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Fixed Income – Now Is Not The Time

The Seeking Alpha ETF Investing Guide I recently reviewed the Seeking Alpha Investing Guide and decided to allocate part of my portfolio to a core portfolio of ETFs, similar to that suggested by the guide. I do not intend to completely switch course from my current allocation but to set up a separate core portfolio of ETFs and to allocate a majority of my investments to this Core ETF portfolio over time. After reviewing the investing guide, I drafted a procedure for implementing the suggestions of the guide. Currently, I am reviewing each of the suggested ETFs to determine which to buy. Readers that have read the articles on the first five recommended ETFs are aware that I plan to invest in the sectors that they represent. This article focuses on the three recommended ETFs from the fixed income portion of the Core ETF portfolio: iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEARCA: LQD ) PowerShares 1-30 Laddered Treasury Portfolio ETF (NYSEARCA: PLW ) Schwab U.S. TIPS ETF (NYSEARCA: SCHP ) At this point, I am not inclined to invest in these ETFs, or the fixed income sectors these represent. I expect to keep funds I have allocated for this portion of my portfolio, invested in shorter-term bank certificates of deposit (cd’s) that offer similar interest rates with what I believe is far less risk of capital loss. Investment synopsis of the three fixed income funds The iShares iBoxx $ Investment Grade Corporate Bond ETF seeks to track the investment results of an index composed of U.S. dollar-denominated, investment grade corporate bonds. LQD provides exposure to a broad range of over 1000 U.S. investment grade corporate bonds. LQD can be used by investors seeking stability and income. The PowerShares 1-30 Laddered Treasury Portfolio is based on the Ryan/NASDAQ U.S. 1-30 Year Treasury Laddered Index. The Fund will normally invest at least 90% of its total assets in securities that comprise the Index. The Index measures the potential returns of the U.S. Treasury yield curve based on approximately 30 equally weighted U.S. Treasury issues with fixed coupons, scheduled to mature in a proportional, annual sequential (“laddered”) structure. The Schwab U.S. TIPS ETF goal is to track as closely as possible, before fees and expenses, the price and yield performance of the Barclays U.S. Treasury Inflation Protected Securities (( OTC:TIPS )) Index (Series L). SCHP provides a convenient, low-cost way to capture the performance of U.S. Treasury Inflation Protected Securities. SCHP provides exposure to a portfolio of treasury securities designed to offer protection from the negative impact of inflation while assuming exposure to interest rate risk. US treasury 10 year interest rate chart – 1962 to present Click to enlarge Source: Yahoo Finance (2/13/2016) The chart above shows US treasury 10 year interest rates since 1962. After peaking in 1981, interest rates have fallen steadily to their current rate of 1.75%. Interest rates were slightly lower for a short period in 2012 but other than that, they are at the lowest point over the 50 plus years shown. While I have felt the same way for some time, as interest rates have continued to fall, I would not be comfortable investing in medium or long-term bonds at current interest rates. In the past, I have found that when I make investments that I am not comfortable with, I have a very hard time holding them. Performance of LQD, PLW and SCHP compared to the S&P 500 since June 2002 Click to enlarge Source: Yahoo Finance (2/13/2016) The chart above shows the performance of the three fixed income ETFs versus the S&P 500. LQD had the longest history going back to 2002 and over this time is up 11% versus the S&P up 103%. The chart does not include interest or dividends, which would improve the relative performance of the fixed income ETFs versus the S&P 500. Performance of LQD, PLW and SCHP compared to the S&P 500 – 5 year chart Click to enlarge Source: Yahoo Finance (2/13/2016) The chart above shows the performance of the three fixed income ETFs versus the S&P 500 over the last five years. Again the S&P 500 has outperformed the 3 fixed income ETFs and again this chart does not include interest or dividends, which would improve the relative performance of the fixed income ETFs versus the S&P 500. ETFs in the US corporate bond category ETFs in the US treasury bond broad duration category ETFs in the US treasury inflation protected category Source: Seeking Alpha (as of 2/13/2016) Above are lists of the top 10 fixed income ETFs in each of the categories represented by the three recommended ETFs. Each category is listed by assets under management (AUM). As the tables show, there are a number of alternatives that interested investors can consider in each category, except the “treasury bond broad duration” category which only lists 2 ETFs on Seeking Alpha’s ETF Hub. Fund characteristics iShares iBoxx $ Investment Grade Corporate Bond ETF PowerShares 1-30 Laddered Treasury Portfolio ETF Schwab U.S. TIPS ETF Weighted average duration (years) 7.98 10.34 7.5 Weighted average maturity (years) 12.28 15.84 8.3 SEC yield (%) 3.73 2.49 0.02 Expense ratio (%) 0.15 0.25 0.07 Source: iShares by BlackRock, Powershares and Schwab (as of 12/31/2015) The fund characteristics are shown in the table above. I consider these characteristics versus a bank certificate of deposit (cd). Bankrate.com currently shows a one year cd at 1.30% and a five year cd at 2.27%. I do not feel that the potential yield improvement justifies the additional risk associated with the additional time to maturity, duration and the default risk of the corporate bonds. Other investors may be in a different position and see this differently. Conclusion Readers that have read the articles reviewing the first five recommended ETFs from Seeking Alpha’s ETF Investment Guide are aware that I plan to invest in the sectors that these ETFs represent, either in the recommended ETF or a very similar ETF. I do not feel the same way about the recommended fixed income ETFs, iShares iBoxx $ Investment Grade Corporate Bond ETF, PowerShares 1-30 Laddered Treasury Portfolio ETF and Schwab U.S. TIPS ETF. After peaking in 1981, US ten year treasury bond interest rates have fallen steadily to their current rate of 1.75%. Although others may feel differently, I would not be comfortable investing in ETFs made up of medium or long-term bonds at current interest rates. In the past, I have found that when I make investments that I am not comfortable with, I have a very hard time holding them. At this point, I am not inclined to invest in the three recommended fixed income sectors or ETFs: iShares iBoxx $ Investment Grade Corporate Bond ETF PowerShares 1-30 Laddered Treasury Portfolio ETF Schwab U.S. TIPS ETF I expect to keep funds I have allocated for this portion of my core ETF portfolio, invested in shorter-term bank certificates of deposit (cd’s) that offer similar interest rates with what I believe is far less risk of capital loss. I expect to review this periodically and consider investing in these ETFs and sectors when long-term interest rates have increased from current levels. Addendum Seeking Alpha’s Investment Guide Core ETF Portfolio ETF Ticker Fund Name Fund Description Expense Ratio VOO Vanguard S&P 500 ETF Large cap US stocks 0.05% IJH iShares Core S&P Mid Cap ETF Mid cap US stocks 0.12% VTWO Vanguard Russell 2000 ETF Small cap US stocks 0.15% IEFA iShares Core MSCI EAFE ETF Multi cap foreign developed market stocks 0.12% IEMG iShares Core MSCI Emerging Markets ETF Multi cap emerging market stocks 0.18% LQD iShares iBoxx $ Investment Grade Corporate Bond ETF US investment grade corporate bonds 0.15% PLW PowerShares 1-30 Laddered Treasury Portfolio ETF US Treasuries 0.25% SCHP Schwab U.S. TIPS ETF US TIPS 0.07% VNQ Vanguard REIT Index ETF US REITs 0.10% DBC PowerShares DB Commodity Index Tracking ETF Broad commodities 0.85% Simply Investing – Philosophy Establishing a core portfolio in well-diversified, low expense ETFs, held for the long term, is a good idea for most all investors. The core of a small portfolio can start off as simple as one well diversified global ETF with a low expense ratio, like Vanguard Total World Stock ETF (NYSEARCA: VT ). Typically, as the portfolio grows, the core of the portfolio would include exposure to the ten asset classes listed above. There are four steps needed to set up an efficient investment plan. The decisions and actions required to set up the plan and purchase the ETFs can be done in about 4 hours (see the further reading section below for more details): Decide on an asset allocation plan among the ETFs in the core portfolio. Open an online brokerage account with a linked online bank account. Determine if you will invest all your investment funds at once or over a period of time. Determine which investments to buy in your taxable and tax deferred accounts. The core ETF portfolio outlined above, after tax, should significantly outperform either individual stock picking or a portfolio managed by a financial advisor. Over the typical investors time horizon of 40+ years, the expected advantage of this core ETF portfolio is staggering. Investors that enjoy the investment analysis process and are willing to spend the time to analyze and invest in individual stocks or sectors can still do this. I believe, the majority of these investors should still set up a core ETF portfolio, but can allocate a small, fixed percentage of their portfolio to “edge” positions, which offer additional risk and opportunity. Further reading ETF Investing Guide – Written by Seeking Alpha’s Founder in 2006 is a great guide for setting up a portfolio of ETFs. Set Up A Core ETF Portfolio Now – Describes the four steps required to implement the suggestions in the ETF Investing Guide. The ETF Investing Guide is made up of 54 articles and takes some time to read and assimilate the information. This article condenses the information from the guide down to four steps that can be completed to set up a core ETF portfolio in around four hours. Disclosure: I am/we are long VT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

MLPs: A Great Opportunity In The Near Future, Just Not Yet

Home Portfolio News Articles StockTalk Marketplace PRO Seeking Alpha WHERE DO YOU WANT TO GO? Seeking Alpha home page » My portfolio page » Latest Financial Analysis & Opinion » TOP NEWS Apple drags down futures Boeing stung by big guidance cut Apple lower after mixed results, light guidance Mortgage applications move higher again Biogen tops estimates Mixed earnings report from UTX Toyota remains world’s top-selling automaker See latest news » TOP ARTICLES My Top 10 Monthly Dividend Stocks: Updated Apple’s (AAPL) CEO Tim Cook On Q1 2016 Results – Earnings Call Transcript Wall Street Breakfast: Equities Cautious Ahead Of Fed Facebook For Investors? Introducing SA Social 5 Huge Misunderstandings About The Current Investing Environment Why Dip Buyers Will Get Clobbered: The U.S. Economy Isn’t Doing ‘Just Fine’ Why MannKind Is Heading Towards Bankruptcy All That Matters From AT&T Earnings Two Harbors’ MSR Black Hole Evaluating Bankruptcy Risk In The Energy Sector Using Altman’s Z2-Score Top Authors   |      RSS Feeds   |  Sitemap   |  About Us   |  Contact Us Terms of Use | Privacy | Xignite quote data | © 2016 Seeking Alpha

Sector Investing: Why It Matters

This was originally published on December 29, 2015 Within the S&P 500, there are 10 sectors that comprise the key benchmark, and it remains my preferred way of dissecting the market for clients, and giving clients an orderly structure or framework to think about the giant morass that is the capital markets. The primary tool for analyzing sectors for clients remains the excellent sector earnings work done by Thomson Reuters and FactSet, as well as Howard Silverblatt of Standard & Poor’s, and Estimize (although Estimize has a narrower focus than the other firms) which is shared every week on this blog for readers. (Sam Stovall of Standard & Poor’s wrote a book on sector investing that was published in 1996. I just found the book on Amazon and bought it for some holiday reading this weekend.) Why worry about sectors? Well, give this a little thought: The bull market in the S&P 500 that ran from August 1982 to March of 2000 was dominated by two sectors: Technology and Financials. A lot of the old market pundits and the so-called gurus from the 1990s used to say that “The Financials are the market generals” and there was real truth to this. The Financials were the S&P 500’s primary market leader in the 1980s and 1990s. The S&P 500’s decade-long bear market from 2000 through 2009, the decade with the lowest average return for the S&P 500 since the 1930s, was a result of brutal bear markets in two sectors (guess which sectors): yes, Financials and Technology. Technology came first, with the Nasdaq correcting 80% from March 2000 through October 2002, and then the mother-of-all sector corrections with Financial stocks correcting (looking at the Financial Select Sector SPDR ETF (NYSEARCA: XLF )) from $38 to the $6 area from mid-2007, though late 2008, early 2009. Technology as a percentage of the S&P 500’s total market cap hit a peak of 33% in the first quarter of 2000 (really unbelievable when you think about it) and Financials hit their peak in mid-2007. I thought that Financials had gotten close to 30% as a percentage of the S&P 500’s market cap, but from looking at historical data, maybe Financials’ peak total of the S&P 500 was closer to 25% rather than 30%. The reason the Energy bear market hasn’t really impacted the S&P 500 like the Technology and the Financials’ collapse is that when crude oil started to fall from $110 to today’s $35-$37 per barrel, Energy as a percentage of the market cap of the S&P 500 was just 10%. It is now roughly 6.5% today. As the above implies, “Size (in terms of market cap) Matters”. Three bear markets: Technology, Financial and Energy – all sector-driven. Here is our latest spreadsheet where we updated sector weightings ( FC – marketcapvsearningswt ). As readers can see from this spreadsheet, Technology and Financials remain the two largest sectors within the S&P 500 at 37% of the S&P 500, and since they had their absolutely crushing bear markets in the last decade, what are the odds (in your opinion) that Technology repeats 2000-2002 or Financials’ 2007-2009? 20% corrections can happen at any time for a variety of reasons, but would a reader think that Financials and Technology could correct 30% or 40%? Here are the sector weightings for the S&P 500 as of late December 2015 (courtesy of Bespoke, rounded to the nearest 1%): Technology: 21% Financials: 16% Health Care: 15% Consumer Discretionary: 13% Industrials: 10% Consumer Staples: 10% Energy: 6%-7% Utilities, Materials, Telecom: 3% each The top 5 sectors of the S&P 500 are 75% of the market cap of the S&P 500. The top sectors which we’ve discussed at length are 37%. Consumer Discretionary’s 10% return year to date is heavily influenced by Amazon (NASDAQ: AMZN ) since the stock is a member of the Consumer Discretionary sector. Bespoke has noted that without Amazon’s 140% return year to date, Consumer Discretionary would be up just 2%-3% in 2015. Conclusions about 2016: Given the above, and the Technology and Financials’ weights, I just don’t think there is a sustained bear market in our future. Technology and Financials remain the largest sector overweights for clients coming into 2016. I’m leery of Health Care in a Presidential election year. I do like Industrials in 2016 IF the dollar can remain right where it is, or weaken a little. The biggest change to client accounts in the last 4 months has been adding the Energy Select Sector SPDR ETF (NYSEARCA: XLE ), and the iShares U.S. Energy ETF (NYSEARCA: IYE ) to client accounts with the market correction in August-September. We haven’t had any Energy exposure for years. There is more owned now than at any time in the last 5 years. Also bought in September, early October were the Vanguard FTSE Emerging Markets ETF (NYSEARCA: VWO ), and the iShares MSCI Emerging Markets ETF (NYSEARCA: EEM ), or the Emerging Markets ETFs. The underperformance of emerging markets relative to the S&P 500 the last 7-8 years has been remarkable. We have never owned Emerging Markets for clients before these positions. Finally, I took a shot at some Brazil (NYSEARCA: EWZ ), the last month. Brazil is the confluence of Energy risk, commodity risk, socialism, and inept incompetence, in one ETF. There is an approximate weighting of 5% in Energy, Emerging markets and Brazil in client accounts, depending on a number of other factors.