Tag Archives: energy

What The 3rd Quarter Tells Us About The Stock Market In October

As things currently stand, investments that are more likely to benefit from lower borrowing costs rather than higher ones have been winners. The demand for higher yielding stocks contradicts the idea that the Federal Reserve can demonstrate any genuine conviction when attempting to move the overnight lending rate higher. Relative strength for utilities and REITs in the stock world, as well as relative strength for investment grade debt in the bond universe, suggest that the Fed will barely bump overnight lending rates, if at all. Three months ago to the day (6/30), I served up a list of reasons for lowering one’s exposure to riskier assets . I discussed weakness in market internals where fewer and fewer corporate components of the Dow and S&P 500 had been propping up the popular U.S. benchmarks. I talked about the faster rate of deterioration in foreign stocks over domestic stocks via the Vanguard FTSE All-World ex-US ETF (NYSEARCA: VEU ):S PDR S&P 500 Trust ETF (NYSEARCA: SPY ) price ratio. Additionally, I highlighted exorbitant U.S. stock valuations, the Federal Reserve’s rate hike quagmire and the ominous risk aversion in credit spreads. Three months later (9/30), a wide variety of risk assets are trading near 52-week lows or near year-to-date lows. Higher yielding bonds via the PIMCO 0-5 Year High Yield Corporate Bond Index ETF (NYSEARCA: HYS ) as well as the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ) are floundering in the basement. Energy via the Guggenheim S&P Equal Weight Energy ETF (NYSEARCA: RYE ) has broken down below the S&P 500’s correction lows of August 24, suggesting that a bounce in oil and gas may be premature. Even former leadership in the beloved biotech sector via the SPDR Biotech ETF (NYSEARCA: XBI ) reminds us that bearish drops of 33% can destroy wealth as quickly as it is accumulated. Is it true that, historically speaking, bull market rallies typically fend off 10%-19% pullbacks? Absolutely. Yet there is nothing typical about zero percent rate policy for roughly seven years. For that matter, there was nothing normal about the U.S. Federal Reserve’s quantitative easing experiment – an emergency endeavor where $3.75 trillion in electronic dollar credits were used to acquire government debt and mortgage-backed debt. And ever since its 3rd iteration came to an end eleven months ago, broad market index investments like the Vanguard Total Stock Market ETF (NYSEARCA: VTI ) have lost ground. The same thing happened in 2010 during “QE1.” Once it ended, risk assets had lost their mojo. Then in September of 2010, rumors swirled about the Fed engaging in a second round of quantitative easing (a.k.a. “QE2″). And then the bull rally was back in business. As things currently stand, investments that are more likely to benefit from lower borrowing costs rather than higher ones have been winners. Utilities and REITs are up over the last three months; in contrast, industrials, financials and retail have been battered. The demand for higher yielding stocks contradicts the idea that the Federal Reserve can demonstrate any genuine conviction when attempting to move the overnight lending rate higher. (Some seem to believe that the next significant move might even be to ease.) Relative strength for utilities and REITs in the stock world, as well as relative strength for investment grade debt in the bond universe, suggest that the Fed will barely bump overnight lending rates, if at all. Granted, the Federal Reserve would like to tell you the job growth is solid, even as chairwoman Yellen and her colleagues ignore the disappearance of high-paying manufacturing jobs on a daily basis. It has gotten so bad that, according to ADP, the manufacturing sector has experienced a net LOSS for 2015. Is it any wonder that the extraordinary growth of part-time service workers alongside the loss of full-time manufacturing positions have contributed to significant declines in median household income? Should we ignore the reality that 19.5% of the 25-54 year-old, working-aged population is not participating in the labor force (a.k.a. unemployed) – a percentage that has increased every year from 16.5% in the Great Recession to 19.5% today? These are not “retirees” that we’re talking about here. We are maintaining our lower-than-normal asset allocation for our moderate growth and income clients at Pacific Park Financial, Inc. During June-July, our equity exposure moved down from 65%-70% stock (e.g., growth, value, large, small, foreign, etc.), down to 50% (mostly large-cap domestic). Our income exposure moved down from 30%-35% (e.g., short, long, investment grade, high yield, etc.) down to 25% (almost exclusively investment grade). The 25% cash component that we’ve been holding? We would need to see a desire for greater risk through greater pursuit of high yield bonds at the expense of treasuries. We would want to see a pursuit of capital gains over safety in a rising price ratio for the PowerShares S&P 500 High Beta Portfolio ETF (NYSEARCA: SPHB ):iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ). The fact that the SPHB:USMV price ratio is near its lows for the year tells me that it is still better to be safe than sorrowful. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

Global X YieldCo ETF: Not Ready For Prime Time

YieldCos are a relatively new market entrant focused on paying dividends. Despite some popularity among income investors, they are, at best, untested. But that didn’t stop Global X from creating an ETF to track them. I have misgivings about exchange traded funds, or ETFs, in general. While a good idea on one level, Wall Street has a habit of turning good ideas into misused and abused ideas. Which is why Global X YieldCo Index ETF (NASDAQ: YLCO ) caught my attention. I’d say this ETF is a risky investment that most investors should avoid. Here’s why… What’s a YieldCo? So an ETF is a collection of stocks or bonds that trade on an exchange all day long. Sort of like a mutual fund, sort of like a closed-end fund. The ability to trade all day makes ETFs similar to closed end funds. But the market price for a closed-end fund can vary greatly from its net asset value. The structure of ETFs lead them to trade pretty close to net asset value, like a mutual fund. ETFs are also very cheap to own. There is, in fact, a lot to like about ETFs, so long as you stick to large, well diversified funds. But Wall Street, seeing a hot new product, has ramped up its marketing machine. How many S&P 500 ETFs do we need? Not many. Which is why ETFs have gotten more and more obscure, often targeting niche areas and risky investment approaches. Is there a place for these vehicles? Probably. Should average investors be putting their money in them? Probably not. Which is why a YieldCo ETF caught my eye. YieldCos are a relatively new business construct, dating back to around 2012. At this point, they are very similar to a limited partnership structure in which there is a sponsor company that sells its assets to the YieldCo. The YieldCo then spits out income to shareholders. The big difference is that the YieldCo is generally a regular company, so there’s fewer tax headaches than you would face with an LP which is structured as a partnership. On the surface this sounds great. The YieldCos in existence have generally owned electric generating assets with long-term contracts in place, so there’s even some ability to predict a reliable income stream. Investments in the renewable power space (solar and wind, for example) are most often highlighted, though YieldCos own other types of electric generation, too. Growth comes from buying more and more assets. Like LPs and REITs, however, YieldCos spit out so much income that they have to issue more shares to pay for additional assets. There’s nothing inherently wrong with this, since there are obvious precedents for the business model. However, that still doesn’t mean this relatively new business model will work out as planned. Moreover, the focus on renewable power projects means that YieldCos are tapping into a current investor interest. That’s great right now, but what if investors lose interest? So, by and large, I’d say that YieldCos have an interesting story behind them. But, and this is a big but, the long-term legs of the story remain untested. So investors should tread lightly in the YieldCo space, tempering a desire for income and income growth with a bit reality about the very short life most of these entities have lived. If you want proof of these risks, take a moment to look at the recent events around NRG Energy (NYSE: NRG ) and its YieldCo NRG Yield (NYSE: NYLD ). Diversify to reduce risk Of course, one way to offset the risk of owning just one or two YieldCos would be to buy a portfolio of them, right? And that’s where Global X’s YieldCo product comes in. It owns 20 of the largest YieldCos and provides a one-stop shop for getting diversified exposure to this potentially up and coming space. Wait… There’s some problems here. YLCO does own 20 stocks, but its prospectus explains a minor detail you’ll want to watch: “The components of the underlying index are YieldCos selected from the universe of global publicly listed equities, which have a minimum market capitalization of $500m and an Average Daily Value Traded (“ADVT”) over the last three months greater than $1 million. If less than 20 securities satisfy this criteria, the market capitalization and ADVT requirements are lowered. If there are still fewer than 20 securities, the parent companies of proposed YieldCos with the nearest anticipated listing dates will be included in the index until there are 20 index constituents.” In plain English that says, “We want to own 20 YieldCos but there aren’t that many of them right now. So we buy all that we can, even really tiny ones. Since that still may not lead to 20 holdings, we’ll buy companies that aren’t YieldCos but that have said they want to spin one off.” So YLCO has built a niche ETF in a sector that doesn’t have enough stocks in it to support a portfolio of 20 sufficiently sized companies. Think about that for one second. You are buying everything in the sector without any regard to whether or not it’s a good or bad company. With only little regard to size. All a company needs to be is a YieldCo, or a company that says it wants to spin a YieldCo off, to pass muster with Global X. Sure, you’ve got broad exposure to this relatively new niche, but is that really the way you want to get it? If the YieldCo sector continues to grow and manages not to implode, YLCO could become a useful way for investors to get diversified exposure to the space. So, on that level, it’s not a bad idea. However, the YieldCo space just isn’t mature enough at this point to support what YLCO wants to offer. And, in the end, conservative investors should avoid it. In fact, I’d go so far as to say that most investors should avoid it until the YieldCo space has grown some more and YLCO has been stress-tested by the market.

Sector Rotation Watch: The FED Is ‘The New Anchor’

Summary The FED changed everything. The Sector Rotation Model since “crash Monday” had been indicating a turn to ‘risk on’ as bullish sectors began outperforming and bearish sectors lagged. Sector performance since the FED announcement has become decidedly bearish. The FED changed everything. Sector Rotation Background If you’re familiar with my discussions on “Sector Rotation”, you can skip to the next section ” Current Sector Performance” as the info here is simply a repeat for newcomers. Professional money managers rotate through the different market sectors depending on their beliefs about where we are in the economic cycle. These managers have a mandate to be fully invested, so when the economy – or market – turns down, professionals seek safety in “non-cyclical” stocks, or those where earnings are less likely to decline in a recession, and vice versa. The Sector Rotation model below explains it in a simple diagram. Chart 0 – Sector Rotation Model Individual investors have greater flexibility than professionals because they don’t have mandates to be fully invested, so they can exit the stock market rather than finding sectors “to hide in.” However, individuals are notoriously poor at making these decisions and have to deal with numerous behavioral biases, so a word to the wise: if you are older, nearing retirement, then caution and conservatism are warranted and your allocation to volatile equities should be decreased regardless of where we are in the investment and business cycle. If you are younger and can remain invested for the long-term, then you may want to remain fully invested, and possibly tilted toward “the right sectors” during weaker economic times. Current Sector Performance In my September 16, 2015 “Sector Rotation Watch”, while discussing the upcoming September FED announcement, I said “… but with the dissentions on the FOMC board, I’m not sure they are close to a decision.” By this I meant I did not think they could make a decision at all, implying they were “deer in headlights”. They froze, didn’t they? I also said “I’m not sure it even matters.” While I was right about the FED freezing, I might have been very wrong about the market not caring. In the comparison chart below, the left panel shows what the sectors were doing ahead of the FED announcement (since the “crash Monday”, 8/24) while the right panel shows sector performance after the FED. Chart 1 – Comparison of Sectors, pre- and post-FED (click to enlarge) Since “crash Monday” (8/24) on the left, the Sector Rotation Model would have you believe it was “full risk on”, with bull market “cyclical” sectors like Tech (NYSEARCA: XLK ) and Discretionary (NYSEARCA: XLY ) performing very well and “non-cyclicals” of Staples (NYSEARCA: XLP ), Healthcare (NYSEARCA: XLV ), and Finance (NYSEARCA: XLF ) lagging. Utilities (NYSEARCA: XLU ) aren’t just lagging, they seem to be showing a significant bullishness by lagging so far behind. Re-“anchoring” the comparison to the FED announcement and the Sector Rotation Model has reversed course; “places to hide” – aka non-cyclicals – have started performing better and “bull market” cyclicals have fallen off. The most notable performance is from the utilities sector, which is clearly in the lead, and even has a slightly positive return. This stands in sharp contrast to the pre-FED performance for utilities, although you should note they started performing better prior 5 days prior to the FED announcement (see the left panel). Not quite as important, but notable, is that consumer staples has pulled ahead of consumer discretionary, the long-time winner of this bull market. I would watch the discretionary sector very closely going forward, to see if it continues to weaken (bearish) or bounces back (bullish). There are two other things of note since the FED spoke, both being weak performances. The bull market mavens of Energy (NYSEARCA: XLE ) and Industrials (NYSEARCA: XLI ) had fallen hard in the past year, perhaps giving early warning caution signs, but since “crash Monday” they had been experiencing the “bounce back tendency” of laggards. Since FED day, these two sectors have tried to join their cohort of Basic Materials (NYSEARCA: XLB ) in a race to the bottom. Healthcare is almost winning that race, thanks to an idiot ex-hedgie CEO and the heavy media mania on his drug price increases, helping to create some “HillarySpeak”, or simply, a whole lot of bad press on drug stocks. We have gone from “risk on” to “risk off” very quickly, but more precisely, it was actually “risk-on, FED announcement, more risk-on, but just for 1 hour, then it turned sharply, intraday at 3pm, to risk-off”. This is essentially the title to an Instablog I posted on Sept 19. I’m trying to post “more timely” comments than publishing allows by using my Instablog, although it may be sporadic this next week due to outside time constraints. To get notices when I write an Instablog, you have to “follow me.” In chart 2 below, you can see the intraday reversal on FED day (a Thursday), which I highlight with the blue vertical line. I show it on three different symbols to show problems that occur when you look at index symbols. In the left panel, I show the S&P 500 index, and since not all 500 stocks open exactly at 9:30 – some are delayed – it appears the S&P opened at the prior days close. This issue occurs across all the sources I checked. The middle panel is the S&P e-mini but I can set TradeStation to only show the trading during the NYSE “normal” hours, and while the shape is right (Friday shows a gap down), the e-mini shows greater volume on Friday; this is due to the fact that it was a “triple witching day”. Thus I prefer the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) and any other “index ETFs” rather than the index themselves; the SPY shows volume on the FED day to be the greatest. Chart 2 – FED announcement (click to enlarge) A lot of people I respect keep telling me the economy is doing fine, recovering slowly but recovering nonetheless. They watch for “early warning signs” in the economy and the picture seems unclear (isn’t that what the FED just said through its “in-action”?). The market fell hard on China economic weakness, revealing its vulnerability, but rebounded; then the FED rained on the parade. It is obvious the market did not like the FED announcement as it has turned, sharply and decisively. There is one aspect to the Sector Rotation Model that is really interesting and might even give clues by itself. I noted how the utilities sector has gone from extreme lagging to extreme leading. Michael A Gayed , #3 on Seeking Alpha’s list of tops for Market Outlook, runs a “beta rotation strategy” at his firm and it is based simply on what the utilities sector is doing. They look at a rolling 4 week return for the XLU and if the utilities sector is outperforming the broader stock market, up more or down less, then the following month position yourself in utilities, and vice versa. In simpler terms, if over the last 4 weeks, professionals are “running for the exits”, out of the broader market and into the safety of utilities, then join them; and vice versa. Michael gave a very insightful presentation on December 28, 2014, to the Virginia Chapter of the CFA Institute, explaining this strategy. It is well worth the time to watch his presentation, but their study is a fast read. The model performance is significant, with it outperforming about 80% of the time and generating 4.2% outperformance annually. This 4.2% may not seem like much to an individual investor, who dreams of “double-baggers” and “triple-baggers” and such, but if stocks return 7% annually, in 20 years, your portfolio will be 3.9x larger; returning 11.2% annually, it’s 8.4x larger, more than twice as large. Like I say so often, you have to “do the math” and the math of compounding is significant. That is why everyone should start savings and investing as soon as they start working. I have to repeat one thing Michael said in the presentation and it is “the reason buy and hold does not work is that no one holds.” You need to have a plan and be careful about “running hot and cold” every time you read an article that runs counter to your thinking. Keep this in mind when you read the “spoiler alert” about his strategy that I simply must give you now. Michael says you might not want to buy utilities for the next month if they “show a pulse of strength” because 10% of the time, this type of move foretells a VIX spike. In other words, 10% of the time utilities “show a pulse of strength”, the market sells off hard. I wish Michael had defined this numerically because utilities are looking like they might be “showing a pulse of strength”, especially starting early last week (~9/22). Watching short-term news like the FED announcement can be important, especially when it might impact the long-term picture, but be careful about the short-term noise in the market. Fed speak is not noise, not always, such as Yellen mentioning “negative interest rates”. Negative interest rates is loosening, the exact opposite of the expected tightening rate hike some expected. The possibility of the FED pursuing negative interest rates is an important long-term dynamic. Understanding the long-term is critical no matter what your trading time frame; that is, if you trade on a 5 minute basis, you had better know what is happening on an hourly and daily basis, and while you would not trade on a 5 minute time frame based on what is happening on a yearly or decade basis, you still need to understand that higher time frame. If you have not read them yet, my first three articles are “primers for investing”, explaining the long-term nature of market moves. My sector rotation article discusses trying to “play rotating sectors” in a secular bear market (almost impossible) and it also discusses the extreme volatility you will experience, down and up, as discussed in greater depth in my article on long-term secular bear markets. Understanding these secular equity markets is dependent on understand long-term secular moves in interest rates . Given the background these prior articles provide, I’ll stick with the view from my prior Sector Watch article, even though the short-term call was “risk on” at that time and now it’s “risk off.” I repeat what I said then: “Whether we break to new highs, only time will tell, but given the higher risks associated with a longer-term view, and in light of my recent articles, I would still use any rally to raise cash, probably even if I was really young and investing for the long run.”