Tag Archives: economy

2016, A Possible Recession, And Your Portfolio

Summary The U.S. stock market and financial system will not suffer meltdown in 2016. But a recession in 2016 is a real possibility. However, a 2016 recession is not likely to be a deep one. You may want to think about your portfolio for a fairly static economy. When I began work on this article on Sunday, December 13, the popular press was awash in doomsaying triggered by the Third Avenue Focused Credit Fund event. In the few days since then, markets have calmed down; the Fed has raised its target rate by 25 basis points, without adverse market reaction; and the brouhaha has generally subsided. Columns in The New York Times and The Wall Street Journal by respected pundits have sought to allay investors’ fears. (See James B. Stewart here and Jason Zweig here .) I have persevered with this article nevertheless, for two reasons: Meltdowns do not go in a straight line, and in most cases they take many months. That considered, the calm of the moment does not provide answers to the questions that have been raised. Going into 2016, many of us are trying to determine our investment posture; as part of that process, we are trying to decide what assumptions to make about economies and markets. There are many pundits forecasting doom and some forecasting excellent things, with many in the middle as well. The Third Avenue event causes rational investors to ask whether it (and the economic and technical forces that caused it) has changed the way we should look at 2016. Possible Snowball and Contagion Effects The closure of Third Avenue Focused Credit Fund on December 10 rattled both credit and stock markets. Will the impact extend in breadth and time as a trigger to a full-scale correction? And will the credit market impacts lead to a U.S. recession? Although I wrote last week that the Focused Credit Fund probably was unique in its level of illiquidity, it nevertheless is possible that its closing could be significant because contagion can reach far beyond the reasonable zone due to a snowball or cascading effect. And once markets correct, they tend to continue going in the same direction and to over-correct. In addition, some pundits are noticing “eerie” associations with Bear Stearns and Lehman Brothers, for whatever such things are worth. The rational conclusion should be that the Focused Credit Fund was unique in important ways, including in the weakness of the credits that it invested in and the illiquidity of its portfolio. But part of the problem with the Focused Credit Fund was that the lowest end of the credit scale performed far worse than the upper end of the high yield market over the last year. I discussed this in my regular column at NexChange.com. What is happening to high-yield bonds? As the following graph from the St. Louis Fed shows, over the last year, CCC-rated bonds have increased in yield from about 7% to about 16%, which implies enormous capital losses, the amounts depending on the duration of the bonds. The higher end of the high yield market has held up much better, but it is in negative territory for the year. (click to enlarge) It would be quite rational for many high yield fund investors to change their minds about the desirability of owning that asset class at this point in the credit cycle. Many investors in high yield funds have been reaching for yield in ways that they are uncomfortable with. They know that high yield bonds can decline in value, and the mindset of many is that they hope to get out before the really bad stuff happens. Now that the really bad stuff has happened to the low end of the asset class, maybe it is about to happen higher up as well, so they want out. If that coincides with the Fed raising rates, as it does (which gives them hope of better returns on less risky investments in the future), the impetus to get out may be confirmed. If many people redeem their high yield open-end mutual fund shares, that will force many such funds to sell bonds, which will tend to depress the prices of those bonds. That might induce more stockholders to redeem, which would keep the snowball rolling. Indeed, that is a likely scenario, at least for a while. But open-end funds are a small part of the high yield picture. There also are high-yield ETFs and hedge funds that invest primarily in the asset class. Those types of funds raise different issues from the open-end funds. ETFs actually may be systemically safer than open-end funds from a liquidity point of view. That is because ETFs do not permit shareholders to redeem their stock; instead, shareholders sell their stock to someone else, who becomes a shareholder at whatever price the two agree on, usually through the medium of the stock market. For every seller, there has to be a buyer. Therefore the ETF does not have to sell any portfolio holdings when a shareholder elects to sell. The stock price of the ETF may decline, but its internal liquidity is not affected. I do not see the ETF as a destabilizing force. Indeed, its structure may even reassure the markets, and the largest high yield ETFs (BlackRock’s (MUTF: BHYAX ) and JPMorgan’s (MUTF: OHYFX ) seem to be holding up quite well, even as they have declined in price. Hedge funds are more like open-end mutual funds than they are like ETFs. That is, their shares are not traded, so when an investor decides to redeem, the hedge fund has to sell portfolio securities. However, hedge funds do not offer to redeem every day. Usually they offer to do so once a quarter-and only with significant advance notice and in limited quantities. Therefore hedge funds could play a minor role in the snowball effect of declining high yield bond prices, but they are unlikely to play a major role. Some hedge funds may decide to liquidate, as a couple seem to have done recently. One of the things I think we learned in 2007-2009 was that hedge funds could liquidate from time to time with little impact on the market as a whole. Hedge funds in the aggregate are now larger than they were then, but as a percentage of the total securities market, they probably are not a significant factor. To repeat, hedge funds do not permit redemptions daily, so they seldom have to liquidate portfolio securities in a great hurry, other than to meet margin calls. Meanwhile, other forms of high yield debt, such as leveraged bank loans, may come under increased pressure. Leveraged loans already are stuck in the pipeline and the regulators are nattering at the banks about risk. Will they unload those loans at a loss? Or will they hold them and take the regulatory heat? The impact on investment grade bonds Will there be a significant impact on the investment grade bond market? The answer is NO. That is because the investment grade bond market trades at fairly small spreads to Treasuries, and investment grade bonds are not likely to be regarded as poor credit risks for which there is no market. Look at what happened in 2008-2009. Although credit dried up for riskier companies, it did not dry up for high-rated companies, which have had almost continuous access to the bond markets (perhaps with few weeks of hiatus in late 2008). Thus far, it looks like the pressure of the high yield bond bust should not have great systemic significance. But we still need to ask who is holding what kinds of debt in highly leveraged accounts. I am going to digress slightly here to discuss what we have learned (or should have learned) about asset bubbles over the last seven years since the Great Recession and accompanying financial crisis. If the Third Avenue event is gong to trigger a significant financial meltdown, then it will do so because there was a bubble in the pricing of some large asset class or classes. (Bear in mind, please, that we already have suffered through pricing implosions in oil and gas and in natural resources used in construction. Any additional price implosion will come on top of those implosions, whose effects are still working their way through the debt markets, with large amounts of actual losses still to be recognized.) Asset Bubbles and Their Dangers: What Have We Learned? Since 2008, numerous conferences and constant study and discussion have sought to understand the nature of asset bubbles in order not to permit a repeat of the housing bubble of 2003-2006. I have participated in some of the conferences and written some of the papers. To be candid, I think we have learned a lot less than we should have learned, given the amount of effort that has gone into the process. For example, we have no good definition of a bubble and no good way to decide when one is inflating. But we have learned some important things. One of the most important things that at least some of us have learned from studying asset bubbles is that the fall in the price of the assets is not what causes the systemic problems. It is the degree of leverage enjoyed by the holders of the assets. That is, how are the assets financed and by whom? Are the assets financed with debt or with equity? If with equity, people or institutions lose money, but there is no significant cascading effect. If, on the other hand, the assets (including bonds and other debt assets-one person’s debt is another person’s asset) are financed with debt and are highly leveraged themselves, then there can be an enormous cascading effect, as sales of the assets cause their price to decline, which causes margin calls, which causes more sales, more price declines, then still more margin calls. That is what happened to mortgage-based securities in the fall of 2008. They were held largely by highly leveraged entities. Are there asset classes that today are held significantly by highly leveraged players? A second thing that at least I have learned from the study of bubbles is that their bursting is systemically dangerous only when accompanied (preceded?) by a serious recession. We all should recall that the recession of 2007-2009 was 10 months old before Lehman Brothers failed, and the stock market top occurred 12 twelve months before that event. The financial crisis of fall 2008 did not cause the recession that began in 2007. As I interpret the data, it was the recession that joined with the high leverage in financial institutions to cause the financial crisis. Reinhart and Rogoff’s This Time Is Different is the best study of financial crises, as far as I know. I have not gone back to check, but thinking about my two readings, I do not recall any financial crises that were not accompanied by recessions. And in correspondence with me, Prof. Rogoff has disclaimed any intention to imply that the financial crises cause the recessions. He has made no finding to that effect. Either one may come first, it appears, and either one may cause the other. An important implication of this learning is that the high price of an asset class by itself does not, historically, cause recessions and financial crises. It is borrowing against such appreciated assets from highly leveraged important financial institutions that causes the big damage to financial systems, which in turn usually exacerbates an already-existing recession. Does it look like high-priced assets are leveraged with highly leveraged financial institutions? The following set of graphs that I have copied from John Cochrane’s Grumpy Economist blog, and he copied from The Wall Street Journal, comes originally from the Federal Reserve Board. Professor Cochrane is worried about the same high leverage in financial institutions that I am worried about. You can see from the first graph that asset prices are in territory that at first may look scary. In total, several asset classes may be higher than will turn out to be warranted by underlying values. Many people say these asset classes are in bubble territory. I cannot tell whether they are in a bubble or whether the prices accurately reflect future value. They do look, however, like they are high by historical standards, and therefore one should be wary that they may be overpriced. But look at the next graph, please, the one in green. It shows that in historical terms, financial institutions are less leveraged and less mismatched than at any time since the graph’s start date of 1990-and knowing something about banks going back to the 1960s, I would guess that the picture is better today than at any time going back that far. The green graph does not tell us all we might want to know about how the assets reflected in the magenta graph have been financed. Some of them may have been heavily financed. But even if so, if they were financed by financial institutions included in the green graph, those institutions are not highly leveraged by historical comparison. Therefore a fall in the prices of those assets seems unlikely to cause a financial crisis-at least in the U.S. (I do not know whether Fannie and Freddie are included in the financial institutions graph. Probably they are not. But they are highly leveraged, except that in practice they have infinite capital in the form of a U.S. government guarantee, as a consequence of which neither their level of current leverage nor the level of losses they might suffer on home loans is relevant to the discussion.) (click to enlarge) Is this good news about the lower risks in the U.S. financial system due to good management, new regulations, better supervision, or something else? It cannot be due to normal cyclicality because the data in the graphs include a couple of cycles. I nominate two causes: higher capital requirements and stress tests. If we want a safer financial system, then we should encourage the continuation of those policies. They are, in my opinion after being on all sides of banking during about a 47-year professional life, the things that can make the system safer. Much of the rest of the regulatory apparatus is, in my view, a waste of time and money. As a consequence of these improvements, I am confident that the U.S banking system can ride out even a fairly severe recession without needing government assistance and with a minimum of bank failures. That means that when the next recession comes, as it will come some time, the economy is not likely to suffer the double whammy that a financial crisis imposes. That does not mean that banks will keep lending freely in a recession. That is highly unlikely, as an article that I will publish in a few days will show. But the lack of credit availability will be due to the usual causes: weak borrowers and skittish bankers who forget that the most profitable loans are made when the economy looks bad. It will not be caused by the dysfunction of the financial system. What else should we worry about? How could a possible recession relate to a hypothetical financial meltdown? Almost all financial crises involve real estate loans. The 2007-2009 event primarily involved residential mortgage loans. But it also involved commercial mortgage loans at the level of the smaller banks and it was commercial real estate loans primarily that brought down Lehman Brothers. Residential mortgages are fairly easy to get a handle on because the vast majority of them are funded by Fannie or Freddie or the HFA-in short, by government authorities that report regularly and that are watched carefully by think tanks such as the AEI’s International Center on Housing Risk headed by Ed Pinto. Not much risk in housing is going to get past Pinto & Co. I confess that I do not keep up with Pinto’s every report. My impression is that housing prices are again high (see the following graph) and that Fannie and Freddie again have excessive leverage. But since they are now owned by the government, losses they suffer merely get wound into any government deficits, and therefore they will not be part of any financial squeeze. The private securitized mortgage market remains moribund. Against that somewhat comforting background, if look at house prices from an historical point of view, based on the following graph of real house prices from Calculated Risk, we can get a bit alarmed because by that measure, prices are high. A few years ago, I wrote an article on U.S. house prices in which I took 1991 as the base year. In real terms, I asked, how do prices stand versus 1991? They were high and they are high. Suppose we take 1997 as the next base year? Still high. 2000? Still high. In fact prices are near 2004 levels, just before the full lift-off caused by the flood of financing through private label securities. But we are not near the all-time high of 2006. Therefore I think it is reasonable to conclude that if prices go down, they will not go down as much as last time, and the financial system is in better shape to absorb the impact of lower prices on the value of related loans and securities built on those loans. (click to enlarge) Commercial mortgage loans are harder to get a handle on than house loans. Commercial loans are owned not only by banks but also in large amounts by REITs, insurance companies and other institutions. The banks seem to be, as I said, in pretty good shape to withstand losses, though smaller banks tend to be heavily invested in commercial real estate because that is the type of collateral most readily available to them. REITs usually are not highly leveraged. Therefore they should be able to sustain losses without creating a snowball effect. Their investors may lose money, but for the most part, they are not highly leveraged. Insurance companies that have reached for yield in the years ZIRP are harder for me to get a handle on. There may be significant dangers there, especially in Europe. The foregoing discussion of asset classes is by no means exhaustive. But it suggests to me that declining asset prices probably can be absorbed by the U.S. financial system. The stock market also does not seem to threaten the financial system. Although pries are high by historical standards, as are profits, the high prices are made to look very high by the increases in price of the FANGs (Facebook, Amazon, NetFlix and Google) and some similar though lesser known companies. The valuations of some of those companies seem outrageous in traditional terms. And the market as a whole is quite fully priced. But that has been the situation for several years. Indeed, the market as a whole did not increase in price in 2015, so there is no reason to see a pressure-cooker type of condition. Although I have been saying for the last few years that there will be a major correction sometime in the next few years, I actually see less reason for that to occur than in the recent past. The market already has suffered a meltdown of natural resources stocks. It is hard to see them declining much further, though some leveraged companies in that sector will fail. Retail stocks are not very highly valued (and should not be, in my opinion). The high prices almost all are in tech-related areas that have outperformed in recent years. But even if that sector declines in price, it seems not be highly leveraged, it seems not to be held by highly leveraged stockholders, and the losses do not look systemic. That is not to say there will not be a next recession. What is likely to cause the next U.S. recession? But even if we think there will be a cascading effect due to high leverage in some asset classes, there may not be the kind of systemic impact that we saw in 2007-2009. That is because of two factors: As the green graph above showed, financial institutions in the U.S. have more capital to absorb losses than they had in the earlier period. The recession of 2007-2009 was well under way by fall 2008, and it was caused as much as anything else by the end of homeowners’ ability to tap their home equity for general spending purposes. The “household ATM” died between 2006 and 2008, leaving households unable to spend but still having to repay. The following graph from Calculated Risk shows how this works. (click to enlarge) I also explained the phenomenon in the first chapter of Debt Spiral and in a Seeking Alpha article a few years ago. Without the household spending that was made possible by home equity extraction, the U.S. economy would have been in or near recession from the recession in 2002 through to the recession that began in 2007. Here is an excerpt from page 7 of Debt Spiral: In this reading, the U.S. has barely recovered from the so-called mild recession of 2001. If we smooth out the last 15 years, we find little growth in GDP and less growth in the incomes of middle class Americans. The causes of that relative stagnation are hotly debated. My suspects are foreign competition and the failure of the American workforce to keep pace with the educational requirements of work, compounded by the percentage of children born out of wedlock (now around 40%) which saps the beneficial effects of the American family and the energy of the single mothers who bear the brunt of the problem. Nevertheless, the U.S., unlike much of the world, has had an economic expansion over the last five years, and that expansion, though weak by historical standards, is continuing. What could derail it? The expansion has been spurred by robust auto sales (financed by often-unsound auto loans), asset priced rises spurred by Fed policies (now being reversed), declining unemployment and modestly increasing employment (that is threatened by the rising cost of labor that some parties advocate), and high corporate profits (that look like they may level out or decline). The strong dollar also looks like a threat to U.S. exports and, even more important, a threat to domestic companies in the form of increased foreign competition. Weak growth or even outright shrinkage of many foreign economies suggest that one should not look to robust foreign sales for help. Indeed, the high levels of emerging market borrowings denominated in dollars suggest that many emerging market companies and nations will have trouble repaying, as I have written elsewhere. The fevered acquisition activity among large companies that also suggests a late-stage recovery. The big companies are looking to reduce competition rather than to grow organically. And they prefer to buy back stock rather than invest in growing their businesses. Those all are signs that growth will slow further and that a rising stock market is unlikely. If there are outstanding investments, they are most likely to be among younger companies or companies that have sound balance sheets but businesses that have temporarily disappointed. Cam Hui says he is worried about the next recession being ugly because of the Fed’s balance sheet, a possible crisis in China, and possible blow-ups lurking in the global financial system. I pick on Cam because he is so brilliant. But the Fed’s balance sheet will just sit there. It will not be allowed to impede provision of liquidity, and lowering interest rates is, in my not too educated opinion, not all it was cracked up to be. China is unlikely to suffer a financial crisis because, although many Chinese entities are functionally bankrupt due to bad loans, as I have explained , those loans can be carried for quite some time yet. There may well be blow-ups lurking in the global financial system-possibly in Europe or Japan. But they are unlikely to make a big difference to the U.S. economy. Take 1997 as the template. In short, I do not see reason to believe there will be a major recession in the U.S. in the near future. But a statistical recession seems quite possible. Those statistics will not be nice for the people who lose their jobs, and the attendant reduction in asset values will be bad for retirees and others who need asset appreciation. But my guess is that the recession will be brief and not too ugly. But I also guess it will be followed by more less-than-average growth. A better-educated American workforce is what can end the malaise and restore prosperity. (That is the subject of my book, The Education Solution .) I do not see any short-term policy solution-on the left or the right. Both proclaim pro-growth policies. But growth comes primarily from more people who have the skills the workforce needs. So show me where to put my money! Yes, where should we put our money? That’s why you started reading this Megillah (long story) in the first place. Stay the course, as usual, I say. None of this is very new. Long-term, the American stock market is still the best place to be. But if you can figure out what currency is going to be strong in the next rotation, assets denominated in that currency would be a good bet. I do not know what that currency will be. But I would continue to own the kinds of companies that have high profit margins and earn high amounts per employee. They pretty much all have natural moats that allow them to keep their profit margins high. The discrepancy between the high margin players and the low is reflected in the following graph that shows income as a percent of revenue. The red line represents the nation’s top 20 employers. The blue line represent s the nation’s top 50 companies by market cap. As you can see, the big employers have not been a able to increase their profitability since 1980, whereas the most valuable companies have consistently increased their profitability, mostly by using technology to achieve moat-like protections for their margins. By not having to deal with large numbers of employees, they retain greater control over their costs. Net income as a percentage of gross income (Data from S&P IQ, graph by the author) (click to enlarge) The contrast when we consider real income per employee is even greater than when we looked at profitability in terms of sales. The profitable companies have consistently increased their income per employee, while large employers have been stuck at the same basic level. Probably that is because it is hard to increase the productivity of low-level employees without sharing a substantial part of the gain with them. The large employers also tend to be in businesses that are highly competitive, with little intellectual property protection, and consequently low profit margins. Net income per employee (Data from S&P IQ, graph by the author) (click to enlarge) Even if there is a recession in the near future, I do not think that the political forces seeking higher wages for low-end employees will abate. Therefore, although from time to time large employers may represent good value in market terms, because of wage pressures I do not see them being high-growth, high-profit businesses. The ascendancy of the FANG-type investments is not over in my judgment. Thus, although I do not know which particular investments will shine in 2016, I believe they will come from the high-income per employee group. In 2014 that group included, among the top 50 companies by market cap, tech companies Apple (NASDAQ: AAPL ), Alphabet ( GOOG , GOOGL ), Facebook (NASDAQ: FB ), Qualcomm (NASDAQ: QCOM ), and Microsoft (NASDAQ: MSFT ); two credit card giants, Visa (NYSE: V ) and MasterCard (NYSE: MA ); oil giants Exxon Mobil (NYSE: XOM ) and Chevron (NYSE: CVX ); drug companies Pfizer (NYSE: PFE ), Gilead Sciences (NASDAQ: GILD ), Amgen (NASDAQ: AMGN ), Biogen (NASDAQ: BIIB ), Johnson & Johnson(NYSE: JNJ ), and Celgene (NASDAQ: CELG ); and cigarette company Altria (NYSE: MO ). (Note: I do not invest in cigarette companies.) Close behind were megabanks Wells Fargo (NYSE: WFC ) and JPMorgan Chase (NYSE: JPM ). Not all of them were winners in terms of stock prices; for instance, Amazon (NASDAQ: AMZN ), a big market winner, is an outlier with low profitability. And Berkshire Hathaway ( BRK.A , BRK.B ), one of my favorite companies, is a big employer as well as the owner of numerous companies with successful moats. One can find reasons that each of these companies will not be among the FANG class of 2016. High market valuation may hold back tech stocks. Pricing headwinds for products could derail drug companies. Disruptive competitors could steal card companies’ volumes or compress their margins. Continued low prices of natural resources could prevent oil companies from improving. Likely larger reserves for loan losses could hold back the megabanks. Maybe the winners therefore will come from smaller companies that illustrate similar profitability characteristics. I am not trying to predict the winners. I only mean to suggest that the market as a whole is more likely to be stagnant than up or down sharply, which leaves equity investors searching for winners. The debt markets do not look a whole lot more promising: returns on investment grade debt not so great and returns on high yield debt, particularly of the foreign and weaker varieties, looks like they will come under continued credit quality pressure. It has been several years since I have been able to be highly optimistic about some asset class. I guess that continues for now. It may be that some of the beaten down sectors will be the winners. I would put some of my money there. I guess I am forecasting what they call a stock picker’s market, much as 2015 has been, though I am aware that predicting “more of the same” usually misses the big action. Mine is not a great investment outlook, I am afraid. But compared with the forecast of a meltdown, it is not too bad. If you are reading this article because you have money invested or to invest, consider yourself among the fortunate. In a tough — though I still think improving — world, we are the lucky ones. Happy New Year to Seeking Alpha readers from me and my family to you and yours. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

PNM Resources’ (PNM) CEO Pat Vincent-Collawn on 2016 Earnings Guidance Conference – Call Transcript

PNM Resources Inc. (NYSE: PNM ) 2016 Earnings Guidance Conference Call December 18, 2015 11:00 AM ET Executives Jimmie Blotter – Director-Investor Relations Pat Vincent-Collawn – Chairman, President and Chief Executive Officer Chuck Eldred – Executive Vice President and Chief Financial Officer Analysts Brian Russo – Ladenburg Thalmann Anthony Crowdell – Jefferies Leon Dubov – Luminus Management Tim Winter – Gabelli & Company Operator Good morning, and welcome to the PNM Resources 2016 Earnings Guidance Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Jimmie Blotter, Director of Investor Relations. Please go ahead. Jimmie Blotter Thank you, Laura and thank you everyone for joining us this morning for the PNM Resources 2016 earnings guidance conference call. Please note that the presentation for this conference call and other supporting documents are available on our website at pnmresources.com. Joining me today are PNM Resources Chairman, President and CEO, Pat Vincent-Collawn and Chuck Eldred, our Executive Vice President and Chief Financial Officer. As well as several other members of our Executive Management team. Before I turn the call over to Pat, I need to remind you that some of the information provided this morning should be considered forward-looking statements, pursuant to the Private Securities Litigation Reform Act of 1995. We caution you that all of the forward looking statements are based upon current expectations and estimates and that PNM Resources assumes no obligation to update this information. For a detailed discussion of factors affecting PNM Resources results. Please refer to our current and future Annual reports on Form 10-K, Quarterly Reports on Form 10-Q, as well as reports on Form 8-K filed with the SEC. With that, I will turn the call over to Pat. Pat Vincent-Collawn Thank you, Jimmie and good morning, everyone. I hope you all are having a wonderful holiday season. As we approach the end of this very busy and successful year, it’s time to look ahead and provide our earnings guidance for 2016. But first I would like to talk about our most recent and very important news, the New Mexico Public Regulation Commission approval of BART that we’ve received earlier this week. Let’s start on Slide four. I’m very pleased to say that on December 16, the PRC formally approved our plans for the San Juan generating station. This ruling comes almost exactly two years after our initial filing with the commission. We knew that this plan was the best for our customers, for the company, for the state as a whole and the environment. It also paves the way for New Mexico’s compliance with the Clean Power Plan. Now we can move forward with implementation. I would like to congratulate and say the PNM team that has worked tirelessly on BART. This has been a long and challenging process and I am proud of the people, who are responsible for bringing it to a successful conclusion. I would also like to acknowledge and thank the other folks that have been involved including Governor Martinez and her office, various community and business groups. The Navajo Nation, the EPA and many of our interveners who have involved – have been involved extensively for years now. BART has been an all consuming task for many people for quite sometime and I am thankful to see the Commission support, the settlement agreement that we presented to them. We will now move forward with plans to retire Units 2 and 3 at the end of 2017. And we will replace the power with the mix of resources we’ve proposed, which is an additional 132 megawatts from San Juan Unit 4, and additional 134 megawatts from Palo Verde Unit 3, 40 megawatts of solar for which construction is almost complete and a gas peaking plant to be built on the San Juan site. The New Mexico Commission approval was a critical milestone in completing this process. In addition, we need FERC approval on the 203 filing. And we have asked for that to be done before year end. The approval we need is at a staff level. So it does not need to be addressed by commissioners in an open meeting. Once all of the regulatory approvals are received the sale of the mine can be completed. And we will be able to enact the new coal contract and the ownership restructuring agreement for San Juan, which together brings significant savings for our customers. And finally the SNCR equipment has been installed on San Juan Unit 1 and 4 and is expected to be fully operational next month. We will recover the cost of the equipment in the rate case that is currently pending before the commission. That case also includes a previously approved 40 megawatts of solar replacement power. The remaining items related to the BART settlement will be included in the 2018 rate case, which we expect to file in December of 2016. I want to emphasize that the implementation of the BART plan combined with the significant investments we have already made position San Juan for continued operation into the future while meeting and in many cases exceeding environmental regulations. Emissions from BART will put the plant in compliance with the haze regulation and place New Mexico in good shape to comply with the Clean Power Plan. The environmental upgrades we have made between 2006 and 2009 and the installation of the BART result in significant reductions as several emission including a 78% reduction in NOx and 87% reduction in SO2 and 85% reduction in particular matter emissions. In addition the plant has a 99.5% removal efficiency for mercury. Balanced draft will assist the plant in complying with the National Ambient Air Quality Standards by eliminating fugitive emissions of NOx, SO2, mercury and other pollutants. Coal ash at San Juan is dry handled and returned to the former surface mine pit for reclamation. There are no wet coal ash storage ponds or pipes transporting coal ash. Regarding 316(b), San Juan uses the closed cycle cooling systems and is thus well situated to comply with the rule. EPA’s final stream effluent guidelines rule, that was issued earlier this year is expected to have minimum impact on San Juan since it is a zero discharge facility. So the bottom line, we know of no existing, or anticipated environmental regulations that would reduce the viability of our plants going forward. Let’s now move to Slide 5. Looking forward, we continue to focus our strategic financial goals of earning our authorized returns, maintaining investment grade credit ratings and providing above average industry earnings and dividend growth. We remain on track with our earnings growth call, you can see that our 2016 guidance range of $1.55 to $1.76 continues along our 7% to 9% growth trajectory. I’m pleased to say that TNMP is expected to continue to perform well driven by increased loads and recovery of our transmission investments. PNM had a challenging start to 2015 in the regulatory environment, but we’re back on track. The re-file rate case is proceeding as expected. Rate should be effect in the third quarter of 2016. From a customer perspective, when you net the fuel and other savings against the rate request, the overall impact to customer bills is only 5.4%. Over the last few years, we have implemented companywide efforts to strengthen relationship with customers and to improve their experiences with PNM. Despite the challenges we continue to face, we have achieved company record high levels of customer satisfaction. Another regulatory challenge this year was related to the definition of the future test year. Now that the commission has modified its interpretation of the future test to a definition to make it consistent with the statue, there is no longer a need to continue the appeal we filed in the state Supreme Court. We will be taking step to conclude that matter in the next month or so. And obviously, the PRC approval of BART lays the ground work for our 2018 rate case. If you turn to Slide 6, will give you an update on the dividend. As you saw last week, the Board increased the annual dividend by 10%. This makes the annualized dividend $0.88. We continue to target our 50% to 60% payout ratio. The Board will continue to review the dividend each year, and in the near-term we expect continued above average increases. Once we are through our heightened CapEx period, the Board may consider increasing the 50% to 60% payout ratio to bring it more inline with the industry. Now, I’ll turn it over to Chuck Eldred, our Chief Financial Officer for a closer look at the numbers. Chuck Eldred Thank you, Pat and good morning everyone. 2016 will be a transitional year for the Company. We have much for the uncertainty behind us now with the PRC approval of the BART plan, and going forward our regulatory filings at PNM should be focused on recovery of the investments that are required to prudently run our business. At TNMP, we continue to see low growth, and we’ll continue to make prudent investments to support the reliability of that business. Now let’s go to the details of 2016 guidance beginning on Slide 8. On this Slide, we compare the previously issued 2016 earnings potential to the 2016 guidance we’re issuing today. As you can see the ranges between earnings potential and guidance are similar. But there are adjustments to the individual items as you move away from the rate base math that the earnings potential is based on. Beginning with PNM retail, 2016 guidance is at $1.08 to $1.24. This is a slight adjustment to the earnings potential view. The expectations shown here reflects the full ask and varies depending on the implementation date between July 1 and October 1. I’ll provide you with some information to help you make your own assumptions on the rate case in a moment. In addition to the rate case, PNM retail will also be affected by other drivers. For example, regulatory lag for the first portion of the year and load, which we continue to forecast conservatively. Next is renewables at $0.06. This is inline with the earnings potential previously shared. Per transition earnings potential showed a range of $0.08 to $0.10, but we’re guiding this business to be $0.09 to $0.10. The tightened range is based on our forecast for 2016. However unit three is fully hedged for 2016 and we have updated the guidance for the prices we expect to see. Items not in rates is expected to be inline with the midpoint of 2015 at $0.03 to $0.04. This brings total PNM to $1.12 to $1.30. Santa Fe continues to be an example of what the differences between our earnings potential and guidance. Santa Fe is expected to continue to have key cost filings and strong load growth. Therefore guidance is $0.49 to $0.51, which is above their earnings potential, but slightly lower than the 2015 midpoint. Corporate and other is also a little higher than the earnings potential that we have discussed with benefits in 2016 provided by the retirement of the 9.25% debt in 2015 and the restructuring agreement in the San Juan. That brings the total range of 2016 to $1.55 to $1.76. Once we have the rate case finalized, we’ll be able to provide an updated guidance range for you. Now turning to Slide 9, we continue to see positive movement in Albuquerque’s employment growth, outpacing the state in New Mexico and getting closer to the U.S. rate. We also continue to forecast customer growth at PNM at 0.5%. We’re forecasting low growth at a range of flat to down 2%, while we see signs of the economy continues to stabilize, we do not see enough growth to counterbalance the effects of energy efficiency. Now turning to Slide 10, I walk through the assumptions related to PNM’s general rate case in 2016. As you remember, we filed for $123.5 million increase based on a 10.5% ROE. Implementation of this full request on July 1 would increase PNM’s EPS by $0.40. A 25 basis points difference in the ROE would impact EPS by $0.04 on an annualized basis. Implementation of full request after July 1st would also reduce the amount in 2016. There you can see some sensitivities around the effect of delays in the rate implementation would have on our 2016 EPS. As a reminder, key dates upcoming for the rate case includes staff and intervener testimony due at the end of January, rebuttal testimony due in February, and hearings in March. It’s our objective to stay on the current schedule with this case. Now turning to Slide 11, it reflects the rest of PNM’s assumption for 2016 compared to 2015. The purchase of the 64 megawatts of Palo Verde Unit 2 leases in January were increased earnings by $0.12. This represents a full year impact of the eliminated O&M costs for the actual lease expense, partially offset by increased depreciation and interest expense tied to the purchase. Weather has lowered PNM EPS in 2015 by $0.03 through the third quarter. So we’d assume an increase to get us back to normal weather for 2016. O&M cost associated with the outages should be lower in 2016 by up to $0.02 as we’ve gotten through some major outages at San Juan for the installation of the SNCRs. The outage schedule is in the appendix. Palo Verde Unit 3 earnings are expected to come in $0.12 lower than 2015 as market prices continue to be depressed. These sales are fully hedged for 2016 at an average around the clock price at $26 per megawatt hour. Since Palo Verde 3 will serve the New Mexico retail customers beginning in 2018, we’re not able to sell that power for this asset under the long-term contract, so we’ll be able to – we’ll be exposed to the lower price levels in the meantime. As I mentioned earlier, we have projected low growth at the range of flat to down $0.02 with each percentage point equals a $0.05 of earnings. Also reducing earnings in 2016 is lower AFUDC as our capital spending level comes down from 2015 peak that was in our capital plan. In addition to the 2016 total capital being lowered, $164 million is for the Palo Verde 2 lease purchase. This capital will not earn AFUDC as the asset is already constructed. Depreciation and property tax are expected to increase $0.04 to $0.06 as a result of the capital that is placed into service. Interest expense should be higher in 2016 due to the $250 million of long-term debt that we issued in August of this year. On the third quarter earnings call, I talked about how the FERC Generation and Navopache contract will begin to face out in 2016, reduced in earnings by $0.03 that you can see here. Also you’ll remember that we saw a pickup in 2015 of $0.03 related to the one-time El Paso Natural Gas FERC tariff refund. This will not occur in 2016. Finally, revenue from our renewable rate rider is expected to decline in 2016 as our renewable rate base deprecates. You’ll remember that we added 40 megawatts of solar in 2015, but we have included this in our general rate case and it’s not part of the rider. One item that is typically a driver for us that you do not see on this list that the impact of the Palo Verde Nuclear Decommissioning Trust gains. That’s because the gains are expected to be similar to 2015. As we continue to position the Unit 3 portion of the trust for addition to retail rate base in 2016, you can find an assumption on this item as well as our usual breakdown of quarterly EPS for the company in the appendix. Now let’s turn to TNMP beginning on Slide 12. We continue to see strong growth within this business segment. While employment growth in Houston has decreased from a year-ago, it continues to be positive measure and Dallas continues to outpace the State of Texas in the United States. Keep in mind, the Dallas area accounts for nearly 40% of TNMP’s revenues, while the Houston area accounts for approximately 50% and West Texas makes up less than 10%. I want to note that the West Texas portion of the TNMP’s territory is the Permian Basin. Although the area has been more exposed to oil prices and drilling is down, their production is up. And as a result, we have not seen a reduction in our load. TNMP residential customer growth is forecasted at 1% again for 2016, and overall load is also again projected to increase between 2% and 3%. Now let’s turn to TNMP’s full earnings guidance and drivers on Slide 13. Once again we expect to implement two TCOS increases during the year. We expect to make those filings in January and July with implementation in March and September respectively, adding $0.03 to $0.04 to EPS. We are projecting the load increase of 2% to 3%, which increases earnings by $0.01 per each percentage point. We expect to see O&M to be flat to an increase, this results in drivers that are zero to negative $0.02. We continue to make capital investments to support the growth in our service territory, which leads to increase depreciation of property taxes that we’ve forecasted at $0.02 to $0.03. A portion of these cost related to transition assets which is about 40% of capital are recovered through TCOS filings. Interest expense also rises in 2016, this is in fact of issuing the long-term debt. Next let’s review some of the changes we’re seeing in the corporate and other segment on Slide 14. Well, I know that you’re all familiar with a retirement of our 9.25% debt in 2015, and the associated increase in short-term debt levels. I also want to remind you that San Juan restructuring agreement is expected to go and effect in January 2016, and if the demand charges paid to PNM Resources from the existing parties related to the additional 65 megawatts at Unit 4 is part of corporate and other segment, until it is moved to PNM which will likely occur at the end of 2017. This will result in $0.01 improvement to earnings in 2016. Therefore in total, we expect the corporate and other segment to improve slightly over 2015. So now let’s review some detail on how we’re investing at the business and what that means for earnings beyond 2016. So wrapping up on Slide 15, you can see the earnings potential for each of the remaining years for 2019, our view is consistent with our earnings target of 7% to 9% growth for that time period, and it’s consistent with the numbers that we have seen before. We continue to execute on our current plan to maximize the earnings potential that we can realize in our business by focusing on regulatory outcomes and earning our authorized returns. Now I’ll turn it back over to Pat. Thank you. Pat Vincent-Collawn Thanks, Chuck. We’re focused on execution, we’ve remain committed to achieving constructive regulatory outcomes, maintaining operational excellence, improving customer satisfaction, and running the business efficiently. We’re now happy to take questions. Question-and-Answer Session Operator Thank you. [Operator Instructions] And our next question will come from Brian Russo of Ladenburg Thalmann. Brian Russo Hi, good morning. Pat Vincent-Collawn Good morning, Brian. Chuck Eldred Good morning, Brian. Brian Russo Just Chuck to clarify on PV3 is it completely unhedged in 2017? Chuck Eldred Yes, we – it’s not hedged in 2017 at this point. We typically try to hedge in our rolling 12 month basis and obviously with prices as low as they are. We would like to think that there would be some anticipation or some improvement in 2017, but it’s just too hard to predict. So we’re really on the downside of the lower gas prices and hedging that asset and – but it’s fully hedged in 2016. And that as a result of the lower prices that we’re able to hedge in 2016 resulting into the $0.12 hit… Brian Russo Got it, understood. And then how does the sales assumption in the current rate case of PNM electric compare with your flat to negative 2% outlook assumption for 2016? Pat Vincent-Collawn I’m sorry Brian, would you give us the question again. Brian Russo Yes, just the sales assumption in current rate case filing. How does that compare with your actual outlook for 2016? Chuck Eldred Brian, it’s really – the final would be more flat to what we expect over 2015, but again we’re going to be conservative because we just don’t see enough consistency in the trends to give us comfort to think it would be any better than that and we’re going to continue to be a little more pessimistic on the – thinking about the downside effect of that on a continuous basis. And then address that, and there’s a rate case it’s pending right now. Brian Russo Okay, great. Thank you. Pat Vincent-Collawn Thanks Brian. Operator And the next question comes from Anthony Crowdell of Jefferies. Anthony Crowdell Good morning. Chuck Eldred Good morning. Pat Vincent-Collawn Hi, good morning, Anthony. Anthony Crowdell Just one housekeeping question and something else I think you had said, when do you expect to file the 2018 general rate case? Pat Vincent-Collawn In December of 2016. Anthony Crowdell Got it, okay. And then – and I guess just lastly, if you look at 2015 your regulatory calendar was very busy we had future test years, BART we had settlements I guess people pull out everything else. It looks like things have maybe cleared or maybe a little easier in 2016. I guess my question is has all the emotion that went on in 2015 poisoned the well that when we look at the 2016 rate proceeding going on and then you’re going to file again in December of 2016 for the 2018 case, has all that emotion poisoned the well in the next couple of rate proceedings. Pat Vincent-Collawn I don’t think so Anthony I think that given the fact that we’ve remained constructive throughout the whole 2015 rate case and we’re willing to go back and work with the interveners. I think they’ve really appreciated that and I think the commission even said at the hearing that they appreciated everybody’s positive attitude and working towards the settlement obviously we had one party that did not join that settlement or a couple of parties that didn’t join that settlement. But I think everybody understands that we remain positive, we stay positive, that this was the most complicated case ever to be seen in New Mexico and now we’re kind of back to much more plain-vanilla rate cases. So I don’t think that, that anything got poisoned I think that the way the company and the employees handled itself was very good. Anthony Crowdell And just lastly, the BART proceeding, I think the BART was like – I believe 4 to 1 do you know the last time the commission unanimously approved something? Pat Vincent-Collawn Anthony, we have to get back to you on that for certain, there have been some smaller things the commission has unanimously approved in terms of some riders. I think they unanimously approved opening a workshop and something, so I don’t know off the top of my head, but we will get back to you. And when commissioners have voted against, there have actually been different commissioners voting differently, there was about yesterday for example, some of the folks wanted more time on the SPF rate case and the commissioner said no – it was 4 to 1 but it was commissioner Montoya voting against that as opposed to commissioner Espinoza who voted against the BART proceeding. So it’s been a different mix of commissioners voting, but… Chuck Eldred I think some of the smaller items… Pat Vincent-Collawn Yes. Chuck Eldred Solar at 40 megawatts the delta purchase, which we called the Rio Bravo generating station. There has been a lot of smaller projects throughout the proceedings over the last year that are included in the 2016 rate case that have been approved that have been supported by the commission. So, but, we can go back and give you some answers and details. Anthony Crowdell Thanks and… Pat Vincent-Collawn The future test year unchanged, Anthony when the commission decided to go with the definition that we and SPF had advocated that was unanimous. Anthony Crowdell Okay, great. Thanks for taking my question and enjoy the holidays. Pat Vincent-Collawn Thanks, Anthony, you too. Chuck Eldred Thank you. Operator [Operator Instructions] Our next question comes from Leon Dubov of Luminus Management. Leon Dubov Hi guys, good morning. Pat Vincent-Collawn Good morning, Leon. Chuck Eldred Good morning. Leon Dubov I just want to make sure I understand the assumptions for the rate case that you are having guidance. So if I look at the Slide 8 or the PNM Retail, $1.08 to $1.24, you said that includes the full implementation of – your full ask for the rate case? Chuck Eldred That’s a full ask use in the July 1 and the October 1, and then we’ve adjusted it for load in some of the regulatory lag to reflect that… Leon Dubov So again, this assumes full ask with… Chuck Eldred Full ask, yes… Leon Dubov Or the different implementation dates that’s what make the difference? Chuck Eldred That’s correct. Pat Vincent-Collawn Correct. Leon Dubov Okay. And then I can use that with the sensitivities you gave on the Slide 10, so effectively if we got in August first implementation date, it would be $0.08 off the top end, is that the right way to read that? Chuck Eldred That’s correct. Yes. Leon Dubov Okay. Got, it. Thank you, I just wanted to … Chuck Eldred And again I want to answer that. We are focusing very, very intently on the July 1 date. So the schedule we have out there is, our objective is not to – from our standpoint have any alteration to that timing. Leon Dubov Thank you. Pat Vincent-Collawn Thanks Leon. Operator And next we have a question from Tim Winter of Gabelli & Company. Tim Winter Good morning, and congratulations on getting all of this approved. The BART approval and the test year. Pat Vincent-Collawn Good morning, and thank you, Tim. Tim Winter You should see if Jimmy and Chuck, will let you take a vacation anytime soon. Pat Vincent-Collawn Actually I canceled my vacation to be here today Tim. So, but maybe next year they’ll let me have one. Tim Winter I was wondering if you could talk a little bit about the future test year procedures. Do you have, basically all the procedures and processes setting out to file for that or do you still need to do some more work with the commission? Pat Vincent-Collawn Well, we need to go ahead and take back the appeal at the Supreme Court and finalize that. But in terms of hours we practice this so we now have that in this rate case. That we have under right now, while it is not a future test year we worked through with the staff and interveners to make sure we had the models and the data in a way that they felt was complete. So between that and the fact that we’ve done it before and that SPS has done this before. We feel we’re in good shape to file the one in December of next year. Tim Winter Okay, great. Thank you. Pat Vincent-Collawn Jim, if I need some help getting a vacation next year. Can I call you? Tim Winter Absolutely. Pat Vincent-Collawn Great, thank you. Tim Winter Thanks for having the call. Pat Vincent-Collawn Thanks, Tim. Operator And this concludes our question-and-answer session. I would like to turn the conference back over to Pat Vincent-Collawn for any closing remarks. Pat Vincent-Collawn That’s okay. Thank you all for joining us. I know it’s a busy holiday season for everyone. We’ve had a good year here at PNM. Resources and again I just want to thank everybody at the company and the community and the Governor’s office at the Navajo Nation that worked with us to bring the BART plant to a fruition. I hope you all have a wonderful, safe and happy holiday season. I look forward to seeing you all in the New Year. Thank you. Operator The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect. Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY’S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY’S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY’S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com . Thank you!

Low Risk, High Return, A Dream Come True: SPLV

Most active managers fail to beat their indices. Passive management is systematic and delivers expectations over the long term. Stock-picking is lucrative, but time consuming. SPLV facts make it attractive. When it comes to investing in equities in North America, the S&P 500 is one if not the most popular index used as a guideline and benchmark. There are various exchange-traded funds that replicate the composition and the return of the S&P 500. Best known ETFs in this space are: State Street SPDR, SPY iShares, IVV Vanguard, VOO This index has delivered an annualized return of approximately 7.48% (depending on month calculated) in the past ten years with an annualized standard deviation of approximately 15.05%. This performance is certainly not rock star, but is respectable and relatively consistent. On a longer time period (since 1928), the S&P 500 has averaged around 10% annualized. So what is the S&P 500? The S&P 500 is an index composed of 500 companies in the U.S., considered leaders in their respective industries. Companies in this index are mostly of large capitalization and together they represent around 80% of the economy. Therefore, this index is considered a representation of the U.S. market. Some companies in this index are Apple (NASDAQ: AAPL ), Johnson & Johnson (NYSE: JNJ ), and General Electric (NYSE: GE ) . Knowing this index represents the U.S. market and that it has performed relatively well, we ask ourselves if we can make a better index. Like all changes, there may be something to sacrifice. Second, what do we seek in an investment? It turns out two and only two things are priority. First, we want our investment to appreciate the most be in terms of capital appreciation, income (dividend or interest), or both. Second, we want our investment to be as less risky as possible. We measure risk as continuous change in value (standard deviation) and loss of permanent capital. How do we minimize risk? Our first action is to diversity; this way we eliminate diversifiable risk known as unsystematic risk (company going bankrupt or not meeting expectations). Second, we invest in strategy that has delivered expected returns over an expected holding time period. Meet the S&P 500 Low Volatility Index. This index is a stripped version of the S&P 500, by selecting 100 constituents with the lowest volatility over the trailing 12 months from the S&P 500 and rebalancing the index quarterly. What is so great about this index? The risk-adjusted returns are impressive. Here is a graph of the index performance: (click to enlarge) As can be seen, the returns in the graph demonstrate adequate upside and safer downside risk in comparison to the S&P 500. How about the performance and the standard deviation of the index? (click to enlarge) Source: SP Indices The return table shows that on all periods except 3 years, the Low Volatility Index performs better than the S&P 500. Also, the Low Volatility Index demonstrates that it has been less risky than the S&P 500 in the trailing 3, 5, and 10 year periods. Before you get excited, I have talked about this index and the returns and risk it has provided over the previous 10 years but the index is not an instrument to invest in. So where can you invest in a fund that replicates this index? PowerShares S&P 500 Low Volatility Portfolio (NYSEARCA: SPLV ). This ETF has over $5 billion in assets under management and charges a total expense ratio of 0.25%, making liquidity and fees manageable. In terms of performance, the ETF has delivered an annualized return of 13.33% since inception versus 12.59% for the S&P 500 Index. The funds top ten holdings currently are Plum Creek Timber (NYSE: PCL ), PepsiCo (NYSE: PEP ), Republic Services ‘A’ (NYSE: RSG ), Procter & Gamble (NYSE: PG ), Campbell Soup (NYSE: CPB ), Stericycle (NASDAQ: SRCL ), McCormick (NYSE: MKC ), Paychex (NASDAQ: PAYX ), Ace (NYSE: ACE ), and XL Group (NYSE: XL ). Source: PowerShares Currently, this ETF is the only investment option in this index (per my research). There are other low-volatility ETF’s out there, but their methodology differs. It is clear SPLV is an attractive position to be considered for any portfolio.