Tag Archives: energy

Selectivity: The New Way Forward For Investors

We believe these changes position investor portfolios to capture what we view as the best opportunities in global equity markets that we expect to play out over the next several years. More specifically, some of the broader changes we’ve made are from a thematic perspective: Equity and multi-asset class portfolios underwent a fairly significant reorientation away from companies levered to the commodity complex (i.e., the Energy and Materials sectors) to those more levered to services/consumption (i.e., the Information Technology and Healthcare sectors). Portfolios also continue to have significant exposure to the Consumer Discretionary sector as we seek to capitalize on service/consumption trends. Additionally, we notably decreased exposure to the Industrials sector and meaningfully increased exposure to Consumer Staples in our Non-U.S. Equity portfolios. Equity positioning is driven by our bottom-up, fundamental research, complemented by our top-down macroeconomic viewpoints. Primary driving factors behind the portfolio repositioning include: The waning commodity supercycle, combined with China’s structural transition from an investment-driven model of growth to one driven more by consumption. And more broadly: Emerging markets’ burgeoning middle class, along with ongoing advancement in emerging market consumers’ wealth. China’s economic transformation does indeed present the risk that Chinese GDP deviates from investor expectations. The transition to a slower – albeit more stable and sustainable – pace of growth, however, is necessary and well underway, as evidenced by GDP and Purchasing Managers’ Index (PMI) data. Data showing contribution to real GDP is released annually in China. The most recent release shows that in 2014, consumption contributed more to GDP growth than investment. More recently, PMI data shows that activity in the services sector continues to expand (i.e., a reading above 50), whereas manufacturing activity has been contracting. This suggests that the rebalancing story continues to play out. (click to enlarge) More broadly, emerging market consumers currently spend only a fraction of what their developed world counterparts spend, due in large part to income disparities. As the emerging markets’ middle class grows, consumer spending on goods and services should become larger contributors to GDP. According to McKinsey & Company, emerging markets’ consumption is expected to equal $30 trillion by 2025, a 150% increase from 2010. (click to enlarge) In our view, all of these dynamics present long-run opportunities for investors seeking growth. We believe that the changes in our portfolio positioning will enable investors to benefit from the trends that we think will move global equity markets over the next several years. Nevertheless, flexibility is paramount to any investment strategy in order to adapt to an ever-changing economic backdrop. To be sure, a selective approach is critical, as opportunities are far from uniform across all countries and sectors. Learn more about the importance of selectivity in today’s environment, in our latest video series from our investment team experts. 1 Source: Winning the $30 trillion decathlon

Fundamental Items Rarely Affect Valuation

By Rupert Hargreaves Almost all fundamental investors based their research, analysis and investment decisions on the assumption that some positive relationships exist over time between equity valuation and key financial metrics. However, while a large amount of investment activity is based on the assumed relationships between the aforementioned factors, research conducted by S&P Capital IQ, shows that for the past decade it has been impossible to prove a strong statistical relationship between commonly referenced fundamental financial statistics and the direction of the equity market, momentum, and valuation: “Whether we are looking at various measures of profit margin, reported revenue and earnings growth, or even estimated future sales and earnings growth, the past decade’s correlations between price-to-earnings (P/E) valuations and a variety of commonly referenced fundamental financial statistics randomly range between strongly positive and negative readings.” – S&P Capital IQ Global Markets Intelligence Valuation versus fundamental data items Any investor that’s been watching the market for more than a year or two will know that the relationship between the valuation assigned to equities by stock market investors and underlying fundamental characteristics, over time, is extremely complex. There are many internal (stock specific) and external factors that can affect valuations. According to S&P Capital IQ ‘s research on the matter, the only net positive correlation relationship with P/E multiples since 2005 is related to selling, general, and administrative expense margins or the ratio of non-price of goods sold expenses to revenues. The best way to explain this relationship is with a table. (click to enlarge) P/E Valuation vs. Fundamental Data Items Based on a decade’s worth of data, S&P Capital’s research shows that a change in a company’s selling, general, and administrative expense margin is the only factor that will consistently impact earnings multiples across sectors. There is a clear reason for this correlation. Higher expenses will compress profit margins, weigh on profit and ultimately investors will abandon the company, driving the P/E lower. However, it’s unclear why a similar relationship doesn’t exist across other fundamental metrics. Prime example The tech sector is a prime example of an industry where the average P/E does not reflect the underlying and improving fundamentals. After the tech stock market bubble burst in 2000, the S&P 500 technology sector entered the economic recovery cycle in the first quarter of 2002 with a forward 12-month P/E valuation ratio of 54x. Between 2002 and 2010, tech sector valuations continued to be consistently marked down, although, the sector’s earnings growth averaged 23% per quarter throughout the period. The sector’s forward P/E reached a low watermark of 10.7 during Q3 2011 and has only recently started to readjust higher – as shown below. (click to enlarge) Interesting trends Aside from the obvious disconnect between P/E multiples and underlying fundamentals, S&P Capital IQ’s data highlights some other interesting trends. For example, the energy sector is currently trading at a forward P/E multiple of 33, exceeding the levels recorded while exiting the 2001 recession. The energy sector exited the 2001 recession with an elevated forward P/E of 24 that steadily declined to 8.6 by Q4 2005, well into the economic recovery and actually half way through the Fed’s tightening cycle, which took place between June 2004 and June 2006. The sector’s P/E bottomed in 2005, steadily increasing as the price of crude oil continued to rise from $50-$60 per barrel in the final quarter of 2005 to as high as $145 in July 2008. The sector P/E reached a peak of 15.3 in Q4 2008. These historic trends show that the current extreme forward energy sector P/E ratio reflects severely depressed anticipated future earnings per share relative to existing share prices, not unlike the excessive valuations seen at the tail-end of the tech stock market bubble in 2000. The excessive valuation now needs to be worked off as revenue and profit growth slowly becomes aligned with market pricing. The consumer discretionary sector illustrates more contemporary equity market valuation-related issues. Specifically, between mid-year 2004 and mid-year 2006, as the Fed continued to raise short-term interest rates at every Federal Open Market Committee meeting, investors became more cautious toward the consumer discretionary sector, pushing the sector’s P/E multiple down to 18.4 in the second quarter of 2006, from 19.4. Over the same period, sector earnings grew at an average of 8.8%: “Moving ahead to current valuations, the consumer discretionary sector’s forward P/E ratio has averaged 19.1x in the past two years while sector earnings per share growth has averaged 10.5%. Interestingly enough, this figure is close to the average P/E of 19.4x recorded by the sector during the prior period of Fed tightening when earnings grew by 8.8%. From this perspective, investors appear to be comfortable with a prospective Fed tightening cycle, as they were during most of the prior tightening cycle, as long as consumer discretionary sector earnings continue to grow at a healthy pace.” – S&P Capital IQ Global Markets Intelligence

4 Sector ETFs Crushing The Market In Q4

We are in the middle of the final quarter of this year and the U.S. stocks are shrugging off all global worries and geopolitical issues to give stellar performances. This is especially true as the S&P 500, Dow Jones, and Nasdaq have climbed 6.7%, 7.4% and 7.7%, respectively, so far this quarter and erased all the losses made in the third quarter. Notably, all the three major indices logged the biggest gains last month since October 2011 after a tumultuous ride in August and September. The robust gains were attributed to better-than-expected earnings reports especially from a number of technology players, a wave of mergers & acquisitions, and improvement in the battered energy sector. Additionally, recent headwinds have faded with substantial positive developments seen in the global economy and financial market lately. In particular, the Chinese economy is regaining momentum on the back of better-than-expected GDP growth data and another rate cut, emerging markets are showing signs of stability, and the Japanese and European central banks are seeking additional stimulus measures to revive their economies. Further, seasonality is driving the stock market higher given the crucial holiday shopping season and an expected Santa Claus Rally. Moreover, better economic data including the October jobs report, consumer confidence, inflation and manufacturing data have also injected optimism. All these good tidings have increased the appeal for riskier assets once again leading to a bullish trend in stocks, though bouts of volatility still show up. Given this, we have highlighted four sectors and their related ETFs that have easily crushed the broad market funds by wide margins and been the star performers since the start of the fourth quarter. Energy Despite the fact that oil is exhibiting large swings in its prices, the energy sector has been leading the way higher this quarter. Decreasing U.S. output, a declining rig count, recovering global fundamentals and improving demand are driving up the price of oil, which on the other hand is under pressure from persistent supply glut and a strong dollar. As a result, crude oil price rose to over $49 per barrel in early October and is currently on the verge of going back to the $40 level. While most of the energy ETFs has delivered solid returns, the oil exploration & production corner has been the biggest winner with PowerShares Dynamic Energy Exploration & Production ETF (NYSEARCA: PXE ) gaining 16.3% quarter to date. This fund tracks the Dynamic Energy Exploration and Production Intellidex index, holding 30 stocks in its basket. It is pretty well spread out across various securities as none of these holds more than 5.51% share. It is the high cost choice in the space, with 0.64% in expense ratio. The ETF has AUM of $101.8 million and trades in a low volume of nearly 26,000 shares per day. It has a Zacks ETF Rank of 4 or ‘Sell’ rating with a High risk outlook. Technology After energy, the technology sector has been on a tear with stocks like Amazon (NASDAQ: AMZN ), Alphabet (NASDAQ: GOOGL ) (NASDAQ: GOOG ), Netflix (NASDAQ: NFLX ), Microsoft (NASDAQ: MSFT ), Linkedln (NYSE: LNKD ) and Facebook (NASDAQ: FB ) delivering outstanding performances on the back of a string of solid earnings’ reports. PowerShares Nasdaq Internet Portfolio (NASDAQ: PNQI ) is the top performer in this space, having returned 13.7% so far in the quarter. The fund targets the Internet corner of the broad technology space by tracking the Nasdaq Internet Index and charges 60 bps in fees per year. With AUM of $223.2 million, it holds a basket of 94 securities with concentration on the top five holdings at around 40.9% share. The fund trades in a light volume of around 21,000 shares a day. In terms of industrial exposure, Internet software and services makes up for 57% share, followed by Internet retail (38.1%). PNQI has a Zacks ETF Rank of 2 or ‘Buy’ rating with a High risk outlook. Materials The material sector has been gaining strength especially on its chemical business while metals & mining and steel are still struggling. Growing automotive and residential construction market as well as increasing production is lifting the sector as a whole. That said, iShares U.S. Basic Materials ETF (NYSEARCA: IYM ), having a Zacks ETF Rank of 4 and a High risk outlook, has gained 12.7% so far in the final quarter of 2015. The ETF tracks the Dow Jones U.S. Basic Materials Index and holds 54 stocks in its basket. The top two firms – DuPont (NYSE: DD ) and Dow Chemical (NYSE: DOW ) – dominate the fund’s return with over 10% share each while the other firms hold no more than 7.51% of assets. The fund has AUM of $365 million and charges 43 bps in fees and expenses. Volume is good as it exchanges around 108,000 shares in hand a day. The product is heavily skewed toward the chemical segment, as it makes up for more than three-fourths of the portfolio while steel, forestry & paper, metals & mining receive minor allocations. Biotech After a brutal sell-off in the third quarter, the biotech sector rebounded strongly thanks to attractive valuations, strong earnings growth, and encouraging industry trends. In addition, biotech stocks got a boost from its defensive nature, as these act as safe havens in times of political or economic turmoil. Though most of the biotech ETFs have provided handsome returns, BioShares Biotechnology Clinical Trials Fund (NASDAQ: BBC ) is leading the way higher, gaining in double-digits so far this quarter. This ETF has a novel approach to biotechnology investing as it provides exposure to the companies that have a primary product in Phase I, II, or III of FDA trials by tracking the LifeSci Biotechnology Clinical Trials Index. Holding 90 stocks in its basket, the fund is widely spread out as each firm holds less than 2.3% share. The fund has accumulated $24.7 million in its asset base and charges a higher annual fee of 85 bps per year. It trades in a light volume of 23,000 shares a day and has a Zacks ETF Rank of 3 or ‘Hold’ rating. Original Post