSX ) invests the lion’s share of its assets in equity securities, including common and preferred stocks of domestic real estate companies, including REITs. IVRSX has year-to-date and one-year returns of 1.4% and 4.7%, respectively. The annual expense ratio of 0.96% is lower than the category average of 1.29%. ETFs The three popular real estate ETFs carry a Zacks Mutual Fund Rank #2 (Buy) each and have Medium risk outlook. These ETFs have also attracted significant inflows in the month-to-date period and gained significantly in recent times. Vanguard REIT Index ETF (NYSEARCA: VNQ ) provides exposure across 150 stocks of REITs by tracking the MSCI US REIT Index. With $30.6 billion assets under management (AUM) and a strong daily average volume of around 4 million shares, VNQ is the most popular ETF in its category. The ETF has 0.12% in expense ratio, compared with the category average of 0.45%. The fund has returned 7.7% and 2.9% over the three-month and year-to-date frame, respectively. VNQ has seen an inflow of $535.17 million in the month-to-date period. iShares U.S. Real Estate ETF (NYSEARCA: IYR ) provides exposure across 117 domestic real estate securities by tracking the Dow Jones U.S. Real Estate Index. With $4.6 billion AUM and strong daily average volume of around 9 million shares, it is the second most popular ETF in its category. The ETF has 0.43% in expense ratio, compared with the category average of 0.45%. The fund has returned 8.6% and 2.2% over the three-month and year-to-date frame, respectively. IYR has seen an inflow of $557.95 million in the month-to-date period. iShares Cohen & Steers REIT ETF (NYSEARCA: ICF ) provides exposure across 30 securities large-cap real estate companies by tracking the Cohen & Steers Realty Majors Index. It has $3.7 billion AUM and moderate daily average volume of around 220,000 shares, and is currently the third largest ETF in its category in terms of AUM. The ETF has 0.35% in expense ratio, compared with the category average of 0.45%. The fund has returned 6.9% and 1.2% over the three-month and year-to-date frame, respectively. ICF has seen an inflow of $26.35 million in the month-to-date period. Original Post
Cash on corporate balance sheets grew at a 1% pace to $1.84 billion in 2015. That’s a record level of dollars on the books. On the other hand, debt grew at a clip of nearly 14.8% to $6.6 trillion from $5.75 trillion. That’s a 15% surge in debt obligations. In fact, American companies have grown their debt load at a double-digit annualized rate since the economic recovery began in 2009. Doing so has put corporations in a precarious situation – circumstances where cash as a percentage of debt is lower than at any time since the Great Recession. Obviously, the data points themselves are unnerving. Yet, the trend for cash as a percentage of total debt over time may be even more alarming. Consider what transpired between 2006 and 2008. Cash growth began to slow. Debt began to skyrocket. And cash as a percentage of debt steadily declined until, eventually, stocks of corporations found themselves losing HALF of their value. Are stocks set to log -50% bearish losses going forward? Perhaps. Perhaps not. Yet the notion that debt can perpetually grow at a double-digit rate without adverse consequences is about as inane as the idea that the U.S. government’s debt troubles are irrelevant to the country’s well-being. At least in the U.S. government’s case, its leadership can print currency and/or manipulate borrowing costs. (Note: That is not an endorsement of policy; rather, it is an acknowledgement of government power.) Companies? They’re at the mercy of the corporate bond market such that, when existing obligations are retired, new debt may need to be issued at much higher yields to entice investors. Think about it. Ratings companies like S&P may find themselves downgrading scores of corporate bonds to junk status due to ungodly cash-to-debt ratios. What’s more, yield-seeking investors might squeamishly back away from speculation if spreads between corporates and treasuries widen further. Additionally, Fed efforts to raise overnight lending rates may push junk yields further out on the ledge where the combination of widening spreads, rating agency downgrades and Fed policy direction collectively reinforce a negative feedback loop. By many accounts, low-rated bonds have been struggling for quite some time. Get a gander at the three-year chart of the SPDR Barclays Capital High Yield Bond ETF (NYSEARCA: JNK ) below. Granted, the bounce off of the February lows is astonishing. (Channel your gratitude toward a 70%-plus recovery in crude oil prices.) Nevertheless, the total return for JNK is a scant 1.4% over the three-year period. That is negligible reward for a huge amount of risk . In contrast, the iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) offered a total return of 9.2% over the same period. That is low risk for reasonable reward. The problem may only get worse. At present, junk status (‘BB’) is the average rating for companies issuing bonds. How bad is that historically? It’s worse than before, during or after the financial collapse in 2008-2009. Indeed, you have to travel back to the 2001 recession to find an average rating as anemic as the one that exists right now. It is certainly true that when the European Central Bank (ECB) announced its quantitative easing (“QE”) intentions in the first quarter, the reality that they’d be acquiring corporate bonds as well as sovereign debt provided a fresh round of speculative yield seeking. Income producing assets that had been struggling under the worry of multiple Fed rate hikes in 2016 – emerging market sovereigns via the PowerShares Emerging Markets Sovereign Debt Portfolio ETF (NYSEARCA: PCY ), the SPDR Barclays International Treasury Bond ETF (NYSEARCA: BWX ), high yield via the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ), crossover corporates via the iShares Baa-Ba Rated Corporate Bond ETF (BATS: QLTB ) as well as the iShares Intermediate Credit Bond ETF (NYSEARCA: CIU ) – rocketed higher. On the flip side, the belief that yield-seeking and risk-seeking behavior will occur as long as central banks keep borrowing costs subdued is flawed. In the bond world, bad ratings eventually override yield-seeking speculation. In the stock world, stretched valuations eventually cap upside potential . It is worth noting, in fact, that the S&P 500 has been flat for 18 long months, which roughly corresponds to when corporate earnings peaked back on 9/30/2014 . Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.
Some investors have come to believe that ultra-low interest rates alone have made traditional valuations obsolete. The irony of the error in judgment? Experts and analysts made similar claims prior to the NASDAQ collapse in 2000. (Only then, it was the dot-com “New Economy” that made old school valuations irrelevant.) The benchmark still trades below its nominal highs (and far below its inflation-adjusted highs) from 16 years ago. Without question, exceptionally low borrowing costs helped drive current stock valuations to extraordinary heights. In fact, favorable borrowing terms played a beneficial role in each of the stock bull markets over the last 40-plus years, ever since the post-Volcker Federal Reserve began relying on the expansion of credit to grow the economy. Indeed, we can even take the discussion one step further. Ultra-low interest rates had super-sized impacts on the last two bull markets in assets like stocks and real estate. Bullishness from 2002-2007 occurred alongside household debt soaring beyond real disposable income ; excessive borrowing at the household level set the stage for 40%-50% depreciation in stocks and real estate during the October 2007-March 2009 bear. Bullishness from 2009-2015 occurred alongside a doubling of corporate debt – obligations that moved away from capital expenditures toward non-productive buybacks and acquisitions. Would it be sensible to ignore the near-sighted nature of how corporations have been spending their borrowed dollars? Click to enlarge It is one thing to recognize that ultra-low borrowing costs helped to make riskier assets more attractive. It is quite another to determine that valuations have been rendered irrelevant altogether. For one thing, the U.S. had a low rate environment for nearly 20 years (i.e., 1935-1954) that is very similar to the current low rate borrowing environment. The price “P” that the investment community was willing to pay for earnings “E” or revenue (sales) still plummeted in four bearish retreats. In other words, low rates did not stop bear markets from occurring in 1937-1938 (-49.1%), 1938-1939 (-23.3%), 1939-1942 (-40.4%), or 1946-1947 (-23.2%). Click to enlarge Economic growth was far more robust between 1936 and 1955 than it is in the present. What’s more, during those 20 years, valuations were about HALF of what they are today. If low rates alone weren’t enough to DOUBLE the “P” relative to the “E” back then, why would one assume that low rates alone right now are enough to justify exorbitant valuations in 2016? When top-line sales and bottom-line earnings are contracting? When economies around the globe are struggling? Equally important, the inverse relationship between exorbitant valuations and longer-term future returns since 1870 has taken place when rates were low or high on an absolute level; the relationship has transpired whether rates were falling or rates were climbing. It follows that central bank attempts to aggressively stimulate economic activity and revive risk asset appetite did not prevent 50% S&P 500 losses and 75% NASDAQ losses in 2000-2002, nor did aggressive moves to lower borrowing costs prevent the financial collapse in 2008-2009. Clearly, valuations still matter for longer-term outcomes. In all probability, in fact, fundamentals began to matter 18 months ago. Take a look at the performance of the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) versus the iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) over the 18 month period. Even with borrowing costs falling over the past year and a half – even with lower rates providing a boost to corporations, households and governments – “risk on” stocks have underperformed “risk off” treasuries. It gets more interesting. The prices on riskier assets like small caps in the i Shares Russell 2000 ETF (NYSEARCA: IWM ), foreign stocks in the Vanguard FTSE All-World ex-US ETF (NYSEARCA: VEU ) and high yield bonds via the SPDR Barclays Capital High Yield Bond ETF (NYSEARCA: JNK ) have fallen even further than SPY. In complete contrast, the price of other risk-off assets – the CurrencyShares Japanese Yen Trust ETF (NYSEARCA: FXY ), the iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ), the SPDR Gold Trust ETF (NYSEARCA: GLD ) have surged even higher than IEF. By the way, 18 months is not arbitrary. That is the period of time since the Federal Reserve last purchased an asset (12/18/2014) as part of its balance sheet expansion known as “QE3.” Since the end of quantitative easing, then, indiscriminate risk taking has fallen by the wayside. Larger U.S. companies may have held up, though the prospect for reward has been dim. Smaller stocks, foreign stocks and higher-yielding assets have not held up particularly well; their valuations may be on their way toward mean reversion. In the big picture, then, are you really going to get sucked in to the idea that low rates justify perpetual increases in stock prices? The evidence suggests that, until valuations become far more reasonable, upside gains will be limited. Additionally, until and unless the Federal Reserve provides more shocking and more awe-inspiring QE-like balance sheet expansion a la “QE4,” where the 10-year yield is manipulated down from the 2% level to the 1% level, low rate justification for excessive risk-taking would be misplaced. What could the catalyst be for indiscriminate risk taking? What could spark a genuinely strong bull market uptrend? Reasonable valuations that are likely to result from a bearish cycle. Fed policy reversal might then force the 10-year yield to 1% or even 0.5%, and we could then discuss how they “justify” still higher valuations than exist in 2016. Nevertheless, unless the Fed has found methods for eliminating recessions outright and permanently inspiring credit expansion, bear markets will still ravage portfolios of the unprepared investor. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.