Tag Archives: etfs

Are You Selling The Drama Or Buying The Rally?

The critical concern at this juncture is to address whether or not new information genuinely makes risk taking more desirable. Have prospects for the global economy truly improved? If history teaches us that benchmarks tend to retrace half of their losses before retesting their lows – if you feel like you’ve been here before and you don’t choose to be scarred like that again – perhaps you might anticipate better buying opportunities in the weeks ahead. Mini-crash for equities ignites panic selling? Check. The commodity super-slump, ever-widening credit spreads, corporate sales recession and rapid deterioration in market internals throughout June and July assured a reassessment of risk. The brutality and swiftness of that risk reassessment was less destructive for those who respected the dozens of warning signs and acted proactively. Extremely oversold conditions and short covering spark panic buying? Check. As I explained on Tuesday after six days of relentless price depreciation, the S&P 500 had only closed on the lowest end of its 3-standard-deviation range (0.13% probability) on two other occasions – at the tail end of the eurozone sell-off (10/3/2011) and on Tuesday, 8/25/2015. That’s why I wrote in Tuesday’s article, ” Yes, you’re going to see higher prices in the immediate term. Relief rallies happen . ” On the other hand, corrections in other key historical periods (e.g., 1987, 1998, 2010, 2011, etc.) suggest that relief rallies are likely to be short-lived. Typically, stock prices bounce significantly off potential lows, then retest those lows a few weeks later. The S&P 500 SPDR Trust ETF (NYSEARCA: SPY ) plunged 16% in late July-early August of 2011. The exchange-traded index tracker went on to recover one-half (nearly 8%) in late August and September, but ultimately broke to new lows in early October. Similarly, the current correction for SPY came close to 12%. Should anyone be surprised in the vehicle’s ability to reclaim one-half (approximately 6%) of the erosion in price? If history teaches us that benchmarks tend to retrace half of their losses before retesting their lows – if you feel like you’ve been here before and you don’t choose to be scarred like that again – perhaps you might anticipate better buying opportunities in the weeks ahead . The critical concern at this juncture, however, is to address whether or not new information genuinely makes risk taking more desirable. For instance, have prospects for the global economy truly improved? Are corporations actually going to post top-line revenue increases in the 3rd quarter or blockbuster profitability in the 3rd quarter? Will the Federal Reserve’s timeline for tighter borrowing costs be compatible with real prospects for the U.S. economy? If the answers to these questions are “affirmative,” then stocks may be off to the races. Let’s start with the macro-economic backdrop. Is it possible that the seasonally adjusted, revised-and-re-revised GDP of 3.7% for the U.S. in Q2 is a game changer? Probably not. For one thing, the economic growth for the year is at 2.2% – the same low annualized rate that it has been throughout the six-year recovery. Second, the most respected forecasting arm of the Federal Reserve, the Atlanta Fed, anticipates 1.4% 3rd quarter GDP, which means decelerating activity. Last, but hardly least, the global economy is reeling, from debt-slammed Europe to commodity dependent Latin America to recession-wracked China. It follows that prospects for the global economy do not look substantially better, other than the hope and faith that investors may place in China’s multi-faceted stimulus efforts. Perhaps there is new data to suggest that corporations are growing their bottom line earnings per share that would justify a sustainable bullish stock uptrend. This does not look to be the case. According to S&P data compiled by the web log, Political Calculations, trailing 12-month earnings per share for the S&P 500 have declined from S&P analyst projections throughout 2015 from the projections analyst made three months ago (May 20, 2015), six months prior (February 15, 2015) and nine months earlier (November 13, 2014). Top-line revenue? The revenue recession began at the start of 2015 as the Dow Industrials posted sales declines in Q1 (-0.8%) and Q2 (-3.5%); analyst projections for sales declines are coming in at -4.0% for Q3. So new information on the global economic expansion is not particularly compelling. Meanwhile, companies do not appear to be enhancing their top or bottom lines, which does not help price-to-sales (P/S) or price-to-earnings (P/E) valuations. Why, then, would stock investors become enchanted by anything that has taken place in the last few days? Granted, President of the New York Fed, Bill Dudley, helped send stocks rocketing on Wednesday (8/26) with commentary that hiking the Fed’s overnight lending rate in September is looking “less compelling.” Anything that pushes off the possibility of higher debt servicing costs or higher financing costs excites stock bulls. Keep in mind, of course, nobody at the Fed has suggested that they would not raise interest rates here in 2015. It follows that the hope for a continuation of Fed accommodation – hope for a rate hike delay, a slower pace for rate hikes (e.g., every other meeting), and/or smaller increments (one-eighth of a point) – remains the best bet for stock bullishness. We are still proceeding with caution. Most of our clients have 50% exposure to domestic equity ETFs such as the iShares S&P 100 ETF (NYSEARCA: OEF ), the Health Care Select Sect SPDR ETF (NYSEARCA: XLV ), the iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ), the Vanguard Mid-Cap Value ETF (NYSEARCA: VOE ) and the Vanguard High Dividend Yield ETF (NYSEARCA: VYM ). In some instances, we have bought the dips on accidental high yielding dividend aristocrats like Wal-Mart (NYSE: WMT ). Investment grade bonds make up 25% of most portfolios with funds like the iShares 3-7 Year Treasury Bond ETF (NYSEARCA: IEI ) and the Vanguard Total Bond Market ETF (NYSEARCA: BND ). Most importantly, in May and June, when the S&P 500 regularly sat near the 2100 level, we raised our money market cash account levels . Those cash levels are still at 25%. The purpose? Cash reduces portfolio volatility during periods of market stress, limits the downside loss during sell-offs and provides opportunity to buy quality assets at lower prices. Even if I am wrong about the S&P 500 retesting its lows, we are unlikely to miss the bull train as we await a definitive confirmation of improving market internals . 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.

The Sky Seems To Be Falling. What Now?

Summary Understanding portfolio risk in the context of net worth. Assessing the cause of current distress. Discussing what to do in times of distress. Every successful investor should have a good idea of his asset allocation and risk tolerance in order to manage active market exposure accordingly. I consider an affluent investor with 40% net worth in real estate, 40% in an actively managed portfolio, and 20% in cash and other liquid assets to be prudent and well balanced. But in times of distress like the past few days, the actively managed portfolio becomes the center of focus. Understanding portfolio risk in the context of net worth I find volatility of a portfolio best describes its risk. Most commonly used volatility is in fact the annualized standard deviation of portfolio returns on a daily or monthly basis. I personally run an enhanced equity portfolio with roughly 30% volatility, which is about twice of the S&P 500 index volatility, and has generated about 40% annualized returns in the last six years. Assuming returns are normally distributed, an easy way to quantify 30% volatility is the following: With 68.2% probability, the annual portfolio return will be in the range of up +30% and -30%; With 13.6% probability of each, the annual portfolio return will be between +30% and +60% or between -30% and -60%; With 2.3% probability of each, the annual portfolio return will be up or down more than 60%. As you can see, with volatility of an actively managed portfolio at 30%, the chance of a significant drawdown within a year is still fairly high. However, keep in mind, you ought to view your net worth as a whole when determining risk tolerance. With the portion of an actively managed portfolio at 40% of the net worth, assuming other assets are relatively stable, the actual volatility of your net worth is only 12%, significantly lower than viewing the active portfolio as an isolated entity. We all enjoy upside volatility, but sporadic downside volatility is fair play. Most market participants are prepared to endure such risk in search of long-term profitability. Assessing the cause of the current distress I believe the current selloff has sentimental, rather than fundamental, drivers. Aside from some weakness in the Chinese economy, the global economy is tracking reasonably well with Europe finally starting to emerge from the shadow of sovereign debt crisis. However, U.S. equity markets had sustained several years of stellar performance without correction. Wary of the sustainability of global growth, investor sentiment was gradually shifting towards the defensive side. At this point, it is difficult to assess whether the selloff was triggered by the nearing of Federal Reserve rate hike, or by the recent yuan devaluation by the People’s Bank of China. In addition, the Chinese government’s inability to stem losses in the equity market casts doubt on its ability to navigate through the current softness in its economy. The selling accelerated through the negative feedback loop in various markets. It is most likely an aberration, rather than the start of a bear market. It may take a few weeks for the markets to work out the kink. Investors are also eagerly anticipating what and when central banks’ next moves will be. Meanwhile, doing nothing is not the best course of action. Don’t panic, let’s discuss what to do in times of distress 1) Assessing portfolio risk Evaluate your portfolio and determine if you have too much risk exposure. If you do have too much risk, a straight-forward action is to cut positions proportionally across the board. Even if your exposure is on target, it may make sense, in times of distress, to take some chips off the table in case the selloff intensifies. Keep the powder dry and wait to add back the exposure at more attractive levels. 2) Hedging with equity index futures Even though it is often wise to hedge actively managed portfolios with correlated index options to extract alpha, it is typically not feasible in distress, simply because the elevated implied volatility makes purchasing options cost prohibitive. At one point, the implied VIX touched 50% during the session on Monday, while it traded mostly between 12.5% and 25% over the past few years. Index put spreads may be a possibility as we will discuss below. However, if you don’t have time to do a detailed portfolio analysis, and feel there is too much risk, you can immediately take some market risk out of your portfolio by shorting, say, S&P e-mini futures. Each e-mini has a notional size of close to $100,000, shorting 10 e-minis will take out close to $1,000,000 long market exposure from your portfolio. This method is extremely helpful during potential market bounce after the selloff, especially if you are not convinced of its short-term sustainability of the rebound. It would have worked perfectly during the 4% bounce this morning (Tuesday). 3) Hedging with high-beta names During the selloff of the last few days, high flyers such as Netflix (NASDAQ: NFLX ) and Tesla (NASDAQ: TSLA ) started to show cracks. What goes up a lot could come down hard in a selloff as many momentum chasers will be the first ones to liquidate their portfolios. This makes high flyers the perfect candidates for portfolio hedges. Nevertheless, shorting high flyers could expose you to unquantifiable risk. It is not for the faint of heart. However, buying put spreads on high-beta names could be an attractive way to hedge the overall exposure in the portfolio. An example today is: Buy NFLX Sept 18 $100-strike put for $7 each; Sell NFLX Sept 18 $85-strike put for $3 each. You pay $4 for this put spread, and it is the maximum you can lose; but you could make $11 if NFLX is below $85 at the option expiry on September 18. Although the implied volatility for the higher strike option is likely inflated, the implied volatility of the lower strike option should be even more elevated due to the “skewness” (email me if you want to learn more about this) of the option. If you are proficient in options, you may also sell Sept 4 $90-strike put instead and roll it forward on or near September 4 for more flexibility in assessing on-going market conditions. 4) Treating distress as a godsend in re-allocating portfolio We all have companies we follow and wish owning them at cheaper prices. You know what, now is the time! In times of distress, company stocks are often sold indiscriminately by agitated investors, creating incredible buying opportunities. Use some of your dry powder and dip your toe in the water to acquire a few quality names. Better yet, sell some losers in your portfolio and pick up a few winners on fire sale. It will certainly pay off when markets return to normal. Disclosure: I am/we are short NFLX, TSLA. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Shield Fund Earns Its Name

Summary Hedged Exposure to S&P 500 currently protecting investors’ capital. Delta approaches zero as market drops. New investors in with a -8.33% floor and a 18.95% cap. The recent volatility in the equity markets was a fun test for an investment I introduced upon its launch last April, which is the Exceed Structured Shield Fund (MUTF: SHIEX ). The fund has indeed shielded investor capital as the market plummeted. A detailed description of the mechanics of this fund can be found in my previous article , but as a refresher of the highlights: Passive, synthetic exposure to the S&P 500 via OCC cleared options 1:1 up and down, i.e. no leverage Protection level of -12.5%, or better if market execution allows Ceiling of approximately +15% The fund opened for business on 16 April 2015 and marked at $10 on close of market that day. For several months we were in a relatively sideways market, with SHIEX closely tracking the SPDR S&P 500 ETF Trust ETF (NYSEARCA: SPY ), so there were not any real opportunities to begin to highlight the performance success of an options-based hedge. We were able to observe the success of the 1-to-1 tracking, as SHIEX paralleled SPY. The following chart is the first four months of SHIEX, which is right before the market started cratering. (click to enlarge) At the lowest point, SPY was only down -2.79%. You can see that SHIEX was preserving capital at that point, since it was only down -1.89%. As measured from inception to that low-point, SHIEX had a 0.68 downside capture ratio. That means that for every $1 that SPY lost, SHIEX lost only $0.68. You can also see that SHIEX lagged slightly when SPY turned positive. I wanted to show you the mundane first, in order to set the stage for a stressed, falling market. Let us extend our view to include the most recent market activity. (click to enlarge) As the S&P 500 heads further south, we can see more clearly the impact of the hedge I call a “floor.” Recall that Exceed achieves this by being long (owning) a Put that is out of the money (OTM) by -12.5% or better. For small losses one can hardly notice the effect of this Put. But as the underlying security approaches being at the money (ATM), the delta decreases, approaching 0, and you can see that reflected in the pricing of the fund. The following table will help demonstrate that. The “change” column for both SHIEX and SPY relates to the launch date of 16 April 2015. The second row demonstrates that slight lag I mentioned earlier. The third row, 8/24/2015, is demonstrating the effect of the hedge starting to come into play. While the market has -9.92%, SHIEX has only captured 72.6% of that drop, with a -7.2% drop. But, as the market tanks for a second day, pushing SHIEX closer to its floor, the downside capture ratio shrinks to 66.5%. You can see that clearly in the bottom row. Imagine it like the “ground effect” in aviation. As one gets closer to the ground, the ground (floor) starts “pushing” back. SPY lost -1.18% in the next day of the sell-off, but SHIEX only shed -0.11%. In other words, as the floor was approached, the downside capture ratio sank to 9.3%. That means SHIEX only lost less than a dime for every dollar SPY dropped. Indeed, if SPY continues to drop, you will see the downside capture ratio also continue to drop. The chart for SHIEX will likely look like an invisible Atlas is supporting the fund price. There is nothing mythical about the mechanics, though. This is merely a hedge doing exactly what it is supposed to do: saving investor capital. If the markets continue to correct down, will we see a point where SHIEX will absolutely stop and drop no further? I can’t answer that forward statement, because there are too many variables at play. Recall that there are four, consecutive, 1-year collars being employed at every moment in the fund. Each one expires within a different quarter of the year. The 12.5% floor is set on each collar at a different strike point. The collar that initiated when the S&P 500 was at its lowest will also have the lowest floor, so that will be the critical path to reaching the bottom. But options do not price merely on Delta. Other factors such as volatility, time to expiration, and interest rates also weigh on the value of this synthetic exposure. Also remember that there is a large fixed-income portfolio of investment grade bonds collateralizing the fund, which will have a small impact on the pricing. But, as we have seen demonstrated, the downside capture ratio will continue to shrink towards zero (i.e. an absolute floor)as the long Put approaches being at-the-money. All the historical test data, and mathematical proofs, support this: NASDAQ Exceed Structured Protection Index (EXPROT). Further, they indicate that as the lowest Put goes in-the-money, the hedge will hold solid. (click to enlarge) For every one of the four collars that expires while the market is below the -12.5% or worse, the floor is absolute. The reason is Delta is at 0 (zero). Where is the Fund at this time? Exceed sent out an update on the current state of their collars as of 8/24/2015. This is an average of all four collars currently at-work in the fund: Floor: -8.33% Cap: 18.95% These are the levels that an investor would realize if they invested at the close yesterday. I noted in my introduction piece that the -12.5% floor was a minimum requirement. As you can see, they have exceeded the minimum requirement, and are executing a superior hedge. Further, for those concerned about missing a runaway bull-market, the cap has increased to +18.95%. That is the defined-outcome range of SHIEX as of the most recent, quarterly collar-roll. In this market, by most subjective projections, that is a highly desirable range of outcomes. Unfortunately, the fund has only managed to raise around $7MM assets, which I find disappointing. Disappointing, that is, for all the investors that are losing billions of dollars in this down market with their unhedged, long, domestic, passive and active, large cap investments. I attribute this to a few factors: Lack of awareness of this solution, which I hope to address with articles like this. Misinformation about bundled option strategies propagated by for-profit competitors. Reticence to trust a theoretical strategy; instead preferring to see if it really does work. The numbers are in, and the strategy is working as engineered. Only Schwab and Pershing clients have been able to take advantage of this fund’s strategy. The fund is not yet approved on the TD Ameritrade and Fidelity platforms, but it is my understanding that TD and Fidelity clients will have access within a month. I see little reason to have unhedged exposure to the S&P 500 when this solution is available. The Exceed Structured Shield Index Strategy Fund was just put the test, and it scored. Disclosure: I am/we are long SHIEX. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.