Tag Archives: alternative

Worry, Worry, What? More Worry?

Summary Once again, stock prices seem headed down. How far? How long? Why? A competent answer to these questions calls for perspective as to where we are now, and where we have been, both recently and at prior extremes. Who can provide that perspective of the past? Our best candidate(s) are folks who bet big money, frequently and constantly, on the near future. Who can answer the questions of the future? Our best suggestion is: “No one, definitively, because surrounding circumstances keep changing.”. But continual monitoring of the near future prospects compared to similar data at prior extremes may be a help. Folks who bet big money constantly on future stock prices They are the market-making [MM] community, acting in the opportunity for their own profit by servicing the intentions of clients managing billion-$ equity investment portfolios. What makes that community different from their clients, besides their forecast time horizon, is that as a group they bet directly against one another at the present moment, and the market for that activity presents useful expectations information. The clients, meanwhile are making bets against one another, but with ill-defined forecast time horizons, in markets not addressed to anything but immediate price discovery – that price which will provide a supply~demand clearing transaction of the moment. One that will simply queue up the next transaction challenge immediately following. Expectations of the transactors are not revealed except as to their preference for cash in comparison to the transaction subject. Where the transactors’ cash has come from, or is going to is an un-answered question. The lack of an answer prevents any further analysis or clues from this line of pursuit. In contrast, it is almost perfectly known where the market-makers cash has come from and is going back to. It is from their own capital (and funding) resources, to be used in providing market liquidity time and again, as the opportunity for them to profit presents itself. It needs to be kept liquid, as unencumbered as possible so it repeatedly can be put to work. Market liquidity is provided both by the MM firms’ block trade desks temporarily positioning (owning, net long or short) the momentary imbalance between buyers and sellers, and by other MM speculators (proprietary trading desks) willing to protect the MM positioners by selling them price-change protection insurance in a hedging deal. The cost of the price-change protection is a market-liquidity cost that is borne by the MM client-fund stock transactors. It is wrapped into in the bid-offer spread required by the to-be-consummated block trade. Both buyers and sellers in the negotiated transaction are impacted by their acquiescence to the transaction. The size of that cost, and the way the hedge deal is structured tells the story of what expectations the market-making community holds about what the clients are likely to do next with the subject stock. They are in communication with their clients constantly during every trading day, as they usually have been on several fronts for many years. The MMs have a pretty good idea of client intentions and action targets, despite client attempts to be obscure. The MM community augments that understanding with the instantaneous communications from a world-wide, local people-supported, 24×7 information-gathering system designed to keep them a step ahead, or at least not materially behind, the clients. We systematically translate the MM hedging actions into near-term price range forecasts. Forecasts with time horizons of the periods required to unwind the several types of derivative security contracts that may be involved in the hedge transactions, often no more than two to three months. Those price range forecasts have the great benefit of simple comparability. The extremes of the forecasts, in conjunction with the current market price, define upside and downside price change prospect limits. The balance between those, as portions of the whole range, are useful indications of near-term future price changes for each subject. Our common denominator for that we label the Range Index [RI]. The RI numeric is the percentage of that subject’s current forecast range between the current price and its lower extreme. RIs can span from over 100 (above the top future forecast) to negative numbers (below the lowest likely price forecast) although such extremes are not common. The smaller the RI, the larger is its upside proportion. For that subject a low RI implies the stock is cheaply priced at this point in time. Let’s check out to what extent there may be some forecast ability in the RI for a given security. We choose as a good example the ProShares UltraPro DOW30 (NYSEARCA: UDOW ), because as an ETF tracking the Dow Jones 30 index it is based on stocks actively being traded by major investment funds. Because the ETF is highly (3x) leveraged, its price changes through time are accentuated and easy to recognize. We will take every market day of the last 5 years, and from each starting point measure by how much UDOW’s price changed progressively, week by week, 5 market days at a time, out to nearly 4 months – 16 weeks, or 80 market days. Those results will be shown in a table with a blue central row that is the average price change trend for the ETF over the last 1261 market days – 5 years. To make comparisons easier between time periods of different lengths, all of the averages will be stated in annual compound growth rates, or CAGRs. Then to see what effect might be provided by knowing what the current-day RI was, we will exclude the likely most frequent RIs, the ones where the upside to downside price change proportions on cheaper days are between 1:1 and 2:1, and for the more expensive forecast days are 1:2. Corresponding RIs would be 33 to 50, and 50 to 66. In our table of price change calculations we will aggregate all the price changes in days with forecast RIs of 33 or lower into a row just above the blue average row. For all the days having RIs above 66 we will create a row of average price changes just below the blue average of all days. Please see Figure 1. Figure 1 (click to enlarge) By continuing this process we can fill out our table of annual rates of price changes at different levels of beginning forecast RIs from zero to one hundred, with those beyond contained in the 100:1 and 1:100 rows. Just don’t get overconfident; it’s not shooting fish in a barrel. The data of Figure 1 are averages of annual rates, meaning some are larger, some smaller, and some are even negative where the data are positive (profits), or may be positive where the data is negative. Figure 2 tells what proportion of the experiences indicated by the #BUYS column are in fact positive. For the whole 5 years’ days, that is a bit better than two of every three measures which offer a long investor the chance to make money. But a loss is taken in every third. Figure 2 (click to enlarge) Yes, the nearly half of forecast days (553 of 1258) with twice as much or more downside price change prospect (1:2 RWD:RSK) have worse odds for gain then the average, as well as negative payoffs. But far better PAYOFFS under better ODDS exist for the long-position players. That doesn’t make investing in UDOW an easy task, even with the MMs help. They’re not GOD. One troublemaker in the assignment is TIME. A great philosopher (at least) once observed: “You only have from now on.” No do-overs in most stock investing. It may be interesting, reassuring, (or scary) to study history, but we can’t go back. Do it NOW or tomorrow, or not at all. But yesterday is out. Another troublemaker was identified by the great philosopher, POGO: “We have met the enemy and he is us.” Stock investing is a more challenging game than chess, because moves by the pieces are not tightly defined. There are rules, and over time they may change some, usually well announced. But the true challenge is in trying to guess what the other side will do, and when they may do it. Each side attempts to anticipate the other, some more stridently. That, combined with time, keeps the game alive. Here is a two-year illustration of how the expectations for coming prices of UDOW by the MM community (the vertical lines) have been followed by actual market quotes (the heavy dots splitting each vertical) Figure 3 (click to enlarge) (used with permission) The colors reflect the imbalances between upside and downside price prospects in each forecast, as defined by the contemporary market quote. When current price is at or close to the bottom of the range, green is seen, and at the top, red. Caution lights appear when price is nearing the top of the range. That guidance is helpful, but not perfect. Please note the “go” signals in mid-August this year before UDOW dropped from mid-60’s to mid-40’s. Still, we perform our standard behavioral analysis on the actions of the MM community because it provides another forward-looking evidence of how significant players in this serious game evaluate not only the other investor players, but all of the fundamentals that go into their decisions and probable actions as well. And by providing a disciplined analysis of their conclusions in a wealth-maximizing portfolio setting, we have an historical background of whether and when the behavioral analysis has provided useful guidance. Here is the update of that analysis for UDOW to Monday’s close, November 16, 2015. Figure 4 (click to enlarge) (used with permission) Figure 4 provides a recalculation of MM forecasts indicating a Range Index of 26, or some three times as much upside price change prospect as price drawdown exposure. The row of data between the pictures tells that past UDOW 26 RIs, 38 0f them in the past 5 years of daily forecasts, have actually experienced worst-case price drawdowns averaging -10.3%. Of those 38, 34 or 89% of them, recovered in price over the next 32 market days sufficient to produce profits (along with the 4 losers) of +6.6%, a CAGR of +65%. Conclusion UDOW is an interesting gauge of market sentiment since its price is driven by a market index of 30 huge-cap stocks making up a part of market capitalization that cannot be ignored in market valuations. Its structured price leverage forces additional attention to the ETF, and conversely back from the ETF onto the market as a whole. No question of which is driven by the other, but they must accompany one another. The perspective UDOW provides at this point in time is that UDOW is an odds-on ETF likely to provide a capital gain at a high rate of CAGR over the next 2-3 months. The question of whether a better opportunity may soon be present is ever present, since prior experiences at present forecast levels have seen -10% further price drawdowns. In terms of unleveraged market indexes, that might be -3% to -3.5%. But there is no sign that a more serious concern is present among folks continuously and seriously addressing the matter. Save powder for a better shot, or go for a bird in hand? It’s your capital; it should be your call.

FDD: Weighing Risk With Return

Top weights ‘best-in-class’ European based global companies. Has traded in a very steady range with steady distributions for over six years. The fund maintains a cyclically sensitive bias, with its heavy weighting on the financial sector. It’s beginning to look as though the “New Normal” will indeed be a new normal for some time to come. With few exceptions, most of the global economy has lost a lot of growth momentum after many years of what seemed like limitless expansion. The most recent Organization for Economic Co-operation and Development (OECD) ‘ Global Economic Outlook ‘ reported that “… A further sharp downturn in emerging market economies and world trade has weakened global growth to around 2.9% this year – well below the long-run average – and is a source of uncertainty for near-term prospects… ” The traditional response to an economic slowdown has always been to increase the amount of cash in the banking system and at the same time lower benchmark interest rates. This in turn lowers consumer and business interest rates. The basic principle behind ‘Quantitative Easing’ is that consumers and businesses would be more inclined to borrow for durable goods, inventory, home buying or home construction and so on, thus creating demand which leads to more hiring. As one might expect, there’s a downside to “QE”. Lowering government benchmark interest rates works its way up the government bond market ladder. So, for example, pension funds will receive lower interest rates when they purchase government bonds which in turn affect their actuarial projections to meet pension payout expectations. Also, when short term savings rates decline, consumers will be less inclined to purchase short term certificates of deposits, hence reducing demand for a popular bank product. Last, but by no means least, is that individual investors will receive smaller distributions from their portfolio’s cornerstone government bond funds. A confluence of events stemming from the credit market collapse in 2008, in addition to the recent economic contraction in the Asia-Pacific region has made most QE programs virtually ineffective. The point of the matter is that the individual investor’s cornerstone fixed income may be safe, but may not contribute meaningfully to the overall portfolio for many years to come. One way to replace the loss of distributions in government bond funds without incurring exceptional risk, is through diversifying among high-quality equity, dividend focused funds. One suggestion would be the First Trust Dow Jones STOXX European Select Dividend 30 Index ETF (NYSEARCA: FDD ) . The underlying index is the STOXX® Europe Select Dividend 30 Index (Zurich: SD3P) which is designed to … track high-dividend-yielding companies, across 18 European countries: Austria, Belgium, Czech Republic, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom… The fund provides relatively good return by any standard: a trailing twelve month yield of 4.45% and an SEC yield of 5.02%. The STOXX index itself has a yield of 5.57%. There is a 0.60% net expense ratio which is much higher than the industry average 0.44%. (click to enlarge) The fund was incepted in August of 2007 closing its first day of trading at $30.75. It had declined considerably since then, tracking the STOXX index down over the years closing November 13, 2015 at $12.42. The Price-Dividend History Chart demonstrates that the fund peaked in October of 2007 at $32.26 per share and declined as housing and credit bubbles deflated, dragging global markets down with them. The fund reached its all-time low of $7.75 a share in March of 2009. It recovered by mid-2009 and has since traded in a steady range from $10.86 to $16.04. The pertinent questions investors should ask is, first, whether the fund is able to continue to produce the steady 4.45% distribution and, second, are the returns worth the risk. The best way to answer these questions is to step through the fund’s holdings sector by sector. First, it’s a good idea to understand the fund’s geographical distribution and then its sector allocation. As the pie chart below demonstrates, the fund is heavily weighted in Europe’s top performing economies, in particular, the United Kingdom, Switzerland France and Germany. Data from First Trust Knowing the geographic allocation, it’s now a good idea to chart-out the fund’s sector distributions. Data from First Trust Clearly, the fund is heavily weighted in Financials. Generally, the financial sector is cyclical, that is, it rises and falls with the economy. On the other hand, the second heaviest weight is in Utilities, a non-cyclical sector; it continues to perform regardless of the economy. Similarly Heath Care is non-cyclical, as well as Consumer Staples. Telecom is considered sensitive to the business cycle; however, mobile communications create efficiencies and productivity so Telecom services might not be as sensitive to the business cycle. Similarly, both the Energy and Industrial Sectors are sensitive to the economy, but not nearly as much as Consumer Discretionary or Materials. It seems that overall, the fund is weighted a bit more towards sectors which rise and fall with the economic tide. As to the degree of sensitivity, that would depend on the individual holdings as discussed below. The financial sector includes Europe’s premier banks, insurance and real estate investment. All of these companies are European multinationals and the top weighted funds of this sector have global reach. Three of the 14 holding have payout ratio in excess of 100% of adjusted earning, and those for which no information was available, a percentage of operating cash flow has been substituted. The average yield of the sector is 4.425%. Excluding extreme or absent values, the rough payout ratio average is 70.5%, high but sustainable. Financials 44.92% Symbol Yield Fund Weight Payout Ratio P/E Debt to Equity 5 Year Dividend Growth Rate Primary Business Amlin PLC OTCPK:APLCY 4.14% 5.76% 90.62% 14.37 17.68 6.19% Enterprise insurance and reinsurance Swiss Re OTCPK:SSREY 7.70% 4.28% 71.57% 9.06 33.10 35.92% Reinsurance, property and Casualty Provident Financial OTCPK:FPLPY 2.91% 4.08% 76.59% 26.43 257.46 9.07% Financial services, personal credit and other consumer lending Zurich Insurance OTCQX:ZFSVF 6.46% 3.98% 517% of cash flow 10.30 35.00 4.71% General insurance, consumer and commercial insurance Swiss Prime Site OTC:SWPRF 4.82% 3.31% 89.65% of cash flow 15.05 82.14 1.38% REIT: office and retail Standard Charter OTCPK:SCBFF 1.52% 3.12% 106.85% 14.06 190.27 6.22% International banking, Islamic banking, private and retail services SCOR OTCPK:SCRYY 3.99% 3.09% 26.51% of cash flow 11.39 43.95 6.96% Reinsurance, life, property and casualty, aviation, marine Allianz OTCQX:AZSEY 4.35% 3.02% 46.96% 10.83 53.82 10.81% Holding company for Allianz, insurance and asset management PSP Swiss Property OTC:PSPSY 3.81% 2.64% 88.91% 23.34 47.77 NA Holding company for real estate investment and management Banco Santander SAN 4.68% 2.58% 117.65% 9.19 240.76 0.80% Retail and Private banking; Asset management and insurance Muenchener Rueckversicherung OTCPK:MURGY 4.32% 2.49% 39.18% 9.11 15.73 6.15% Holding company; business and reinsurance, health and asset mgnt Skandinaviska Enskilda Banken OTCPK:SKVKY 5.18% 2.28% 49.68% 11.44 561.00 36.56% Sweden merchant bank; retail, corporate and institutional banking Unibail-Rodamco OTCPK:UNRDY 3.89% 2.26% 42.66% 12.25 87.70 NA French: commercial real estate investment; European shopping centers Baloise Holding OTCPK:BLHEY 4.18% 1.94% NA 9.54 33.03 2.13% Insurance, banking, retirement services Data from Reuters and Yahoo! Finance The Utility sector accounts for four holdings with an average yield of 6.09%. However, the payout ratios indicate that a few of these companies are distributing dividends nearly equal to or in excess of adjusted earnings. Hence it a strange twist, it seems that the financial sector’ dividend distributions are more stable than the utilities. Utilities 14.36% Symbol Yield Fund Weight Payout Ratio P/E Debt to Equity 5 Year Dividend Growth Rate Primary Business SSE Plc OTCPK:SSEZY 5.92% 4.95% 161.35% 27.09 100.33 4.78% UK mainly electric utility; natural gas distribution and storage Snam SpA OTCPK:SNMRF 5.15% 3.82% 19.10% of operating cash flow 13.75 190.00 4.56% Italian natural gas distribution, treatment, management; owns distribution infrastructure United Utilities OTCPK:UUGRY 3.94% 3.62 94.76 24.12 249.98 1.91% UK water and sewage management Fortum OTCPK:FOJCY 9.35% 2.19% 53.88% of operating cash flow 2.60 44.15 5.39% Finland based delivering electricity and heat and related services. Data from Reuters and Yahoo! Finance The Healthcare sector is solid with two world class, well established pharmaceutical companies: Glaxo-Smith-Kline (NYSE: GSK ) and AstraZeneca (NYSE: AZN ) . The holding BB Biotech (OTC: OTC:BBAGF ) is listed by the fund as a ‘materials company’. However, after double checking with several sources, including the company’s home page, it best described as an investment company specializing in Biotech companies. Since the return is a function of the Heath Care sector it seems logical to include this company with the Health Care sector. Health Care 7.36% Symbol Yield Fund Weight Payout Ratio P/E Debt to Equity 5 Year Dividend Growth Rate Primary Business GlaxoSmithKline GSK 5.82% 4.02% 39.40% 6.85 304.36 5.57% R&D pharma, vaccines, consumer health care. A premier global pharmaceutical company; 84 production facilities in 36 countries AstraZeneca AZN 4.36% 3.33% 141.51 47.89 63.10 4.01% R&D biopharmaceuticals for cardio-vascular, oncology, autoimmunity and more. Premier global in over 100 countries BB Biotech BBAGF 4.02% 2.96 15.84 3.75 0.00 125.74 (Labeled as Materials) Investment Company specializing in Biotech seeking researching Alzheimer’s, HIV, Hepatitis C, hypertension, hematology, diabetes and cancers Data from Reuters and Yahoo! Finance Telecommunication Service seems ‘ordinary’; however one holding, Orange (NYSE: ORAN ) qualifies as an NYSE-ARCA listing. Telecoms often have high payout ratios and that seems to be the case here. Telecom Services 7.23% Symbol Yield Fund Weight Payout Ratio P/E Debt to Equity 5 Year Dividend Growth Rate Primary Business Proximus OTC:BGAOF 3.64% 2.78% 7.973% of operating cash flow 22.54 68.78 -11.57% Belgium landline and mobile, telephony, internet and television Orange ORAN 3.82% 2.32% 110.24 46.42 114.76 -11.53% French serves France, Spain, Poland, Africa and Middle East Swisscom SCMWY 4.31% 2.08% 298% of operating cash flow 15.45 185.67 1.92% Switzerland and Italy: enterprise and residential, broadband, television, data, mobile and landline Data from Reuters and Yahoo! Finance The energy holdings are Royal Dutch Shell (NYSE: RDS.A ) and Total (NYSE: TOT ) . Again, both are leaders in every area of energy and with a far reaching global presence. Energy 7.17% Symbol Yield Fund Weight Payout Ratio P/E Debt to Equity 5 Year Dividend Growth Rate Primary Business Royal Dutch Shell RDS.A 7.24% 4.01% 187.27% 107.49 31.26 2.28% Well-to-Distilled Product-to-End Product global Oil and Gas energy company operating in over 70 countries Total TOT 5.63% 3.13% 195.03% 33.42 44.59 0.42% Well-to-Distilled Product-to-End Product global Oil and Gas company operating in over 50 countries Data from Reuters and Yahoo! Finance BAE Systems (OTC: OTCPK:BAESY ) is a well-respected aerospace-defense company often involved in state-or-the-art defense projects, joint U.S. defense projects and is considered as the premier weapons developer of the U.K. Carillion (OTC: OTC:CIOIY ) seems to operate a unique niche as a global support and service provider for ‘public-private-projects’ construction in aviation, commercial, rail, roads, utilities, and other areas as well. Industrials 6.66% Symbol Yield Fund Weight Payout Ratio P/E Debt to Equity 5 Year Dividend Growth Rate Primary Business Carillion CIOIY 5.73% 3.79% 64.23% 12.42 65.38 3.98% Support Services for public-private partnerships, construction in the U.K., Middle East and North Africa BAE Systems BAESY 4.69% 2.73% 93.44% 19.93 156.72 5.08% Aerospace, cyber security, electronics, and defense with divisions in the U.S. and U.K. Data from Reuters and Yahoo! Finance The last table contains combined, the one consumer staple and the one consumer discretionary companies. Consumer Staples and Discretionary Symbol Yield Fund Weight Payout Ratio P/E Debt to Equity 5 Year Dividend Growth Rate Primary Business J Sainsbury OTCQX:JSAIY 4.83% 5.75% 47.5% of operating cash flow NA 49.94 -1.45% UK Consumer Staples: supermarkets and convenience stores, online grocery and general retail good. Also in joint ventures for banking and insurance UBM OTCQX:UBMPY 4.16% 3.52% 76.36 20.42 80.43 -2.52 UK Consumer Discretionary: B2B media and marketing, communications, tradeshows, live events Data from Reuters and Yahoo! Finance All in all, a common thread seems to be that whatever European ‘best-in-class’ companies qualify under the fund’s objective, then they are included in the fund. First Trust lists the fund’s P/E as 13.27, price to book at 1.44, to cash flow, 10.33 and to sales, 0.84. The average 30 day trading volume is 80,874 so it shouldn’t present too much of a challenge to acquire a position. Overall, the fund seems to be well grounded with those premier holdings; however, it does stretch out a bit on the risk curve with others. The argument may be made that European banks have survived the worst of all possible situations and that, although it may take more time they will regain strength. If so, the fund is like to experience share price gains. There’s only one caveat: ECB President Mario Draghi has indicated that the European Central Bank might further weaken the Euro to stimulate growth. This might be balanced out by the strong Great British Pound Sterling and the Strong Swiss Franc. Also, the U.S. Federal Reserve Bank has also indicated that it might increase, slightly, its benchmark rate, hence creating a stronger dollar. This all might affect the fund’s yield by currency translation but, again, that greatly depends on the size of the Fed rate hike. All in all, the fund might not replace the safety of a government bond fund, but risk-wise, it seems to be on par with muni funds and then with a better yield.

The Natural Gas Market Isn’t Heating Up

Natural gas prices remain low. The storage buildup was 49 Bcf – higher than normal for the season. Extraction season should start in the coming weeks. The rise in production efficiency more than offsets the drop in rigs. Even though the natural gas market is getting closer towards moving from injection to extraction season, the price of natural gas remains low. This upcoming winter is still expected to be warmer than normal. And the rise in efficiency in producing natural gas more than offsets the decline in operating rigs. This trend will keep production higher than last year, which could keep pressuring down the price of natural gas. The recent EIA storage report showed another buildup of 49 Bcf; it wasn’t far off market estimates but was still higher than normal. When it comes to the futures markets, a lot has also changed there, as you can see in the following chart of the differences among prices of near term (next month) and future months. (click to enlarge) Source: EIA Right before the end of October, the contango in the futures markets picked up – an indication for a rise in expected future price of natural gas in the coming months. Since then, however, the contango has contracted and the prices have converged to a narrow spread. This could suggest the market doesn’t anticipate the price of natural gas to sharply rise anytime soon. For holders of the United States Natural Gas ETF (NYSEARCA: UNG ), this could result in a more modest adverse impact from the contango on its pricing with respect to the spot price due to lower roll decay. Looking forward, the market still projects the EIA will report additional buildup in storage next week albeit at a much slower pace; the storage depletion will be reported the following week – at a lower rate than the 5-year average. The EIA, in its recent monthly outlook , expects the U.S. storage will drop to 1,862 Bcf by the end of March – the end of depletion season; this will reflect a modestly lower than average withdrawal from storage due to warmer than normal winter. The EIA projects the overall demand for natural gas will only slightly rise in 2016 compared to 2015 – most of this gain will come in the industrial sector that will offset the decline in power and residential/commercial sectors. But if natural gas prices were to remain this low for a while longer, this may push even further up the demand for natural gas in the power sector, which already is expected to experience a sharp gain in consumption in 2015 of nearly 17%, year on year. These projections don’t vote well for natural gas producers, which have already suffered this year from low oil prices. In terms of rigs, according to the latest update from Baker Hughes , the natural gas rotary rig count fell again by 6 rigs to 193 – nearly 45% lower than the levels recorded last year. Although production has recently declined – as of last week, U.S. natural gas production slipped by 0.5% week over week and is only up by 0.8% for the year – the EIA still estimates production will be up by 6.3% for the year and 2% next year. The higher efficiency of gas producers will more than offset the drop in rig activity. But if prices were to remain this low, this may eventually lead to a slower growth in output as producers scale back on projects and cut capital spending. The natural gas market is likely to remain soft in the near term even as it turns into the extraction season. Unless the winter outlook changes or the number of operating rigs start to tumble down again, prices aren’t expected to rise much higher than their current levels in the near term. For more see: Natural Gas is Still Floating… Barely