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What Assets Should You Have In Your Moderate Portfolio?

With flat to slightly negative returns, one could make the case that the static Ibbotson model for diversification is working just fine. On the other hand, the more that one has minimized the downside risk of investment canaries in the financial mines, the more one has been able to relax. Based on the evidence, moderate growth investors who choose an allocation of 60% in large-cap U.S. stocks and 40% investment grade U.S. bonds are likely to outperform the static Ibbotson model in the near-term. If market internals continue to deteriorate and if the macro-economic backdrop continues to weaken, a tactical asset allocation decision to reduce the risk of exposure to extremely overpriced U.S. stocks may be called for. Ibbotson Associates provides asset allocation guidelines that span the risk spectrum from conservative to aggressive. The moderate portfolio consists of roughly 42% in U.S. Stock, 18% in Non-U.S. Stock, 35% Fixed Income and 5% in Cash. It follows that the static Ibbotson model might employ the following ETFs to achieve its moderate growth and income aim: With flat to slightly negative returns, one could make the case that diversification is working just fine. On the other hand, the more that one has minimized the downside risk of investment canaries in the financial mines – high yield credit, emerging markets and smaller corporations – the more one has been able to relax. An allocation of 60% in large-cap U.S. stocks (NYSEARCA: SPY ) and 40% investment grade U.S. bonds (NYSEARCA: BND ) improved performance to 1.6% – a swing of 240 basis points. An argument in favor of diversification across asset class segments is that, if one holds recommended percentages for the next 20 years, recent underperformers will provide value down the road. Moreover, the combination of the above-mentioned asset types performed better than an ethnocentric large-cap-only allocation (60% S&P 500, 40% Barclays Aggregate Bond Index) over the previous 20 years. Here’s the problem: There are times when the breakdown in an asset grouping and/or an influential sector(s) of an economy is symptomatic of larger issues for market-based securities. For instance, the collapse of the banking system in 2008 had been telegraphed by financial stock woes nearly a year beforehand. The Financial Select Sector SPDR ETF (NYSEARCA: XLF ):S&P 500 SPDR Trust ETF ( SPY ) price ratio had been highlighting the rapid-fire demise of financial stocks relative to the broader benchmark. (Note: Back in 2007, “ex Financials” was the popular excuse offered to dismiss S&P 500 overvaluation; in 2015, many are using “ex Energy” to justify S&P 500 overvaluation.) There’s more. Even as SPY notched new record highs in October of 2007, other asset groupings did not recapture highs set in July of 2007. Small companies via the iShares Russell 2000 ETF (NYSEARCA: IWM ) did not make it back. In the fixed income space, preferred shares via the iShares U.S. Preferred Stock ETF (NYSEARCA: PFF ) were weakening as well. In the last year of the previous bull market (2007), lightening up on smaller companies, higher-yielding preferred shares as well as the financial sector benefited investors. Here in 2015, lightening up on smaller company stock ( IWM ), foreign developed stock (NYSEARCA: EFA ), emerging markets (NYSEARCA: VWO ) and high yield bonds (NYSEARCA: HYG ) has also been beneficial. For one thing, each of these asset types sits below long-term 200-day averages – a bearish sign for these asset classifications. Secondly, even when one excludes energy from the high yield bond picture, “ex Energy” spreads have been diverging from the S&P 500 throughout the year. Based on the evidence, moderate growth investors who choose an allocation of 60% in large-cap U.S. stocks and 40% investment grade U.S. bonds are likely to outperform the static Ibbotson model in the near-term. One might consider spreading the large-cap exposure across several ETFs such as the iShares Core S&P 500 ETF (NYSEARCA: IVV ), the iShares S&P 100 ETF (NYSEARCA: OEF ), the Technology Select Sector SPDR ETF (NYSEARCA: XLK ), the iShares Russell 1000 Growth ETF (NYSEARCA: IWF ) and iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ). I have had virtually no allocation to small caps, high yield bonds or emerging market stocks during this late-stage bull market. All of those areas remain mired in long-term technical downtrends. In addition, I have only 25% allocated to investment grade bonds with another 15% in cash/cash equivalents. If market internals continue to deteriorate and if the macro-economic backdrop continues to weaken , a tactical asset allocation decision to reduce the risk of exposure to extremely overpriced U.S. stocks may be called for. Make no mistake about it… large-cap U.S. stocks are overpriced. Year-over-year, corporate earnings have fallen from a height of $106 on 9/30/2014 for the S&P 500 to the most recent estimate just shy of $91 (October 2015). That is a decline of approximately 14%. The earnings contraction over multiple quarters with the TTM P/E Ratio at 22.7 is well above the average since 1870 of 16.6. For those who would rather embrace Forward P/Es, Birinyi Associates at WSJ.com estimates a value of 17.4. This implies that $91 is going to be $121 in the next 12 months. Short of a miraculous revival in energy demand, 33% earnings growth is not particularly plausible. Even a forward P/E of 17.4 is 25% higher than the 35-year average forward P/E of 13. Overvaluation by itself is not a reason to reduce exposure to large caps. A late-stage bull market could continue for several more years; highly priced can become exorbitant. That said, if an economic slowdown becomes an economic standstill, and if the number of large company stocks holding up the market-cap weighted indexes further retrenches, reducing one’s overall equity profile and raising one’s cash level is sensible. Keep in mind, positions that haven’t been working (e.g., high yield bonds, small caps, emerging markets, etc.) will probably cause even greater pain when the market falls. It is critical to keep losses small. Similarly, it is constructive to exercise a methodical approach to raising cash as a late stage bull market carries on. Having some cash available is the way to purchase investments at a better price in the future. Indeed, there’s a reason that one of the premier rules for investing rule is “Sell High, Buy Low.” For Gary’s latest podcast, click here . 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.

Beat U.S. Manufacturing Woes With These Industrial ETFs

The brisk momentum in the U.S. economy seemed to have taken a brief halt to start December as the economy’s manufacturing activity for November shrunk to below a six-year low. Contraction in manufacturing activity came after three years. Almost an eight-year high greenback and steep spending cuts in the energy sector to resist the stubbornly low oil prices were held responsible for this dropdown. However, other economic readings and solid auto sales confirmed that the economy is well on its growth path. The Institute for Supply Management (ISM) reported that the benchmark of domestic factory output declined to 48.6 from 50.1 in October. The data missed economists’ expectations of 50.5. Notably, a reading of below 50 indicates a contraction in activity. The measure for new orders slipped to 48.9, more than a three-year low level. The prices paid index dropped to 35.5 from 39 and fell shy of the expected 40. However, construction spending rose 1% to a seasonally adjusted $1.11 trillion rate, which is the highest level in almost eight years. Market Impact Since the offhand data sparked off concerns regarding the economic health of the U.S. to some extent, the dollar fell from its multi-year high level and PowerShares DB US Dollar Bullish ETF (NYSEARCA: UUP ) lost 0.5% on the day. The little confusion offered the gold ETF SPDR Gold Shares (NYSEARCA: GLD ) a short-lived respite as the fund added about 0.4% on the day. The benchmark U.S. 10-year Treasury note yield dropped to a one-month low of 2.15% as of December 1, 2015, giving iShares 10-20 Year Treasury Bond ETF (NYSEARCA: TLH ) a 0.7% nudge. The possibility of a slower rate hike trajectory (if the Fed shoots the lift-off this month) and a slimming manufacturing activity at the threshold of a rising rate environment left investors edgy. However, along with several other analysts, even we believe that this latest blow to ISM data is more the result of the soaring greenback, the one-and-a-half year long oil price rout that handicapped the entire energy sector and lower demand from abroad due to global growth issues. The underlying current in the U.S. economy seems pretty decent. ETFs to Watch Investors should also note that the stocks were fairly steady after the weak industrial data. Still, some investors may want to take a closer look at the industrial ETFs. Though industrial ETFs have underperformed so far this year, they’ve held their head high in the key trading session. Below, we highlight four ETFs which are still strong bets in an apparently-lagging sector. First Trust RBA American Industrial Renaissance ETF (NASDAQ: AIRR ) This fund provides exposure to the small and mid cap stocks in the industrial and community banking sectors by tracking the Richard Bernstein Advisors American Industrial Renaissance Index. The index first eliminates the stocks from the Russell 2500 Index that aren’t connected to manufacturing or related infrastructure and banking. Then it eliminates companies with non-U.S. sales greater than or equal to 25% and positive 12-month forward earnings estimates. For the banking component, only banks in traditional manufacturing hubs will be included in the holdings list. The approach results in a basket of 37 securities, which are widely spread out across components with none holding more than 4.35% of assets. The fund is often overlooked by investors as depicted by its AUM of $44.9 million and average daily volume of about 19,000 shares. The Zacks Rank #3 (Hold) fund charges 70 bps in fees per year and has lost 1.3% so far this year, but was up 0.7% yesterday. ARK Industrial Innovation ETF (NYSEARCA: ARKQ ) This is an actively-managed ETF seeking long-term capital appreciation by investing in companies that benefit from the development of new products or services, technological improvements and advancements in scientific research. Autonomous vehicle is the top industry in the fund with 33% exposure followed by robotics (31%) and 3D printing (23%). This approach results in a basket of about 40 stocks. The product has accumulated $13.8 million in its asset base and charges 95 bps in fees per year. The fund is down 0.5% in the year-to-date frame but added over 0.2% on December 1, 2015. iShares U.S. Industrials ETF (NYSEARCA: IYJ ) IYJ tracks the Dow Jones U.S. Industrials Index to provide exposure to 212 U.S. companies that produce goods used in construction and manufacturing. The fund is heavy on General Electric (NYSE: GE ) (10.7%). The ETF manages an asset base of $605 million and trades in an average volume of 82,000 shares. The fund is slightly expensive with 43 basis points as fees. It rose 0.4% on December 1, 2015 and is up over 0.5% so far this year. The fund has a Zacks ETF Rank #2 (Buy). Vanguard Industrials ETF (NYSEARCA: VIS ) This fund follows the MSCI US IMI Industrials 25/50 index and holds about 345 securities in its basket. The fund manages nearly $2 billion in its asset base and charges only 12 bps in annual fees. Volume is moderate as it exchanges roughly 105,000 shares a day on average. Aerospace has the top sector exposure with 23.3% weight followed by industrial conglomerates (19.6%). The Zacks Rank #3 product has lost 1.6% so far this year (as of December 1, 2015) but advanced 0.6% in the key trading session. Original Post