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Why Now May Be The Moment To Get In On Value

The market’s almost immediate plunge to start 2016 cast a pall over what might have been shiny prospects for a new year, just two weeks from the Fed’s “balanced” assessment of U.S. economic conditions and the first rate hike in nearly nine years. Often forgotten in the doom and gloom is that volatility means down… and up. What intrigues me as a 30+-year value investor is that value stocks have been among the most volatile. And that seemingly has sent investors packing. At the end of 2015, there was $2.7 trillion in growth mutual funds, almost double the $1.5 trillion invested in value mutual funds. This underallocation to value stocks could mean missed opportunity. Let’s look at a hypothetical $10,000 investment in growth, core and value segments over the last decade. We can see where an investor might have missed out in this case. Click to enlarge Opportunity in the making We believe the recent overallocation to and performance strength in momentum and growth sets the stage for investor rebalancing. While the long-term path to value outperformance is not a straight line, and may be marked by alternating spates of value and growth leadership, we fully expect that investors are going to want and need to re-allocate back to value in their portfolios. As shown below, some of the periods of greatest value underperformance are followed by some of the most significant periods of outperformance. While the timing is impossible to predict, it’s not too great a leap to suggest we may be setting up for a rotation in favor of value stocks. Click to enlarge Actively seeking value Beginning in August of last year, the market began to price in weakening global economic conditions. The bearishness tightened its grip in the fourth quarter and early 2016, and as a result, we saw defensive stocks bid up to very full prices as value stocks got cheaper. It seems clear to me that the heightened volatility over this period has created attractive valuations in certain areas of the market. Indeed, by producing dislocations in the market, volatility effectively separates the potential stock winners of the future from underperformers. As the chart below shows, the valuation spreads within sectors are wider than their long-term historic average in many areas of the market. The greater the controversy in the investment case, the greater the dispersion in valuation. That means some stocks are priced low and others high. We are seeing that most acutely in the energy sector. Click to enlarge But buyer beware: Determining which of those low-priced names are true bargains and which are priced low for good reason requires deep understanding of each industry and company. While we approach the market stock by stock, certain areas seem riper for the picking now: Banks. We see banks as less volatile than they have been in the not-too-distant past, characterized by stronger balance sheets and less volatile results. Yet, they are trading at lower valuations. Energy. The key questions here are: 1) when will oil prices bottom and 2) how high will oil prices go in a recovery? We lean to the optimistic side on both. We think oil prices could bottom in the second quarter and head up in the second half of 2016. And while the consensus sees oil recovering to $50-$60 a barrel, our year-end estimate is above $75. But selectivity is important. An investor grab for high-quality, low-risk stocks without regard for valuation or risk/reward has created some attractive long-term opportunities elsewhere in the sector, but a number of stocks in this sector will continue to underperform. Technology. By our analysis, large-cap tech stocks with high return on invested capital are trading at cheap valuations relative to both their history and the broader market, while also generating solid cash. The significant cash balances allow flexibility, and the recent price declines of fast-growing companies may create attractive merger and acquisition opportunities. Healthcare. Despite current market fears, we’ve found a number of interesting stocks that are attractively priced relative to history and compared to the broader market. Healthcare also exhibits better growth and is cheaper than other defensive sectors, such as consumer staples and utilities. The sector benefits from favorable demographic tailwinds (namely, the aging of the population) and continued innovation. Of course, this only scratches the surface. My colleagues and I are excited about the opportunity ahead. Our objective is to work from the bottom up (starting with the individual stocks) to find compelling investment opportunities that are mispriced by the market over a two- to three-year time horizon. We believe the current environment is wildly conducive to that. While we acknowledge China’s overcapacity and economic weakness, we believe the market was overzealous in pricing in the probability of a U.S. recession. In fact, February and early March have shown a reversal in pessimism… and in markets. This has created some attractive investment opportunities. In our assessment, the period of underperformance has produced some bargains and sets the stage for a rebalancing in favor of value. This post originally appeared on the BlackRock Blog.

Bracketology – An Investing Lesson From The NCAA

“Bracketology,” a term coined by ESPN, is the study of the annual NCAA college basketball tournament. Interestingly the art or science of filling out an NCAA tournament bracket also provides insight into how investors select investment assets. Before explaining, we present you with a question: When filling out an NCAA bracket do you A) start by picking the expected national champion and work backward or B) analyze each matchup, and pick winners starting at the earliest rounds, working toward the championship game? In A, one has a pre-determined idea for which team is the best in the country and disregards the path that team must take to become champions. Those using B’s methodology look at each game and consider the participants, compare their respective records, their strengths of schedule, demonstrated strengths and weaknesses, record against common opponents and even how travel and geography could affect performance. In a methodical, rigorous evaluation, the result is a conclusion about which team can win 6 consecutive games and become the national champion. Outcome vs Process Outcome-based investors start with an expected outcome, typically based on prior results, and select assets accordingly. How many times do we hear the gurus of Wall Street preach that stocks return 7% on average and therefore a well-diversified portfolio should expect the same thing this year? Many investors take the bait and few question the rather simple approach that drives the expected outcome and ultimately the investment selection process. Process-based investing, on the other hand, is a tactic to better determine how assets should perform. The method may be based on macroeconomic expectations, technical analysis or a bottom-up assessment of individual companies to name a few. Process investors do not just assume that yesterday’s winners will be tomorrow’s winners nor do they diversify just for the sake of diversification. They create a procedure to help them forecast which assets are likely to provide the best risk/reward prospects and deploy capital opportunistically. “The past is no guarantee of future results” is a common investment disclaimer. However, it is this same outcome-based methodology that many investment managers use to allocate their assets. Process driven investors employ thoughtful analysis to determine what investments should perform the best. Potential outcomes are the ending point of their analysis not the starting point of their work. A or B? So, why would people use a less rigorous process in investing than the one they use in filling out their NCAA tournament brackets? Starting at the final game and selecting a national champion, is similar to identifying a return goal of, for example, 10%. How that goal is achieved is subordinated to the idea that one will achieve it. In such an outcome based approach, decision making is predicated on an expected result. Considering each of the 67 possible match-ups in the NCAA tournament to ultimately determine the winner applies a process-oriented approach. Each decision is based on the evaluation of comparative strengths and weaknesses between teams. The expected outcome is a result of the analysis of factors required to achieve the outcome. Summary Very few filling out brackets this year will pick Duke solely because they won the tournament last year. Many investors, however, will select investments based on what performed well last year. The following table (courtesy invest-assist.blogspot.com and Koch Capital) is a great reminder that building a portfolio based on last year’s performance is a surefire way to ensure you are not making the most out of your portfolio. Click to enlarge Winning or losing a basketball pool has benefits like bragging rights and potentially winning some money. Managing a client’s investments deserves much more thoughtfulness. Those who apply a well thought out process-oriented approach provide their clients a much more rigorous, durable and time-tested method to consistent performance. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

NOBL: An ETF For Dividend Growth And The Quest For Yield

By Max Chen and Tom Lydon Investors seeking a steady yield-generating exchange traded fund to help diversify their portfolios in a volatile year can look to the ProShares S&P 500 Aristocrats ETF ( NOBL ) for quality stock market exposure and sustainable dividends. “By investing in dividend growth strategies, you not only get high-quality companies that have delivered strong total returns, you also get the potential for attractive yield,” according to ProShares . “If you look at effective yield, you’ll see dividend growth strategies have significantly outperformed the broader market.” NOBL, which has accumulated $1.39 billion in assets under management, shows a 2.03% 12-month yield and a 0.35% expense ratio. The dividend ETF has been outperforming the broader equities market. Year-to-date, NOBL rose 5.5% while the S&P 500 index was only 0.9% higher. Over the past year, NOBL increased 4.3% as the S&P 500 dipped 0.6%. NOBL’s 17.2% tilt toward industrials and 10.4% position in materials helped the ETF capitalize on the recent rally in more undervalued sectors of the market. Additionally, the fund holds large positions in more conservative or defensive sectors, including 12.9% in health care and 25.5% in consumer staples. The recent selling pressure in the equities market has also made dividend stock plays more attractive , especially as the Federal Reserve projects only two interest rate hikes this year, compared to previous expectations for four rate hikes. As the S&P 500 index experiences its worst start to a new year since 2009, yield spread between the benchmark and 10-year Treasuries widened to their largest spread in a year. The difference between U.S. equity dividend yields and government bonds can be used as a proxy for valuation comparison between the two assets. On average over the past year, the yield on 10-year Treasuries exceeded that of the S&P 500 dividends by 7.7 basis points. However, the recent volatility helped push yields on 10-year Treasury notes below 2%. NOBL, which tracks the S&P 500 Dividend Aristocrats Index, targets the cream of the crop, only selecting components that have increased their dividends for at least 25 consecutive years. Consequently, investors are left with a portfolio of high-quality, sustainable dividend payers as opposed to more high-yield focused funds that may contain companies on more precarious financial positions. High-yield equity funds can be enticing to income-seeking investors, but the higher yields come with higher the risks and are often unstable, writes Kevin McDevitt, a senior analyst for Morningstar . Alternatively, McDevitt argues that dividend growth is a more important factor for long-term dividend investors. “Dividend growth plays a big role in determining total income over the life of an investment,” McDevitt said. “As a general guideline, the higher a company’s, and by extension a fund’s, yield, the less quickly it will grow over time. Over the short run, this initial yield matters more than dividend growth. But as the time horizon grows, dividend growth has a greater impact on the overall payout.” ProShares S&P 500 Aristocrats ETF Click to enlarge Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.