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RBS: Sell All Of It, Everything Except High-Quality Bonds

Original post By Stuart Burns We like to think of ourselves as optimists at MetalMiner. If given the option, we prefer the glass half full than the glass half empty, so an article in the London Telegraph and many other newspapers this week reporting RBS Bank’s latest client note makes depressing reading, but unfortunately worthy of discussion. The note advises clients to “Sell everything except high-quality bonds. This is about return of capital, not return on capital. In a crowded hall, exit doors are small,” RBS has advised clients to brace for a “cataclysmic year” and a global deflationary crisis, warning that major stock markets could fall by a fifth and oil may plummet to $16 a barrel. It All Must Go! Nor is RBS playing a new tune; since November, it has been warning the oil price and stock markets are headed lower, sure enough the oil price has continued to fall, dropping to a 12-year low of $30.41 for Brent and $30.43 for West Texas Intermediate this week. Click to enlarge Source: Telegraph Newspaper The markets are clearly spooked and by a number of factors. China’s stock market is being kept alive only on the oxygen of government support via state enterprises buying shares. Oil consumption has stalled due to slow growth and warm weather, and oil supply continues to grow as Iran gears up to enter the market. This year, the biggest factor seems to be the fear of a devaluation of the Chinese yuan, a move Beijing is seeking to reassure the markets is not on the cards. But, guess what? No one believes them. Fears over China, therefore, are multiplying and RBS says, “China has set off a major correction and it is going to snowball. Equities and credit have become very dangerous, “and the bank’s Andrew Roberts, research chief for European economics and rates, expects Wall Street and European stocks to fall by 10% to 20% this year. Larry Summers, the former US Treasury Secretary, in more measured terms, agrees saying it would be a mistake to dismiss the current financial squall as froth. What Does This Mean for Metals? Metals prices have taken their cue from energy and have been weak since the start of the month, but if RBS is right, they could see support in the months ahead. Prices have, in part, been weak due to a stronger dollar, but RBS suggests the Federal Reserve won’t raise rates again at the March meeting and by the summer may be looking at a rate reduction. Either way, if rates don’t rise as the market had been expecting and had priced into the dollar, we could see dollar weakness in 2016 removing one of the factors depressing metal prices. It’s true, global growth is muted, global trade is down and loans are contracting, all in an environment of record debt, not a great backdrop for companies to invest and create growth. Yet, there are some bright spots. Growth in Europe is looking more positive as austerity has largely come to an end. Money supply in Germany is up 10% and growth in the US has remained solid if unspectacular. What to Do? Would you follow RBS’s advice if you were its client? Would you get out of everything? Bank of America runs a Bull & Bear Index that tracks global equity prices and is supposed to give warning of contrarian buy signals. We have all heard of the saying “the night is darkest just before the dawn.” Well, BOA’s index is supposed to peak over the horizon and see if dawn is approaching. Click to enlarge Source: Bank of America As you can see, 88% of global indexes are now trading below their 200-day and 50-day moving averages. The index is therefore at an ultra-negative level of 1.3, but BOA is not suggesting we take our cue and rush out to buy shares. Even though the index has a good track record, the bank says we need certain “catalysts” to be in place, not least a stabilization of the Chinese yuan and oil prices, better Purchasing Managers’ Index data and a halt to the rising dollar before it would say, with any confidence, RBS has got it wrong and the BOA index has it right. As so often before, then, it is down to China. We watch and wait, and hope events unfold more positively in the weeks and months ahead than they have started to so far this year.

What Do Rising Rates Mean For Closed-End Funds?

It’s a misconception that rising rates make it difficult for closed-end funds to deliver competitive results By Christopher Dahlin, UIT Product Strategy and Development Specialist It’s not a stretch to characterize closed-end funds as an often misunderstood investment vehicle. Perhaps that’s because the closed-end fund universe is smaller than those of open-end mutual funds and exchange-traded funds (ETFs), or because their market price and net asset value (NAV) frequently fluctuate. Whatever the reason, closed-end funds occasionally get lumped together as one asset class, even though they invest in a wide array of securities across styles and strategies, just as open-end mutual funds and ETFs do. But the prevalent misconception that closed-end funds generally have difficulty delivering competitive returns in a rising rate environment is of particular importance in light of the Federal Reserve’s (Fed) recent rate hike and the likelihood of more to come. Rising rate fears widen discounts Some investors believe that because many closed-end funds employ financial leverage – which is typically tied to short-term interest rates – increased borrowing costs may inhibit total return-producing capabilities. The graph below illustrates this bias. Starting about the time of 2013’s “taper tantrum” – shorthand for the market’s reaction to then-Fed Chairman’s Ben Bernanke’s indication of possible tapering of its stimulus program – and leading up to the Fed’s recent decision to raise the federal funds rate, fears of the first rate increase since 2006 have led to a broad sell-off among closed-end funds, causing discounts to widen considerably. During this period, the average closed-end fund progressed from trading near NAV to approximately 10% discounts, valuations not seen since The Great Recession. Taper tantrum to rate rise: Valuations not seen since The Great Recession Source: Morningstar Traded Fund Center, Jan. 24, 2013, through Dec. 16, 2015. The CEF average discount is a daily unweighted average of the entire domestically-traded closed-end fund universe. Past performance is not a guarantee of future results. Historical perspective: Returns and rising rates What’s interesting is that, contrary to the recent investor exodus preceding the rate increase, history indicates closed-end funds are capable of producing competitive returns during periods of rising interest rates. Investors need look no further than the last Fed tightening cycle in 2004 for evidence of such closed-end fund outperformance, from both an NAV and market price perspective. As the graph below indicates, closed-end fund valuations widened considerably prior to the Fed’s first 2004 rate increase similar to today’s market. Déjà vu: Closed-end valuations widened prior to the 2004 tightening cycle Source: Morningstar Traded Fund Center, Jan. 1, 2004, through Sept. 29, 2006. The CEF average discount is a daily unweighted average of the entire domestically-traded closed-end fund universe. Past performance is not a guarantee of future results. However, entering that tightening cycle with such large discounts actually allowed closed-end fund discounts to subsequently narrow throughout much of the period and produce outperformance across various asset classes on both NAV and market price, as show in the graph below. Narrowing discounts resulted in outperformance during the previous tightening cycle Source: Morningstar Traded Funds Centre. Index returns: S&P 500 Index, BofA Merrill Lynch Municipal Master Index and BofA Merrill Lynch US Corporate Master Index. Closed-end fund returns: US general equity peers, national municipal bond peers and investment-grade corporate bond peers. Past performance is not a guarantee of future results. An investment cannot be made directly in an index. Using leverage to enhance returns While borrowing costs did increase for most closed-end funds during the Fed’s last period of increasing interest rates, many managers were able to overcome that obstacle by delivering strong investment returns, as shown above. Although monitoring borrowing costs is an important consideration in closed-end fund investing, it’s not the only variable used to determine the effectiveness of leverage. It’s important to note that leverage is a tool that generally magnifies investment returns; as long as the cost of leverage is less than the total return generated by the investments within the fund, leverage may add positively to performance. When evaluating closed-end funds, it’s important to consider both the return potential of the underlying investments as well as the current premium/discount levels relative to historical levels to determine the current valuation of the closed-end fund itself. Although financial history never repeats itself exactly, it does often rhyme. Many closed-end funds today appear to be following a pattern similar to the last time the Fed initiated a cycle of increasing interest rates. Closed-end fund discounts within many sectors are trading in excess of their historical levels. Depending on an investor’s outlook for a particular asset class, this may be an opportune time to take a closer look at closed-end funds. Important information The S&P 500® Index is an unmanaged index considered representative of the US stock market. The BofA Merrill Lynch Municipals Master Index measures total return on tax-exempt investment grade debt publicly issued by states and US territories, including price and interest income, based on the mix of these bonds in the market. The BofA Merrill Lynch US Corporate Master Index tracks the performance of US dollar-denominated, investment- grade-rated corporate debt publically issued in the US domestic market. A closed-end fund is a publicly traded investment company that raises a fixed amount of capital through an initial public offering (IPO) and is then structured, listed and traded like a stock on a stock exchange. An open-end fund is a type of mutual fund with no restriction on the amount of shares issued; it will continue to issue shares to meet investor demand and will buy back shares when investors wish to sell. Net asset value is the per-share value of open-end and closed-end funds and exchange-traded funds (ETFs). Mutual funds’ NAV is computed once a day based on the closing market prices of the securities in the fund’s portfolio’ shares of ETFs and closed-end funds trade at market value, which can be a dollar value above (trading at a premium) or below (trading at a discount) NAV. Financial leverage refers to the use of debt to acquire additional assets. Shares of closed-end funds frequently trade at a discount to their net asset value in the secondary market and the net asset value of closed-end fund shares may decrease. In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions. Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating. Municipal securities are subject to the risk that legislative or economic conditions could affect an issuer’s ability to make payments of principal and/ or interest. Leverage created from borrowing or certain types of transactions or instruments may impair liquidity, cause positions to be liquidated at an unfavorable time, lose more than the amount invested, or increase volatility. There is no assurance a trust will achieve its investment objective. An investment in these unit investment trusts are subject to market risk, which is the possibility that the market values of securities owned by the trust will decline and that the value of trust units may therefore be less than what you paid for them. Accordingly, you can lose money investing in these trusts. The trust should be considered as part of a long-term investment strategy and you should consider your ability to pursue it by investing in successive trusts, if available. You will realize tax consequences associated with investing from one series to the next. Before investing, carefully read the prospectus and/or summary prospectus and carefully consider the investment objectives, risks, charges and expenses. For this and more complete information about the products, visit invesco.com/fundprospectus for a prospectus/summary prospectus. The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals. NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE All data provided by Invesco unless otherwise noted. Invesco Distributors, Inc. is the US distributor for Invesco Ltd.’s retail products and collective trust funds. Invesco Advisers, Inc. and other affiliated investment advisers mentioned provide investment advisory services and do not sell securities. Invesco Unit Investment Trusts are distributed by the sponsor, Invesco Capital Markets, Inc., and broker-dealers including Invesco Distributors, Inc. PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC (Invesco PowerShares). Each entity is an indirect, wholly owned subsidiary of Invesco Ltd. ©2016 Invesco Ltd. All rights reserved. What do rising rates mean for closed-end funds? by Invesco Blog

Loeb Still Relevant After 80 Years

By Ted Theodore About 80 years ago, Gerald Loeb wrote a book about investing that has become a classic and is still at or near the top of any list of favorites for many professional investors, including me. The book is The Battle for Investment Survival . Loeb was a broker who became vice chairman of E.F. Hutton. His central message was that active investing is required in a world where passive investing can be swept away by unforeseen events — events that take a toll on investor psychology and lead, eventually, to costly errors. Thus the battle for survival. But Loeb was very disciplined. He started with, and relied, on the fundamentals of an investment. But if conditions and prospects changed for that investment, he would change. Our own philosophy has clear parallels to Loeb’s principles. As shareholders in companies we are reliant on the record and prospects for those companies – their “fundamentals.” To give us a starting edge, we look for information that tells us a corporation is reliably focused on shareholder interests. We then monitor that information and actively respond to change, good and bad, similar to Loeb’s prescription. Unfortunately, corporate accounts do not give a complete picture of whether they are reliable in the way we need them to be. For example, there is a great deal of discretion in the way companies can report their sales and revenues. The same is true for recognition of their costs and expenses. Even more troublesome, there is very little accountability for how intangibles like good will and trade secrets are treated on income and balance sheets. As the economy has become more service oriented and less production oriented, intangible assets have become even more important. To deal with this challenge and, as a practical matter, we measure our interest in the corporation by whether it is growing its cash. In the end, companies cannot hide behind accounting gimmickry if they cannot grow their cash. So we start with the Statement of Cash Flow. This account adds non-cash charges (like depreciation and good will) back to operating earnings. It also adds back net changes in both working capital and financial capital. Finally, because we think there is added protection for shareholders in companies that invest in their future, we subtract those capital expenditures which are needed to sustain the business. What we end up with is “free” cash flow. While not foolproof, emphasis on changes in free cash flow becomes a benchmark for discerning whether a company is strong or not. Even with a difficult start to the New Year, no one really knows what lies ahead for investors. The environment of the last four years favored the broad category of companies that were buying back their stock. Our process should continue to benefit if the future looks like the recent past. But now that the Federal Reserve has initiated the first tightening in monetary policy in about a decade, we would expect that companies that finance their growth through free cash flow have a better chance to excel than those that have only used debt to buy back their shares, debt that could become more expensive. Those stronger balance sheets and the history of growth in free cash flow would likewise provide a cushion should the economy roll over into recession. At the other end of the spectrum, if some of the macro concerns gradually recede, then it is probable that investors will become less cautious and begin to focus on companies with well-financed organic growth like ours. Ted Theodore, CFA is vice chairman and chief investment officer of TrimTabs Asset Management and portfolio manager of AdvisorShares TrimTabs Float Shrink ETF (NYSEARCA: TTFS ). Additional disclosure: To the extent that this content includes references to securities, those references do not constitute an offer or solicitation to buy, sell or hold such security. AdvisorShares is a sponsor of actively managed exchange-traded funds (ETFs) and holds positions in all of its ETFs. This document should not be considered investment advice and the information contain within should not be relied upon in assessing whether or not to invest in any products mentioned. Investment in securities carries a high degree of risk which may result in investors losing all of their invested capital. Please keep in mind that a company’s past financial performance, including the performance of its share price, does not guarantee future results. To learn more about the risks with actively managed ETFs visit our website AdvisorShares.com .