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Who Will Win And Who Will Lose When The Fed Raises Rates In December

Summary Analysis of the jobs report. Explains why bonds and other interest rate sensitive investments will suffer. Explains why stock picking through logic and common sense is back. Today, we had great news as the US jobs report finally showed signs that the economy may be improving as 271,000 jobs were created, beating economists’ estimates of 180,000, while the unemployment rate fell to 5% for the first time since 2008. This is where the jobs were created: (click to enlarge) But the most important thing about the report is that the average hourly wage finally spiked up for the first time in a long time. Janet Yellen and her gang at the Fed are going to party this weekend, as the release valve from the tremendous bone crushing stress that the Fed officials have been under has just opened, and this report is all the evidence the Fed will need to raise interest rates (for the first time since 2004) when it meets in December. That means that the party of free money at zero interest rates will finally come to an end. The Fed will start raising rates in December and then will probably start raising rates at about .75% per year for the next 5 to 7 years, bringing interest rates eventually in line with the historical average rates. Who will suffer and who will benefit? Well, those who will suffer are: 1) Anyone owning commodities like gold, silver, oil, etc., as the US dollar (NYSEARCA: UUP ) will continue to rise, and since many of these commodities are priced in US dollars, they will fall. You can see evidence of that in the price of gold (NYSEARCA: GLD ), which just hit a 5-year low today on the news. (click to enlarge) So anyone owning commodities or the companies that mine them (NYSEARCA: GDX ) is in for some serious pain going forward. Now, the only thing that can save commodity producers and miners is if inflation starts its way back up. The Fed has to move quickly as the last time we had such low interest rates was in 1973, and from 1974 to 1980 inflation erupted and interest rates went from 3% to 19% in six years. We are currently in a deflationary period and there is little threat of inflation right now, but the Fed needs to get ahead of the curve and move because hyperinflation is serious business, and if one ever lets that genie out of the bottle, it is almost impossible to curtail it. 2) Bond holders (NYSEARCA: TBT ), insurance companies, dividend investors, car manufacturers and dealers, home builders, realtors, furniture/appliance manufacturers, utilities and companies doing buybacks will start feeling the pain coming up. Since investors will start getting higher interest rates on new bonds issued and with savings deposits at banks, with every quarter-point rate increase by the Fed, those holding older bonds will probably sell them to buy the new ones issued at a higher rate. So, what you will see is the opposite of how refinancing your house works, for example. When you refinance your home, you pay off your old mortgage and get a new lower rate. But when you refinance your bonds, you are looking for a higher rate of interest and thus will sell them to buy the new ones. So those holding older bonds will see investors in those bonds sell them, chasing the higher rate and buying new ones. When they sell, the principal of those older bonds goes down as the yield that each one pays has to match the new bonds. So, if rates keep rising, then more and more people will be selling their bond holdings. The biggest holders of bonds are insurance companies (NYSEARCA: IAK ), so insurers will feel the pain as the products each offers, like annuities, will need to pay higher rates of interest to stay competitive, while the principal value of each companies’ bond holdings will slowly decline. So for insurers, it’s a double-edged sword. Dividend investors will suffer as the army of investors chasing dividends will have another safer option to invest in to get interest (like CDs at banks) so companies such as utilities, master limited partnerships (NYSEARCA: AMLP ), REITs (NYSEARCA: IYR ), etc., will have to raise dividend rates, which means each will have to borrow more at the new higher rates to pay them. As each borrows more, the underlying business suffers as costs increase, but revenues and profits stay the same. In my opinion, interest rates will constantly rise at about .75% per year, thus those companies currently borrowing at zero interest rates will no longer be able to do so and thus will curtail buyback plans and stop raising dividend payouts. Management will actually have to grow their companies’ bottom lines and invest in growth. This action will be a paradigm shift and will spur capital expenditures, which will grow the manufacturing base, and those companies that make industrial equipment (NYSEARCA: IYJ ) may benefit. As interest rates rise, home prices will stop rising and demand will slow as mortgage rates will go up and that will hurt home builders and realtors (NYSEARCA: ITB ) as there will be fewer buyers and a lot more sellers. Those who have been successfully flipping houses will finally find an urgent need to dump their entire portfolios of homes in a hurry. Back in 2009, hedge funds bought millions of homes in foreclosure and have since seen those homes rise in value. I would assume these hedge funds will start flooding the markets by putting those homes all up for sale ASAP. So, if you were thinking of selling your home, you better move it. Utilities (NYSEARCA: IDU ) will start to tank as the only reason investors really buy them is for the dividend yield. Since maintenance CapEx charges on utilities have always been very high, utilities, in order to pay out a dividend, have always borrowed money to do so. Thus, each will suffer as interest rates rise and borrowing costs do so as well. The party for car manufacturers and dealers will soon be over as each will no longer be able to offer zero interest rate financing. I went and bought a new Toyota (NYSE: TM ) Tundra truck recently as I wanted to lock in the rate but will not be buying anything again for ten years. So if you are in the market for a car, go buy it soon. The same goes for furniture and home appliances; lock the rates in because you will not see these sweetheart deals anytime soon. Those who will benefit from rising interest rates are: 1) Stock pickers will benefit as investors start to rebalance their portfolios, removing those industries mentioned above and go for more growth and value investments based on each company’s Main Street operations instead of dividend payouts and buy backs. I have not been in a rush to buy anything as I knew this scenario and major paradigm shift was coming and that the markets would be effected as a rebalancing of portfolios will start soon. The companies I have bought have extremely high free cash flow and thus are not going to be much affected by rising interest rates. Most of them are duopolies like Lockheed Martin (NYSE: LMT ), Boeing (NYSE: BA ), Visa (NYSE: V ) and MasterCard (NYSE: MA ), while others operate with very little, if any, debt at all like FactSet (NYSE: FDS ) Biogen (NASDAQ: BIIB ), Michael Kors (NYSE: KORS ), Gilead Sciences (NASDAQ: GILD ) and Accenture (NYSE: ACN ) and have FROICs of 30% or higher. For those interested in more information on how I picked those stocks, you can find out more by going HERE . I also own Apple (NASDAQ: AAPL ) and here is my Friedrich Research on it that shows you why I bought it: (click to enlarge) Multinational firms may suffer due to the strong US dollar, so the smart investor may want to concentrate on those companies that buy supplies or have products manufactured outside (like Apple does) of the US, as the stronger dollar will buy more bang for the buck while those who export will suffer as customers overseas will be buying less as their currencies weaken. Going forward, what is coming up will be a stock pickers’ dream market, where those who should outperform are those who actually do the research and due diligence to get the story right. Investors will no longer be able to buy anything and watch it go up automatically, as the rising tide will now just be calm water and will no longer lift all boats. Investors will need to buy the right stocks and get the story right. The free ride of markets backed up by the Federal Reserve’s zero interest rates will be officially over when the Fed raises rates in December. The next few months will be a rebalancing of portfolios toward growth and value investing instead of index/dividend/buyback investing. Analysts, portfolio managers and stock brokers are now going have to actually work for a living as the free ride of just putting their clients’ money in index funds, bonds and ETFs and watching them go up every day automatically (as more and more people pile in) will no longer be profitable as the party there is over. As a result, more and more people will become confused at this paradigm shift, as most of them were not investors prior to 2004 and don’t know what a rising interest rate cycle is like. Once the Fed starts raising rates, it usually raises for 5 to 7 years, but the Fed will be raising for at least that much this time around, as it is starting from zero and that’s a long way away from the historical average rate. So, in conclusion, the tide will now start rolling out and you will finally see those who are naked and without a clue on how to invest, as they can no longer rely on the Fed Tide lifting all boats. Momentum investors will get crushed as those companies that buy other companies with zero debt will finally not be able to do so anymore, so mergers and acquisitions will come to a screeching halt as will IPOs. As for me, I am very excited as I will be using my Friedrich algorithm and slowly building a strong portfolio of growth/value investments that I can hold for a while as the Fed begins its moves in December. Those who will benefit are those who use logic and common sense, and more importantly, who know what they own and why. With the Fed out of the picture, as of December, logic and common sense should rule the day.

Lipper Fund Flows: Mass Exit For Money Market Funds

By Patrick Keon Lipper’s fund macro-groups (including both mutual funds and exchange-traded funds [ETFs]) suffered net outflows for the first time in five weeks, with over $8.1 billion leaving their coffers during the fund-flows week ended Wednesday, November 4. Money market funds (-$13.8 billion) accounted for the majority of the net outflows, while taxable bond funds (-$100 million) also posted negative numbers. Equity funds (+$5.7 billion) and municipal bond funds (+$63 million) both had net inflows for the week. The S&P 500 Index (+0.57%) and the Dow Jones Industrial Average (+0.50%) both recorded positive performance numbers for the trading week. These numbers capped a month in which both indices recorded their largest monthly percentage increases since October 2011; the Dow was up 8.5% for October, while the S&P 500 appreciated 8.3% for the month. October’s stellar performance came on the heels of two consecutive down months that saw the S&P 500 give back 8.9% in total and the Dow retreat 8.0%. October’s rally could be largely attributed to the easing of global growth fears (which were the main impetus for the meltdown of the prior two months), thanks to the European Central Bank’s indicating it is considering more quantitative easing and China’s economy looking more stable. The Federal Reserve continued to jawbone the market with additional hawkish comments about the potential for an interest rate hike in December. Despite data suggesting a cooling economy should weigh against any moves in December (weak third quarter GDP of 1.5%, a drop in pending home sales for the second consecutive month, and consumer spending recording its smallest increase in eight months), Federal Reserve Chair Janet Yellen continued to prepare the market for a possible rate increase next month. Yellen stated that a rate hike in December would not inhibit the recovery and continued to point to low unemployment and growth in the inflation rate as the key determining factors. This past week’s net outflows for money market funds (-$13.8 billion) were largely attributable to institutional money market funds (-$14.1 billion). The week marked the second week in the last three the group has suffered net outflows. Similar to the prior week, equity ETFs were once again responsible for the overwhelming majority of the net inflows (+$4.0 billion) for the equity group, while equity mutual funds did increase their contribution to $1.7 billion. On the ETF side, Lipper’s Financial Services Funds (+$1.3 billion) and Science & Technology Funds (+$814 million) classifications were the largest contributors to the positive flows, while for mutual funds nondomestic equity funds (+$931 million) accounted for slightly more of the net inflows than did domestic equity funds (+$791 million). Mutual funds were responsible for all the net inflows for taxable bond funds (+$1.5 billion), while ETF products saw over $1.6 billion of net outflows. Lipper’s High Yield Funds and Core Bond Funds classifications (+$1.2 billion and +$494 million, respectively) recorded the two largest net inflows on the mutual fund side. For ETFs two Treasury products had the largest individual net outflows: iShares 1-3 Year Treasury Bond ETF ((NYSEARCA: SHY ), -$1.1 billion) and iShares 7-10 Year Treasury Bond ETF ((NYSEARCA: IEF ), -$247 million). Municipal bond mutual funds took in $53 million of net new money – for their fifth consecutive week of positive flows. Funds in Lipper’s national municipal bond fund classifications (+$30 million) contributed the most to the week’s net inflows.

The Time To Hedge Is Now! 700 Percent Profits On Men’s Wearhouse

Summary Introduction and a brief overview of the series. 700 percent profit since August. Taking profits or riding a little more? Discussion of the risks of employing this strategy versus not being hedged. Back to Bear Rally = Another Chance! Introduction and Series Overview If you are new to this series you will likely find it useful to refer back to the original articles, all of which listed with links in this instablog . In the Part I of this series I provided an overview of an inexpensive strategy to protect an equity portfolio from heavy losses in a market crash. In Part II, I provided more explanation of how the strategy works and gave the first two candidate companies to choose from as part of a diversified basket using put option contracts. I also provided an explanation of the candidate selection process and an example of how it can help grow both capital and income over the long term. Part III provided a basic tutorial on options. Part IV explained my process for selecting options and Part V explained why I do not use ETFs for hedging. Parts VI through IX primarily provide additional candidates for use in the strategy. Part X explains my rules that guide my exit strategy. All of the above articles include varying views that I consider to be worthy of contemplation regarding possible triggers that could lead to another sizeable market correction. I want to make it very clear that I am not predicting a market crash. Bear markets are a part of investing in equities, plain and simple. I like to take some of the pain out of the downside to make it easier to stick to my investing plan: select superior companies that have sustainable advantages, consistently rising dividends and excellent long-term growth prospects. Then I like to hold onto to those investments unless the fundamental reasons for which I bought them in the first place changes. Investing long term works! I just want to reduce the occasional pain inflicted by bear markets. We are already past the average duration of all bull markets since 1920. The current bull is now longer in duration (nearing 82 months) than all but two bull markets during that time period (out of a total of 15). The three longest bulls prior to this are 1949-1956 (70 months), 1921-1929 (97 months), and 1990-2000 (117 months). So, I am preparing for the inevitable next bear market. I do not know when the strategy will pay off, and I will be the first to admit that I am earlier than I suggested at the beginning of this series. I feel confident that the probability of experiencing another major bear market continues to rise. It may have started already or it may not come until 2017, before we take another hit like we did in 2008-09. But I am not willing to risk losing 30-50 percent of my portfolio to save the less than two percent per year cost of a rolling insurance hedge. I am convinced that the longer the duration of the bull market the worse the resulting bear market will be. I do not enjoy writing about the potentiality of down markets, but the fact is: they happen. I don’t mind being down by as much as 15 percent from time to time; that is just a hiccup in the buy-and-hold investing strategy. But I do try to avoid the majority of the pain from larger market drops. To understand more about the strategy, please refer back to the first and second articles of this series. Without that foundation, the rest of the articles in this series may not make sense and could sound more like speculating with options rather than an inexpensive way to protect your portfolio against catastrophic loss. 1220 percent profit since August I originally recommended buying puts on Men’s Wearhouse (NYSE: MW ) back in my August Update to this series. The stock was then trading at a price of $58.49 per share. Friday, after the company slashed its outlook for the current quarter on weaker-than-expected sales, the shares closed at $22.65 per share. In August I recommended buying two put options expiring in January 2016 with a strike price of $0.75 or less for each $100,000 in equity portfolio value. The bid premium at that time was $0.55 and the ask premium was $0.75. If one was patient it was possible to buy those put option for even less that the $0.55 bid premium not long after the article was published. Today, those MW $45 put options are trading at a premium of about $6.00. If we assume the worst case scenario of buying the put options at the ask premium of $0.75, then the profit that is available today is 700 percent [($6.00 – $0.75) / $0.75]. My target price of $25.00 was achieved. Thus, I am suggesting that those who ventured into this positions at my earlier recommendation consider what to do next. This one is likely to continue to be very volatile for the next few days and weeks. Taking profits now or riding a little longer? There may be more profit available, but sometimes it does little good to get greedy. The stock could just as easily rebound next week and leave us wishing we had taken profits. However, it should be noted that if the stock were to remain at this level through the January 20th expiration date, the value of the put option would rise to $22.00. If the stock rebounded by 25 percent between now and then, rising to about $28.50, the options should expire at about a $16.50 premium for a potential profit of 2,100 percent. There is a tradeoff to be considered. Do we take the profit now and cover the cost of our other hedge positions or do we hold onto the position to maintain the insurance coverage and hope that the stock remains depressed for 2½ months? That is a decision each investor needs to make for themselves. For my own portfolio, I intend to take some of the profits on part of my position and let the rest ride. My sense is that MW could linger below $30 until January unless management guides higher due to increased holiday sales. But such an announcement is not likely to come until mid-December or later, so there is still plenty of time to weigh our options (pun intended). I want to emphasize that this strategy is not a get rich quick plan. It is a hedge strategy to provide insurance against a major bear market. When I have the opportunity to take some profits and reduce the cost of my hedging strategy, I will often take at least some of what the market gives me. When one of our candidates implodes as MW just did and like MU and TEX did for us previously, it is prudent to take advantage of situation. I have tried to be clear from the beginning that the strategy has the potential to cost less than one percent of a portfolio value per year for this very reason. Any one of the candidates has the potential to surprise big to the downside over the life of the hedge, thereby helping to offset part or all of the cost of the hedge in any given year. It only takes one good plunge surprise to pay for the most of the cost of our total hedge for a year. The MW situation is just one more example of how that works. If an investor decides to employ this hedge strategy, each individual needs to do some additional due diligence to identify which candidates they wish to use and which contracts are best suited for their respective risk tolerance. I do not always choose the option contract with the highest possible gain or the lowest cost. I should also point out that in many cases I will own several different contracts with different strikes on one company. I do so because as the strike rises the hedge kicks in sooner, but I buy a mix to keep the overall cost down. To build such positions one would need to follow future articles as I provide the best option contracts on the best candidates each month. I build my own positions from the positions listed in the articles. Discussion of the risks of employing this strategy versus not being hedged. I want to discuss risk for a moment now. Obviously, if the market continues higher beyond January 2016 all of our earlier option (except JNK ) contracts could expire worthless. I am not ready to roll positions yet, but will probably when the open interest on contracts expiring in May, June and July have reached at least 50 or more. We need some liquidity to be able to move in and out of positions when necessary. I have never found insurance offered for free. We could lose all of our initial premiums paid plus commissions. If I expected that to happen I would not be using the strategy myself. But it is one of the potential outcomes and readers should be aware of it. And if that happens, I will initiate another round of put options for expiration in July 2016 or January 2017, using from one to two percent of my portfolio to hedge for another year. The longer the bulls maintain control of the market the more the insurance will cost me. But I will not be worrying about the next crash. Peace of mind has a cost. I just like to keep it as low as possible. Mine is a unique hedging strategy. But it is not the only hedging strategy that can work. Each investor needs to consider which strategy makes the most sense for their own purposes. The main reason I am writing these articles is raise the awareness of investors that hedging is a prudent part of an overall investment strategy. One does not need to be hedged at all times; that would be overkill and far too expensive. But when the equities market has been hovering at all-time record highs for months and the bulls have been in charge for as long as is the case in the current environment, investors need to consider whether they can stand another bear market without protecting against those losses. Because of the uncertainty in terms of how much longer this bull market can be sustained and the potential risk versus reward potential of hedging versus not hedging, it is my preference to risk a small percentage of my principal (perhaps as much as two percent) to insure against losing a much larger portion of my capital (30 percent or more). But this is a decision that each investor needs to make for themselves. I do not commit more than two percent of my portfolio value to an initial hedge strategy position and have never committed more than ten percent to such a strategy in total. The ten percent rule may come into play when a bull market continues much longer than expected (like five years instead of two or three). And when the bull continues for longer than is supported by the fundamentals, the bear that follows is usually deeper than it otherwise would have been. In other words, at this point I expect a correction greater than the original 30 percent that I originally forecast. If the next recession does not begin until the second half of 2016 or 2017, I would expect the next bear market to be more like the last two. If I am right, protecting a portfolio becomes ever more important as the bull market continues. As always, I welcome comments and will try to address any concerns or questions either in the comments section or in a future article as soon as I can. The great thing about Seeking Alpha is that we can agree to disagree and, through respectful discussion, learn from each other’s experience and knowledge.