Tag Archives: etfs

If Investors Get More Stimulus, Will They Take More Risk?

The U.S. economy continues to show signs of frailty. U.S. gross domestic product (NYSE: GDP ) expanded at a feeble pace of just 0.7% in the 4th quarter. In the same vein, the Atlanta Fed’s GDP forecast for the first quarter of 2016 is just 1.2%. There’s more. The manufacturing segment of the economy has contracted for four consecutive months. Meanwhile, year-over-year growth for total business sales as well as retail have steadily eroded. Also, year-over-year activity for corporate spending on tangible assets like equipment, buildings and machinery (i.e. capital goods) has decelerated, ultimately turning negative. Throughout the course of the current bull market cycle, investors have relied on the Federal Reserve to stimulate the economy as well as risk asset appetite. The central bank of the United States bought mortgage-backed securities and U.S. treasury debt in the beginning of 2009 (a.k.a. “QE1″). When the economy softened in 2010, the Fed rode to the rescue in 2010 with “QE2.” When the euro-zone crisis threatened the world economy in 2011, monetary policy leaders acquired longer-term Treasury securities with the proceeds of shorter-term debt to push borrowing costs even lower. The media dubbed the new stimulus effort, “Operation Twist.” And economic deceleration in 2012 led to the most remarkable stimulus of them all, “QE3.” What is strange about the picture above? In December of 2015, the Federal Reserve raised its overnight lending rate by 0.25%, even though the U.S. economy had been showing signs of strain. The stimulus removal may not have seemed like a big deal at the time. However, the Fed’s expressed desire to move in the direction of less stimulus has significantly impacted currency exchange rates, corporate bonds, foreign bonds, and investor tolerance for risk. Consider a few straightforward realities in the ETF world. Since the last bond purchase of QE3 in mid-December of 2014, the CurrencyShares Euro Trust ETF (NYSEARCA: FXE ) has depreciated 11% and the P owerShares DB USD Bull ETF (NYSEARCA: UUP ) has appreciated 8.5%. Similarly, FXE is near a 5-year low, while UUP is near a 5-year high. CEOs of U.S. corporations regularly cite the super-sized strength of the U.S. greenback as a severe headwind to profit growth. The directional shift in monetary policy did not simply jolt world currencies. Since the last asset purchase of QE3 in mid-December of 2014, riskier stock assets have lost value. The SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) has charted a volatile path toward 6% losses. And that’s the smallest example of wealth destruction. The iShares Core S&P MidCap ETF (NYSEARCA: IJH ) is off roughly 9%, a small-cap proxy like the iShares Russell 2000 ETF (NYSEARCA: IWM ) is down 14%, the iShares MSCI ACWI Index ETF (NASDAQ: ACWI ) dropped approximately 14%, and the Vanguard FTSE Emerging Markets ETF (NYSEARCA: VWO ) cratered a starling 23%. Bear in mind, the limited desire for risk-taking does not stop at the doorstep of the equity markets. Since the last bond purchase of QE3 in mid-December of 2014, long-term treasuries via the iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ) is up 5%. Even more impressive? The intermediate area of the yield curve via the iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) has tacked on 5% as well; the exchange-traded tracker currently sits at a new 52-week high. Stock bulls have modified their thesis since the breakdown of market internals in the summer of 2015 . Then, there had been great faith in corporate profitability. Today, the earnings picture is decidedly poor, but many are pointing to improving valuations that might support slightly higher price levels. Then, there had been tremendous confidence in the resilience of consumers, particularly in light of energy-related savings. Today, bulls tacitly acknowledge that consumer spending is slowing and that savings has been rising, leading cheerleaders like CNBC’s Jim Cramer to beg the Fed to reconsider its direction on rate guidance. In a nut shell, bullish investors now hope that the Fed reverses course and discusses stimulus once again. Weaken the dollar. Secure ultra-low borrowing costs. Businesses and consumers can ignore total debt levels if the cost to service those debts abates. And investors? They’ll project lower rates for even longer out into the future, allowing them the luxury to pay premium valuations for stock assets. That’s the hope, anyway. Cracks in the Fed facade appeared as recently as February 1, when Vice-Chairman Stanley Fischer hinted that fewer rate hikes may be in the cards. It seems probable that the Fed is/was/has always been prone to backtracking. On the flip side, if the Fed does have a change of heart, will it occur early enough to help the economy and/or inspire investor confidence? Bullish stock investor certainly hope so. Their revised thesis on bear market avoidance depends on it. That said, central bank policy alone may not be able to keep an economy from succumbing to recessionary forces; it may not stop stocks from falling precipitously. The Federal Reserve did not act early enough or powerfully enough to save stocks from collapsing 50%-plus in the 2000-2002 dot-com disaster, nor was the institution prepared to prevent the 50% shellacking in the 2007-2009 banking crisis. In truth, monetary policy gamesmanship bolsters asset prices when market internals are improving. Yet the Fed is not omnipotent; its leadership does not have arrows in its collective quill to avert every and any recession. And that means, if the global economy crumbles, it may do more harm than simply act as a drag on the domestic recovery. Right now, market internals show little evidence of improvement. For instance, over the course of the last 12 months, the New York Stock Exchange Advance/Decline (A/D) Volume Line portrays a very grim picture of risk appetite. Net advancing volume continues to deteriorate as the volume of declining stocks has, more often than not, superseded the volume of advancing issues. Since the last asset purchase of QE3 in mid-December of 2014, corporate credit tells a similar story about risk preferences. The rising price ratio between investment grade corporate credit via the iShares Intermediate Credit Bond ETF (NYSEARCA: CIU ) relative to the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ) is near a 52-week high. Our tactical shift toward lower risk since mid-2015 remains the same. Moderate growth and income investors at Pacific Park Financial, Inc. have approximately 50% in low volatility, high quality U.S. large caps. We have 25% in investment grade bonds, primarily Treasury bonds and munis. The remaining 25% in cash/cash equivalents exists to lessen the volatility while awaiting better buying opportunities in the near future. For Gary’s latest podcast, click here . 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.

Low Volatility ETFs May Be 2016’s Best Bet

This article originally appeared in the February issue of Wealth Management and online at WealthMangement.com. Simple and straightforward is the way to go, particularly given the shaky start to the year. Ask market prognosticators about the recent market rout and prospects for 2016, you will hear a lot about volatility. A recent Barron’s Striking Price column warned investors that “stocks will do about as well in 2016 as they did in 2015, but with more frequent price swings,” citing central bank actions here and abroad, a shallower option market and lower corporate profit margins as contributors to more market oscillations in the year ahead. Société Générale strategist Larry McDonald pointed to weak oil prices when he advised investors to “get long volatility.” And, in a note to clients, Morgan Stanley stock strategist Adam Parker broadly exclaimed “we are likely headed for a choppy year of low returns, and suspect many others think the same.” Volatility isn’t good for stock returns. You can see its deleterious effect especially displayed in the wake of drawdowns. A drawdown is a peak-to-trough decline in an investment’s value. A stock that topples from $100 to $80 before starting to recover suffered a 20 percent drawdown. That’s bad news certainly, but what’s worse is this: It takes more than a 20 percent gain to get back to even. To reach $100, an $80 stock must, in fact, rise 25 percent. After a 30 percent drawdown, a 43 percent move is required to recover lost ground. And on it goes. Big drawdowns need even bigger recoveries. 2016 looks to be studded with drawdowns, making it a banner year for low-volatility plays. And that’s good news for manufacturers of certain exchange traded funds (ETFs). Large-Cap, Low Vol There are eight low-volatility ETFs benchmarked to the S&P 500, each trying to solve the drawdown problem in a distinct manner. If we compare these funds to an S&P 500 tracker such as the iShares Core S&P 500 ETF (NYSEARCA: IVV ), we can get a sense of their effectiveness along a number of risk parameters. First, there’s the maximum drawdown conceded in the past year. Seven of the low-vol funds countenanced smaller drawdowns than IVV’s 12 percent hit. The entire set of ETFs beat IVV on a Value-at-Risk ((VaR)) basis. VaR represents an ETF’s potential daily loss at a 99 percent confidence level. IVV can be expected to lose no more than 2.3 percent of its value on 99 days out of 100. On average, the low-vol portfolios show a 1.9 percent VaR. Another measure, M-squared (M 2 ), gauges the risk-adjusted return of each ETF. M-squared depicts the ETF’s return if it was as volatile as the IVV portfolio. The higher the M-squared value relative to an ETF’s total return, the better. On this basis, the S&P 500-benchmarked ETFs are a mixed bag. Collectively, they skew negative, but that’s due to the performance of one extreme outlier. Without that one fund, the seven remaining ETFs exhibit an average 0.2 percent volatility benefit. This brings us to returns. Only one of the low-vol products exceeded IVV’s gross performance last year. Six conceded upside as the cost of reduced volatility, and one was a double whammy of negative returns and deeper drawdowns. The Best and Worst Performers The best performer was the PowerShares S&P 500 Low Volatility Portfolio ETF (NYSEARCA: SPLV ), which tracks a weighted index of the 100 least-volatile stocks in the S&P 500. SPLV covers all four bases: a higher total return than IVV, a shallower maximum drawdown, less VaR and a significantly high M-squared value. Despite this, SPLV correlates highly to IVV with a .87 r-squared coefficient. Beta, at .90, is close to the benchmark ETF as well. The worst overall performance was turned in by the PowerShares S&P 500 Downside Hedged Portfolio ETF (NYSEARCA: PHDG ), an actively managed ETF built on S&P 500 component stocks overlaid with VIX (CBOE Volatility Index) futures. PHDG can, during periods of exceptional volatility, maintain a substantial cash position as well. Presently, the asset mix is 90 percent stocks and 10 percent VIX futures. Oddly enough, VIX futures are themselves notoriously volatile. And not in a good way. The annualized standard deviation in settlement prices for the January 2016 contract topped 51 percent over the past eight months alone, making it a very expensive exposure to maintain. That, and swaps into and out of cash, contributed to PHDG’s negative return. Also noteworthy is the Janus Velocity Tail Risk Hedged Large Cap ETF (NYSEARCA: TRSK ), a portfolio that allocates 85 percent of its heft to equity exposure and 15 percent to a volatility hedge. TRSK isn’t selective-it holds all the S&P 500 component stocks overlaid with a dynamic long/short exposure to short-dated VIX futures. The hedged portfolio aims for a 35 percent net long exposure. TRSK gets close to its target, too, earning a .31 beta coefficient over the past year. Still, TRSK trades return for low drawdown risk. Two other low-vol portfolios trade in the large-cap space, but are not benchmarked to the S&P 500. The SPDR Russell 1000 Low Volatility ETF (NYSEARCA: LGLV ) draws the least volatile stocks from the Russell 1000 universe on an unconstrained basis, while the stocks selected for the iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ) are chosen and weighted subject to sector and correlation limits. Even though the USMV portfolio is a derivative of a different index, it’s been more closely correlated to the iShares Russell 1000 ETF (NYSEARCA: IWB ) than LGLV over the past year. (The only domestically traded ETF tracking the MSCI USA Index is now equal-weighted. Accordingly, we used an ETF tracking the cap-weighted Russell 1000 as LGLV’s benchmark to better gauge the effectiveness of the embedded low-volatility strategy.) In the end, USMV comes out on top, producing significantly higher total returns and lessened downside risk compared to IWB. Don’t Forget Mid-Caps and Small-Caps The stock universe for the iShares Core S&P MidCap 400 ETF (NYSEARCA: IJH ) is the same trolled by the PowerShares S&P MidCap Low Volatility Portfolio (NYSEARCA: XMLV ). Currently, about 80 of the least volatile S&P MidCap 400 companies take up residence in XMLV. The fund ends up fairly well correlated (r-squared at .81, beta at .79) with IJH, but handily outdoes the index tracker in terms of total returns and risk. Three ETFs follow low-vol strategies in the small-cap space, one tied to the S&P SmallCap 600 Index and two bound to the Russell 2000. Like its SPLV and XMLV siblings, the PowerShares S&P SmallCap Low Volatility ETF (NYSEARCA: XSLV ) tracks a volatility-weighted index of stocks derived from its benchmark. About 120 of the least volatile securities in the S&P SmallCap 600 Index populate the XSLV portfolio, producing a .80 beta and a .84 r-squared value. Even so, the low-vol ETF’s one-year return was double that of the iShares Core S&P SmallCap 600 ETF (NYSEARCA: IJR ). The SPDR Russell 2000 Low Volatility ETF (NYSEARCA: SMLV ) comprises small-cap stocks selected and weighted by low volatility and other factors, yielding a portfolio modestly correlated to the iShares Russell 2000 ETF (NYSEARCA: IWM ). IWM’s movements explain about two-thirds of SMLV’s. The low-vol fund delivers a .70 beta and a .64 r-squared coefficient while nearly trebling IWM’s one-year return. Summing it all up You could say that the low-vol ETFs we’ve examined do what they promise-if VaR is your yardstick, that is. All 14 portfolios produced VaR values below that of their benchmark ETFs. In terms of maximum drawdowns, 13 ETFs-93 percent of those analyzed-experienced shallower slumps than their bogeys. But here’s the kicker: Only 36 percent-5 of 14-low-vol products outdid their associated index trackers’ total returns.The common denominator for these funds is simplicity. Most utilize a straightforward screen that filters stocks by standard deviation, with the least volatile issues given greater weight in the ETF portfolio. Overlays, equal risk weighting and other complex schemes can produce portfolios with low risk parameters, but they often do so at the cost of truncated returns. It’s no wonder really. Many of these low-vol strategies are products of sophisticated financial engineering. Complexity often engenders unintended or unwanted outcomes. Investors seeking low-risk returns in 2016 may want to heed the words of that great engineer Leonardo da Vinci who declared, “Simplicity is the ultimate sophistication.”

Tactical Asset Allocation – February 2016 Update

Here is the tactical asset allocation update for February 2016. As I mentioned last month, I am now using a new data source for the portfolio updates. I am also maintaining the old portfolio formats, in Yahoo Finance, for a while. Here is the link to the Yahoo data. Let’s dive right in. Below are the updates for the AGG3, AGG6, and GTAA13 portfolios. The source data can be found here . The big change here is the use of FINVIZ data and more importantly that these signals are valid after every trading day. So, while I’ll maintain these month end updates, this means that you can implement your portfolio changes on any day of the month, not just month end. FINVIZ will at times generate signals that are slightly different than Yahoo Finance. Click to enlarge AGG3 is now 100% bonds and no cash. This is a significant change from last month where AGG3 was 66% invested. AGG6 is 33.3% cash and 66.6% bonds. AGG6 is more invested than last month’s positions. Below is the YTD performance along with some popular benchmarks. Once change in the performance figures this year is that I am know including the performance of cash when the portfolio sin cash (using SHY as the cash proxy). For the Antonacci dual momentum GEM and GBM portfolios, GEM is now in bonds, BND, and the bond portion of GBM is in cash. I’ve also made my Antonacci tracking sheet shareable so you can see the portfolio details for yourself. Here is the data. Click to enlarge Finally, I am receiving quite a bit of interest in the simple bond quant model I published previously . So, I created a spreadsheet to track one version of the model I presented. The spreadsheet ranks the bond ETFs by 6 month return and uses the absolute 6 month return as a cash filter to be invested or not. Several versions of this model work quite well as discussed in the blog post. Personally, I am now using a 3 month return, 3 month filter, top 3 model but the differences are not that big. That’s it for this month. These portfolios signals are valid for the whole month of February. As always, post any questions you have in the comments. **Note: an observation for this week. Ever notice the percentage of self-called ‘long term investors’ who know what the stock market did on a daily basis? Let me tell you that is long term detrimental to your portfolio performance. It is hard to ignore market data in today’s world. I try very hard to ignore it and have to take active action to avoid finding out about daily gyrations in the market. It’s one of the reasons I do not blog more often. My goal is to only check one per month, that’s it. And even that is too often. If I could auto trade my quant systems I would… I once heard it said that most investors would achieve higher returns if they lost their password to their investment accounts for years. There is a lot of truth in that statement….