Tag Archives: consumer

The Crash Of China Is A Myth

Summary “Crash” of China’s economy is a U.S. headline manufactured myth. What I didn’t see in China this week. China A Share market is still up 35% in past year vs. a decline for S&P 500. Major Emerging Markets ETFs (EEM, IEMG, VWO) are dominated by State Owned Enterprises from the legacy managed economy and part and parcel to failed efforts to manage the stock market. Now is the time to think of buying BABA, BIDU, JD, WUBA, YY and other Ecommerce companies that may be best way to invest in the future of consumption. Before reading please know that I am conflicted. I am the founder of EMQQ The Emerging Markets Internet & Ecommerce Index, which has been licensed as the basis for an ETF (NYSE: EMQQ ). I also have an economic interest in several other China ETFs including NYSE listed YAO, HAO, TAO CQQQ. My Recent Trip to China Tuesday I returned to San Francisco after spending eight days in the Chinese cities of Shanghai, Hangzhou and Nanjing. From the headlines in US newspapers prior to my departure, I might have expected to find a country in turmoil and crisis. Indeed this expectation was reinforced in the week prior to my trip as no less than five “non-investment” people – including my mother – asked me about the “crash” of China. The sensational media coverage seemed to reach a peak the day before my departure as the Wall Street Journal reported that President Xi himself had “botched” the stock market and a CNBC reporter made the quite extraordinary claim that Premier Li Keqiang may “lose his job” because of the stock market declines. Was it possible that the 30 year secular trend of growth in China had reversed since I last visited in April? Here is what I saw: · Shanghai. The city was as frenetic as ever. Tens of thousands crowded the Bund, perhaps hundreds of thousands packed the shopping street Nanjing Road. Restaurants were packed. No signs of a crisis. · Hangzhou. Scenic West Lake, a top tourist attraction in Jiangsu province, welcomed throngs of tourists. Tour buses packed with tourists from around the country clogged the roads and parking lots around the lake. Families strolled the shores, young people took picturesque selfies to post on WeChat. No signs of turmoil. · Nanjing. The city wall and Xuan Wu Gate were also packed with families and tour groups. The constant thumping of construction equipment could be heard in the background constantly as the city continues the work of adding lines to the metro system that serves its 8 million inhabitants. No signs of a collapse. My last day in China I had breakfast with a Shanghai-based Partner at of one of the world’s leading consulting firms. This person has lived in China for 30 years and knows more about the Chinese economy, its businesses and its people than nearly any other expert you can find. While he acknowledged that China continues to struggle with its transitions from a state dominated economy to a private sector economy and from an economy based on manufacturing to an economy based on consumption, his comments reinforced my belief that the “crisis” that populates the headlines of U.S. media is a mirage. It’s not real, it’s not there. The Chinese economy is slowing, but this is not news. The slowing of China’s GDP growth rate has been a fact of life since I first became immersed in China 10 years ago. It’s part of China Economics 101 and is simply the law of large numbers. China will continue to “slow” for the foreseeable future but will still likely grow at a pace 2-3 times that of the developed world for years. Furthermore, should it be required, the Chinese Government has significant tools and resources at its disposal to combat weakness in the “real economy”. The China Stock Market Correction To be sure, China’s stock markets have had a very volatile and negative 12 weeks. The Chinese domestic A Share stock market has undergone a significant correction at best and “crash” at worst. The awkward and clumsy market intervention by the Chinese government was, for good reason, widely criticized and seen as a step backwards in China liberalizing their markets and economy. However, such interventions are not unique to China. In fact, U.S. markets – and many ETFs in particular – were whipsawed only two weeks ago, as regulations and trading curbs instituted by our government in response to the 2010 “flash crash” went awry leaving many ETFs trading at significant discounts to their Net Asset Values (NAVs). And let’s not forget, the China A share market remains up over 30% in the past 12 months vs. a loss for the S&P 500. Even those with a short rear view mirror should see that while the drop was dramatic, it was preceded by a similarly dramatic speculative bubble and is still in positive territory over past year. And let us also acknowledge that there were parties in China warning against the type of speculation that resulted in the spectacular fall. Indeed, the China Securities Regulatory Commission (CSRC) warned investors in December of 2014 that they should “invest rationally, respect the market, fear the market, and bear in mind the risks present.” Buy Fear Most of my friends and colleagues know that while I am active in the ETF marketplace, I am a Warren Buffett groupie at heart. I “pray towards Omaha”. One of my favorite Buffett lines is that “you pay a high price for a cheery consensus”. The opposite of that is that you get your best buys when there is “blood in the streets”. Buy Fear. Sell Greed. Corny yes, but true. By all accounts China “fear” has never been higher with western investors. Buy What? One of the major problems with investing in China and Emerging Markets is that the major indexes and the ETFs that track them are dominated by state owned, legacy, inefficient and often corrupt companies. And it’s not just China that has this problem. Anyone that has followed the PetroBras disaster in Brazil should understand why these companies should be avoided. Yet, a full 30% of the largest Emerging Markets ETFs (VWO &EEM) are invested in State Owned Enterprises (“SOEs”). Many of the Chinese SOEs were part and parcel of the “botched” efforts to prop of the market and instructed to buy their shares or those of other SOEs. Investors seeking to take advantage of the fear that permeates the China investment landscape should look for the parts of the equity markets that will benefit from the long term secular increase in consumption. These sectors include traditional Consumer sectors and also the Ecommerce and Internet sectors that are benefiting both from the increase in consumption and from the spread of smartphones and mobile broadband. While the legacy manufacturing economy is slowing, retail sales posted 10% growth in the most recent quarter. The growth in the Internet and Ecommerce sector remains over 35% today and should remain high even if the broader economy in China slows further. While a year ago investors were clamoring for Alibaba (NYSE: BABA ) it has been kicked to the curb and is, as I write this, trading at near all-time lows. Other Ecommerce names haven’t fared much better as BIDU, JD, WUBA and others have all seen dramatic declines in their share prices. These are the types of companies that investors should be buying now. Unlike the stocks that dominate the indexes, these stocks trade in the U.S. and are not subject to Chinese market interventions or the erratic behavior of mainland China’s retail investors. These companies are also entrepreneurial and much more focused on shareholder returns than SOEs are. In fact, many of these companies including BABA, JD and YY have announced share repurchase programs to take advantage of the dramatic decline in share prices. This may not be the bottom. These stocks could go much lower. However, long term investors seeking exposure to Emerging Markets equities ought to consider these companies or ETFs that track these sectors. Repeat, I am conflicted. I am the founder of EMQQ The Emerging Markets Internet & Ecommerce Index, which has been licensed as the basis for an ETF . I also have an economic interest in several other China ETFs including NYSE listed YAO, HAO, TAO CQQQ. Disclosure: I am/we are long BABA, BIDU, WUBA, YY, JD. (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.

SCZ: Do You Need Some International Small-Cap Companies For Your Portfolio?

Summary SCZ has over 1500 holdings across the globe which appear to give it great internal diversification. The term “across the globe” might be overly optimistic since over 50% of the holdings are in two locations. The weakness for SCZ is that SCHC and VSS both offer materially lower expense ratios and more holdings for enhanced diversification. Since SCZ has a beta higher than 1, it has to be expected to generate fairly substantial returns. On top of the high beta raising required returns, SCZ also needs to be able to beat out SCHC and VSS to justify the high expense ratio. One of the funds I analyzed for exposure to international markets is the iShares MSCI EAFE Small-Cap ETF (NYSEARCA: SCZ ). I’ll be performing a substantial portion of my analysis along the lines of modern portfolio theory, so my goal is to find ways to minimize costs while achieving diversification to reduce my risk level. By reducing risk at the portfolio level investors can get their best shot at producing alpha. Expense Ratio The expense ratio for SCZ is .40% for both gross and net expense ratio. That may not seem bad for international small-cap equity and an ETF with 1555 holdings. However, investors should be aware that they also have options in the Schwab International Small-Cap Equity ETF (NYSEARCA: SCHC ) and the Vanguard FTSE All-World ex-US Small-Cap ETF (NYSEARCA: VSS ). SCHC has an expense ratio of .18% and 1645 holdings. VSS has an expense ratio of .19% and 3352 holdings. It should be no surprise that I see SCHC and VSS as the strong front runners for this kind of portfolio exposure. In the interest of full disclosure, while I don’t have a position in any of these ETFs yet, I do have a pending limit-buy order on SCHC. That order is quite a ways under the current share prices and is only intended to activate if share prices start falling hard again. Geography The geography of the exposure is important in considering international equity options. The chart below demonstrates the exposure for SCZ. Japan and the United Kingdom only represent over 50% of the market capitalization of the holdings in SCZ. I’d like to see more exposure around the globe. This is international and I’m okay with excluding China since I’ve been bearish on their market for months, but I’d like to see a few more continents included. Aside from the concentration being so heavily focused on the top two options, I don’t see any other problems there. Sector Exposures The following chart has the sector exposures within the ETF: I’m not seeing this as a huge problem, but it seems interesting that the exposure is so heavily focused on a few categories again. If it were reasonably possible, I’d like to see better diversification across the industries as well as across the globe. International ETFs are usually plagued by having fairly high levels of volatility and more diversification within the sectors might reduce that volatility some. On the other hand, when financial markets exhibit significant stress factors, it is common for correlation levels to increase throughout international markets so even more diversification in the holdings might not make a material difference in the volatility. Building the Portfolio This hypothetical portfolio has a moderately aggressive allocation for the middle aged investor. Only 30% of the total portfolio value is placed in bonds and a third of that bond allocation is given to high yield bonds. This portfolio is probably taking on more risk than would be appropriate for many retiring investors since the volatility on equity can be so high. However, the diversification within the portfolio is fairly solid. Long term treasuries work nicely with major market indexes and I’ve designed this hypothetical portfolio without putting in the allocation I normally would for REITs on the assumption that the hypothetical portfolio is not going to be tax exempt. Hopefully investors will be keeping at least a material portion of their investment portfolio in tax advantaged accounts. The portfolio assumes frequent rebalancing which would be a problem for short term trading outside of tax advantaged accounts unless the investor was going to rebalance by adding to their positions on a regular basis and allocating the majority of the capital towards whichever portions of the portfolio had been underperforming recently. (click to enlarge) A quick rundown of the portfolio The two bond funds in the portfolio are the PIMCO 0-5 Year High Yield Corporate Bond Index ETF (NYSEARCA: HYS ) for high yield shorter term debt and the iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ) for longer term treasury debt. TLT should be useful for the highly negative correlation it provides relative to the equity positions. HYS on the other hand is attempting to produce more current income with less duration risk by taking on some credit risk. The Consumer Staples Select Sector SPDR ETF (NYSEARCA: XLP ) is used to make the portfolio overweight on consumer staples with a goal of providing more stability to the equity portion of the portfolio. The iShares U.S. Utilities ETF (NYSEARCA: IDU ) is used to create a significant utility allocation for the portfolio to give it a higher dividend yield and help it produce more income. I find the utility sector often has some desirable risk characteristics that make it worth at least considering for an overweight representation in a portfolio. The core of the portfolio comes from simple exposure to the S&P 500 via the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ), though I would suggest that investors creating a new portfolio and not tied into an ETF for that large domestic position should consider the alternative by Vanguard’s Vanguard S&P 500 ETF (NYSEARCA: VOO ) which offers similar holdings and a lower expense ratio. I have yet to see any good argument for not using or another very similar fund as the core of a portfolio. In this piece I’m using SPY because some investors with a very long history of selling SPY may not want to trigger the capital gains tax on selling the position and thus choose to continue holding SPY rather than the alternatives with lower expense ratios. Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. Despite TLT being fairly volatile and tying SPY for the second highest volatility in the portfolio, it actually produces a negative risk contribution because it has a negative correlation with most of the portfolio. It is important to recognize that the “risk” on an investment needs to be considered in the context of the entire portfolio. To make it easier to analyze how risky each holding would be in the context of the portfolio, I have most of these holdings weighted at a simple 10%. Because of TLT’s heavy negative correlation, it receives a weighting of 20% and as the core of the portfolio SPY was weighted as 50%. Correlation The chart below shows the correlation of each ETF with each other ETF in the portfolio and with the S&P 500 . Blue boxes indicate positive correlations and tan box indicate negative correlations. Generally speaking lower levels of correlation are highly desirable and high levels of correlation substantially reduce the benefits from diversification. Conclusion SCZ is the most volatile investment in the portfolio when viewed in isolation as it has a volatility level of 18.7%. That problem is compounded by the high correlation between SCZ and the S&P 500. The combination leads SCZ to having a beta of 1.06% which is unfavorable. Under modern portfolio theory the only way to get risk adjusted returns on SCZ is for it to be outperforming the S&P 500 over the long run since it is increasing portfolio volatility. Will it outperform the S&P 500? I have no idea. The better question would probably be: “Will it outperform SCHC and VSS?” In that regard, I’m skeptical. It certainly could happen but SCHC and VSS have an advantage from having materially lower expense ratios which allow more of the returns to reach shareholders. 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.

How To Avoid The Worst Sector Mutual Funds: Q3’15

Summary The large number of mutual funds has little to do with serving your best interests. Below are three red flags you can use to avoid the worst mutual funds. The following presents the least and most expensive sector mutual funds as well as the worst overall sector mutual funds per our Q3’15 sector ratings. Question: Why are there so many mutual funds? Answer: mutual fund providers tend to make lots of money on each fund so they create more products to sell. The large number of mutual funds has little to do with serving your best interests. Below are three red flags you can use to avoid the worst mutual funds: Inadequate Liquidity This issue is the easiest to avoid, and our advice is simple. Avoid all mutual funds with less than $100 million in assets. Low levels of liquidity can lead to a discrepancy between the price of the mutual fund and the underlying value of the securities it holds. Plus, low asset levels tend to mean lower volume in the mutual fund and larger bid-ask spreads. High Fees Mutual funds should be cheap, but not all of them are. The first step here is to know what is cheap and expensive. To ensure you are paying at or below average fees, invest only in mutual funds with total annual costs below 2.37%, which is the average total annual cost of the 632 U.S. equity sector mutual funds we cover. Figure 1 shows the most and least expensive sector mutual funds. Rydex provides three of the most expensive mutual funds while Vanguard mutual funds are among the cheapest. Figure 1: 5 Least and Most Expensive Sector Mutual Funds (click to enlarge) Sources: New Constructs, LLC and company filings Investors need not pay high fees for quality holdings. The Fidelity Select Consumer Staples Portfolio (MUTF: FDFAX ) earns our Very Attractive rating and has low total annual costs of only 0.94%. On the other hand, the Vanguard Specialized Funds REIT Index (MUTF: VGSNX ) holds poor stocks. No matter how cheap a mutual fund, if it holds bad stocks, its performance will be bad. The quality of a mutual fund’s holdings matters more than its price. Poor Holdings Avoiding poor holdings is by far the hardest part of avoiding bad mutual funds, but it is also the most important because a mutual fund’s performance is determined more by its holdings than its costs. Figure 2 shows the mutual funds within each sector with the worst holdings or portfolio management ratings . Figure 2: Sector Mutual Funds with the Worst Holdings (click to enlarge) Sources: New Constructs, LLC and company filings Fidelity appears more often than any other providers in Figure 2, which means that they offer the most mutual funds with the worst holdings. Our overall ratings on mutual funds are based primarily on our stock ratings of their holdings. The Danger Within Buying a mutual fund without analyzing its holdings is like buying a stock without analyzing its business and finances. Put another way, research on mutual fund holdings is necessary due diligence because a mutual fund’s performance is only as good as its holdings’ performance. PERFORMANCE OF MUTUAL FUND’S HOLDINGS = PERFORMANCE OF MUTUAL FUND Disclosure: David Trainer and Max Lee receive no compensation to write about any specific stock, sector, or theme. 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.