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Why The S&P 500 Is Likely To Revisit The Correction Lows Near 1870

In spite of the Fed’s decision to refrain from a borrowing cost hike, SPY’s price movement strongly suggests the ultra-accommodating policy of zero percent interest rates may be inadequate. We’re likely heading back to the recent low point for the current year. The reality is that our recovery is stalling and has been since the end of the Fed’s quantitative easing stimulus. In Selling The Drama Or Buying The Rally (8/27), I delineated the way in which 10%-plus price corrections had unfolded under similar circumstances in history (e.g., 1998, 2010, 2011, etc.). Specifically, when the prospects for the global economy are deteriorating, U.S. stock benchmarks typically reclaim about one-half of their losses on “hope rallies.” Afterwards, they retest their lows. The most recent example of the price movement phenomenon is the eurozone crisis. In late July/early August of 2011, the S&P 500 SPDR Trust ETF (NYSEARCA: SPY ) plunged 16% due to fears surrounding economic malaise and financial credit concerns in Portugal, Italy, Greece and Spain. The popular ETF then recovered one-half (nearly 8%) of its price decline in late August/September before revisiting new lows in early October. At that point, the European Central Bank (ECB) and the Federal Reserve dropped market-moving hints about extraordinary stimulus measures, effectively ending the panicky price depreciation. In the same vein, the present corrective phase for SPY stopped short at roughly 12%. The popular ETF then retraced about one-half of the price erosion (6%) on two recent occasions. And now, in spite of the Federal Reserve’s decision to refrain from a borrowing cost hike (probably for 2015 in its entirety), SPY’s price movement strongly suggests that the ultra-accommodating policy of zero percent interest rates may be inadequate; that is, we’re likely heading back to the recent low point of the current year. Shouldn’t the Fed’s September decision to hold off any increases in borrowing costs have catapulted the U.S. stock market higher? Shouldn’t we have seen speculative buying demand for riskier assets like high yield bonds and growth stocks? Not when the U.S. has been contending with a sharp slowdown in exports, manufacturing activity as well as consumer sentiment. Not when the Atlanta Fed forecasts anemic GDP of 1.5% for the third quarter. And not when chairwoman Janet Yellen acknowledges the absence of wage inflation as well as the the presence of labor troubles via the labor participation rate. Prior to the rapid-fire declines for the Dow, S&P 500 and Nasdaq in mid-August, I detailed these economic concerns in extraordinary detail. I highlighted the dreadful manufacturing data in the Philly Fed Survey as well the Empire State Manufacturing Survey in 15 Warning Signs Of A Market Top . On, July 30th, I pointed to economic weakness in both the U.S. and across every region of the globe as being one of 5 reasons to lower one’s allocation to riskier assets . Going into yesterday’s (9/17) monumental Fed decision, traders had been positioning themselves for further delay on an increase in borrowing costs. They got it. And yet, they got more than they had bargained for. Not only did the Fed highlight weakness in the global economy as a potential threat to the domestic economy, but they shot down the notion of so many economists and analysts that the U.S. economy is standing on “terra firma.” For amusement, revisit what the overwhelming majority of journalists and media personalities had been saying about the strength of the U.S. economy. After, glance at the analysis and commentary a day later. The chief economist at Natixis Asset Management explained that the Fed’s decision not to act demonstrates that committee members of the central bank clearly think that the U.S. economy is “very weak.” Oh really? Now the economy is very weak? Or how about Dan Veru, chief investment officer at Palisade Capital Management, explaining that the Fed doesn’t want to be responsible for possibly unraveling a “fragile recovery.” Fragile recovery? After six-and-and-a-half years? Wasn’t this the great U.S. expansion that was perfectly capable of a modest move away from the emergency level zero bound? Sometimes, the truth hurts. The reality is that our recovery is stalling and has been since the end of the Fed’s quantitative easing stimulus. This truth is painful for everyday Americans. The fact that corporate sales and earnings growth are both on the decline also stings because, absent a more definitive Fed commitment to zero rate policy or more stimulus or a sloth-like token hike, riskier assets are likely to struggle. In essence, at certain correction levels, the Federal Reserve tends to take certain actions and/or make certain statements to boost market confidence. That level for the S&P 500 is near 1870. Obviously, I cannot know that the S&P 500 will revisit 1870, but I believe it is far more probable than not. Let me repeat. I anticipate the broader S&P 500 retesting the lows of the current correction, though it is impossible for any person to predict the direction of stock assets. For those moderate growth/income investors that have been emulating the tactical asset allocation that I do for actively managed clients, we are maintaining the lower risk profile of 50% equity (mostly large-cap domestic), 25% bond (mostly investment grade) and 25% cash/cash equivalents. This has been the case since we began reducing risk exposure in June-July. The typical target allocation for moderate growth/income of 65%-70% stock (e.g., large, small, foreign, domestic) and 30% income (e.g., investment grade, high yield, short, long, etc.) will not be reestablished until market internals and fundamentals show signs of improvement. Popular holdings for the 50% equity component? We have ETFs like iShares S&P 500 (NYSEARCA: IVV ), iShares USA Minimum Volatility (NYSEARCA: USMV ), SPDR Select Health Care (NYSEARCA: XLV ) and Vanguard Mid Cap Value (NYSEARCA: VOE ). Funds like USMV and VOE have weathered the storm better than many of the leading market-cap-weighted benchmarks. 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.

Be Careful When Investing In Low-Beta Stocks

Summary Beta is a common measure of a stock’s risk, and investing in low-beta stocks (low-risk stocks) has become a highly popular investment strategy among institutional investors today. Our new research shows that betas significantly change over time and seem to depend on the stocks’ ownership structure and how frequently the stocks trade. Low-beta stocks are often thinly traded; when investors buy into low-beta stocks, both their prices and betas increase. The opposite can occur when investors try to exit. Increases in institutional ownership breadth and the stocks’ turnover temporarily increase the stocks’ CAPM beta. The figure below shows the regression coefficients when future changes in stocks’ betas are regressed on changes in ownership breadth and turnover. Solid lines give the regression coefficients; dashed lines present 95% confidence intervals. Source: P. Jylhä, M. Suominen and T. Tomunen, “Beta Bubbles,” working paper 2015 Betting against beta All MBA and finance students learn in their basic finance courses the Capital Asset Pricing Model (CAPM), a theory largely attributable to the Nobel Prize winner William Sharpe. This theory states that riskier assets in equilibrium should earn higher returns, and that the relevant measure for a stock’s risk should be its “beta,” a measure of the stock’s systematic risk. Technically, a stock’s beta equals its correlation with the stock market index, scaled by the ratio of its volatility to the market index volatility. All well in theory, but in practice the CAPM has failed miserably. In real life, stocks with the higher risk measures, i.e., the high-beta stocks, have over the recent decades systematically earned lower returns than the low-beta stocks. In fact, investing in low-beta stocks has become a highly popular investment strategy in the financial market, one that is today aggressively marketed to all major institutional investors. Be careful: Betas do not measure what you think they measure In a recent working paper “Beta Bubbles,” written together with Petri Jylhä from Imperial College and Tuomas Tomunen from Columbia University, we suggest a potential reason why the logically well-motivated CAPM fails to work in practice. Most importantly, we show that the stock’s beta in reality seems to measure not only the stock’s level of risk, but also how frequently it is being traded. We study the US stock markets (NYSE and NASDAQ) starting from 1970s, and calculate the stocks’ betas annually from daily data using the Scholes-Williams (1977) method. We find that the low-beta stocks are commonly held by few passive long-term investors. These stocks have low average turnover; in fact on nearly 70% of the days, their trading volume is less than 0.1% of the stocks’ market capitalization. Intuitively, these stocks are so rarely traded that they rarely co-move with the market . This does not necessarily mean that the low-beta stocks are less risky, just that the traditional risk measure beta fails to measure their risk. The low-beta stocks are more prone to jumps, i.e. large market revaluations of their value. High-beta stocks, in turn, are owned by active, short-horizon investors that continuously trade and monitor the market. These short-horizon investors’ entry and exit from the stock market seems also to occur in tandem with the returns of the entire market. For both reasons, stocks owned by short-horizon investors co-move highly with the market. As the high-beta stocks are also more widely held, their risks are more evenly distributed amongst investors and the investors require less return from holding them. Hence the poor future returns to the high-beta stocks. Importantly, the stocks’ betas change over time as the stocks’ popularity changes. For instance, 20% of the stocks in the lowest-beta decile (the 10% of the stocks with the lowest beta) had an above median beta in the previous year. When a stock goes out of fashion and institutions sell the stock, we find that its beta declines. When a stock becomes popular among the active institutional investors, its beta rises. Low beta bets make sense – but prudence required The stocks in the lowest-beta decile are on average thinly owned and thinly traded. As many of them are unpopular among investors today, they, in principle, make up for great investments. However, as the low-beta investing has now become a popular investment theme, there is large risk that an investor investing in low-beta stocks today is in for a big surprise. The investor may find that the prices of low-beta stocks run up as he tries to take positions in these stocks. After all, these are commonly illiquid and thinly-traded stocks. Secondly, they may find that these stocks’ betas increase, as according to our working paper, the betas are a function of the investor population and the betas increase as the number of investors increase. Thirdly, the investors investing today in low-beta stocks should be expecting that these stocks’ prices drop vastly when all the investors following the low-beta investment theme today eventually try to get rid of their former low (now higher) beta stocks. So indeed, there is reason to be careful with your low-beta bets. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

National Grid Offers Both Capital Appreciation And A Steady Stream Of Dividends

Summary Utility companies are usually in the spotlight whenever dividends are mentioned. National Grid is one of those rare companies that offers a steady dividend stream and a slice of capital appreciation for investors. With a footprint in the U.K. and U.S., this company has a very extensive network of transmission wires and gas pipelines. The company’s financial position definitely warrants a consideration for investors who are in search of both security and income. This hidden gem has been missed out by the majority of the market. Investors who come on board today stand to profit greatly. Introduction With what is happening lately in the market, it is very easy to get distracted by all the noise that is surrounding the business world and lose track of the great businesses that are serving people. As I combed the market for bargains, I picked up on one that will not only offer investors a good return on its capital appreciation but also delivers a steady and growing dividend. National Grid (NYSE: NGG ) is just that kind of a company. This is a business that has a solid balance sheet and is delivering a steady stream of cash flow to investors. Business Overview National Grid owns electric transmission wires and gas pipelines. Its stock offers a better risk to return proposition for the long-term investor. Most investors in today’s market would prefer a stock that dishes out a 5% dividend, brings about a moderate amount of risk and the chance to profit on capital appreciation as uncertainty plagues the global market. The company’s competitive advantage lies largely in its extensive network of transmission wires in the U.K. and Northern U.S. Although this business sounds like a typical utility company, there is more than meets the eye for investors as the company starts to dig deeper into what it owns and how it operates. Transmission and Distribution National Grid functions coordinates and enables the flow of electricity in both England and Wales but not in the U.S. Consumers simply pay a fee to the company in order to have the rights to use the system. This revenue structure enables National Grid’s income to be not only very stable but also predictable. Although it does not possess the toll-like characteristics in the U.S., the company has some very valuable assets and serves nearly 4 million customers. Transmission grids are often linked to one another so that electricity can flow from one state to another. Right now, the company is planning on expanding its network into Iceland, Belgium and other parts of Europe as well. As the assets of the company grow, it will be able to fetch more revenue which will allow it to expand even more, and the positive cycle repeats itself. In the U.K., National Grid owns and operates the National Transmission System, which is a gas infrastructure. The company has a distribution network that serves at least 11 million customers, along with a collection of liquefied natural gas importation terminal and storage facilities. Despite being known by many as a utility company that generates power (with the exception from the power plants in New York), National Grid earns a buck whenever power is being transmitted through the lines it owns. This toll-like business model should give investors seeking a predictable return some comfort and certainty as the majority of risk is now shifted to the power producers. What investors need to keep in mind is that much of its transmission grids are wearing out and it is almost time for the company to reinvest and repair its infrastructure. Knowing that this would be a very capital-intensive project, the company charges a high price to consumers so as to generate sufficient revenue to finance new projects and repair old ones. Most of National Grid’s revenue is fixed and dependent on the amount of assets we are looking at here. As the business and its infrastructure grows, so will the predictable stream of income. As the energy arena keeps progressing, changes are blind to happen. The U.K. has determined that utilities would need at least $300 billion in order to keep up with that change. The company has laid out an 8-year plan to invest in its assets and currently, it is in the second year of that plan. As a result of this, the company is expecting that its regulated assets will grow by approximately 5% to 6% in the U.K. over the next few years. I think that the company has made a wise move in investing in its U.K. assets as it churns the lion’s share of its operating income. In the U.S., the company is upgrading its gas and electricity systems and that will ensure that it will keep turning a steady stream of profit in the long run. Financial Position If one were to look at the balance sheet of any utility company, he or she would realize that it is more or less the same in terms of the amount of debt it has and the margins it generates. Over the coming years, I would not expect to see a drastic change in finances for the company. With expansion plans on the line, the company should be able to grow steadily at a low single-digit pace. Lastly, the dividend would likely hold steady and shareholders can sleep well at night as the company will continue to dish out dividends with a 5% yield. Potential Short Circuit In a utility business, there are two key factors investors need to keep an eye on to know whether or not the company is able to scale: demographic growth and regulation. In terms of demographic growth, it isn’t very robust in either U.S. or the U.K. On the regulatory aspect, the relationship between National Grid and regulators isn’t a bad one. However, if the relationship sours, investors might have a reason to worry. For now, investors can remain comfortable as the business is financially strong and that it can withstand the market’s volatility. Over the long run, I do not foresee people using lesser electricity. Even if solar power was to come into play, it would still require the grid and transmission lines (to a certain extend) to run on. I believe the company has ample time to adjust to the changing market and temporary hiccups should not cause a knee-jerk reaction for long-term investors. Conclusion In a market where interest rates are almost negligent, most investors would be thrilled to find a company that yields a 5% dividend while offering a chance for capital appreciation at the current price. I would recommend investors take a close look at National Grid and see how it can charge up your portfolio. Disclosure: I am/we are long NGG. (More…) 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.