Tag Archives: financial

3 Economic Headwinds That Matter More Than You Think

It is not surprising to see central bank authorities describe current economic circumstances in glowing terms. Unfortunately, the U.S. economy may not be in the greatest shape. The jobs picture is not as rosy as the Fed would have us believe. Neither is household spending. Manufacturing is a mess, while the global economy is under serious pressure. Is the U.S. economy on solid footing? Federal Reserve Chairwoman Janet Yellen seems to think so. In particular, Yellen expressed confidence in household spending as well as job growth during prepared testimony before Congress on Thursday. It is not surprising to see central bank authorities describe current economic circumstances in glowing terms. Later this month, members of the Federal Reserve Open Market Committee (FOMC) hope to hike borrowing costs for the first time in nine years. Unfortunately, the U.S. economy may not be in the greatest shape for the Fed to act. For example, while the headline unemployment rate is only 5% – a condition that Yellen describes as close to full employment – the percentage of working-aged Americans (25-54) with a job has not been this low in more than three decades. (Back then, Michael Jackson was thrilling music fans with “Thriller” and Prince was going insane with “Let’s Go Crazy.”) Let’s examine the chart above in detail. The 25-54 year old demographic is the prime working-aged sector of the American population. Grammy and grandpa are not the ones who have stopped working entirely; rather, millions upon millions of 25-54 year olds are no longer counted as participants in the workforce. Indeed, when you strip out millions upon millions of working-aged individuals, your headline unemployment rate is going to move lower. Yet that’s not full employment. How can we be close to full employment when 19.3% of 25-54 year old Americans don’t hold a job? If you want to see genuine job growth, look no further than 1985-1989 and 1995-1999. During those periods, you see the percentage of 25-54 year olds with employment catapulting higher. During a five-year span (1989-1994) that encompassed the early 1990s recession? Jobs were hard to come by. That’s why one can see the flattening of the 25-54 year old demographic at that time. Similarly, one of the reasons that the mainstream media called the 2002-2007 economic expansion a “jobless recovery” was due to the flattening of the labor force participation rate in the 5-year run. How, then, can Fed committee members express so much confidence about labor market gains? At best, the chart might be showing signs of a bottoming process, where the new normal is a 19% rate of unemployed Americans (25-54). The rate of decline does appear to have slowed over the last few years. At worst? The pace of declines in the percentage of working-aged individuals who have left the workforce re-accelerates. Of course, Yellen did not merely point to labor gains in Thursday’s testimony. She described vibrant household spending in a nod to a service-oriented economy. What are the problems here? For one thing, families are planning to spend less in the coming year. According to the New York Fed Survey of Consumer Expectations, the median household expects its spending to grow a mere 3.47% as of mid-October, which happens to be near its lowest level in the survey’s two year history. Similarly, the Conference Board’s Consumer Confidence Index fell to 90.4. Not only did the reading on consumer confidence severely miss consensus estimates of 99.5, it was the lowest reading since September 2014. It gets worse. The personal savings rate hit 5.6% in October – the highest level since December of 2012. The combination of higher savings, lower confidence and plans to curtail spending habits hardly supports Yellen’s contention that household spending will be a bright spot. Of course, sometimes what Fed committee members don’t say about the economy is telling as well. Yellen seems entirely unperturbed by the manufacturing sector’s flirtation with recession. That was not the case in 2012 when the Federal Reserve unleashed its boldest stimulus measure to date – a third iteration of quantitative easing affectionately dubbed “QE3.” Then, the prospect of a manufacturing recession mattered. Now it’s irrelevant? From my vantage point, the manufacturing slide is very relevant. First of all, the more important service-oriented sector will have to demonstrate impressive acceleration to offset the drag of a shrinking manufacturing sector. (The personal savings rate, household spending plans and consumer confidence are not particularly supportive of such an offset.) Second, manufacturer struggles forewarn additional layoffs in high-paying jobs as well as ongoing corporate revenue declines at U.S. multinationals. Demand by foreign countries continues to wane. Granted, Yellen tried to boost morale when she explained that downside risks from abroad have lessened. Unfortunately, this one does not pass the sniff test. At least one financial institution, Citi (NYSE: C ), expects China to become the first major emerging market to slash interest rates to zero, precisely because of economic deceleration. Meanwhile, Brazil’s economy shrank by a monumental 4.5% in its most recent reading. The fact that Brazil’s gross domestic product fell by a record 4.5 per cent in its third quarter tells you that Latin America’s largest country is staring down the barrel of one of its worst recessions ever. Okay, then. The jobs picture is not as rosy as the Fed would have us believe. Neither is household spending. Manufacturing is a mess, while the global economy is under serious pressure. What does it all mean for stock investors? Well, if you believe perma-bull hype, stocks are in phenomenal shape. On the other hand, if you look beyond the S&P 500 – if you examine broader market indices like the New York Stock Exchange (NYSE) Index – you have reservations about overexposure to stock risk. Consider the admonition of billionaire hedge fund manager, David Tepper, in May of 2014. “Don’t be too frickin’ long.” That was 18 months ago. For those who insist that the stock market keeps grinding higher, broader stock market indices suggest otherwise. The commentary herein, and the caution that I have been expressing since early 2014, has focused on how one should position himself/herself in late-stage bull markets. Long-time readers understand that the majority of my clients still own long-time positions such as the Vanguard High Yield Dividend ETF (NYSEARCA: VYM ), the Technology Select Sector SPDR ETF (NYSEARCA: XLK ), the iShares USA Minimum Volatility ETF (NYSEARCA: USMV ) and the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ). What I have largely proposed over the last 18-21 months is that investors reduce their overall exposure to risk, lightening up on the asset class canaries – small caps, high yield bonds, commodity-related companies and emerging markets. In other words, don’t be too freakin’ long. 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.

CET: An Out Of Step Old Timer That’s On Sale

Central Securities Corp. is one of the oldest closed-end funds around. It sticks to a value focus, which has kept it out of sync with the broader market of late. But with an around 20% discount, it might be worth a look for patient investors. Central Securities Corp. (NYSEMKT: CET ) is one of those closed-end funds, or CEFs, that kind of gets lost in the crowd. It hasn’t been a standout performer lately and what it does is, well, kind of boring. But for a long-term investor seeking a value fund it might be just the kind of boring you’ll like since it’s trading at an around 20% discount. Value versus growth There are two broad camps in the investing world, value and growth. There’s a lot of wiggle room in there, but it can be interesting to compare the two broad-based approaches. For example, since the bottom of the market was reached during the deep 2007 to 2009 recession, the Vanguard Growth ETF (NYSEARCA: VUG ) had handily outdistanced the Vanguard Value ETF (NYSEARCA: VTV ). VUG data by YCharts That’s not so surprising in hindsight, but it provides an important backdrop for research. If you are looking at a growth-focused CEF and comparing it to the market, it will probably look good. If you are looking at a value-focused CEF, well, not so much. Which is where Central Securities comes in. CET is a value fund and, perhaps, worse, it likes to own securities for a long time-which means it isn’t likely to switch into today’s hot stocks to follow the lemmings or to window dress its portfolio. In other words, when Central Securities is out of step with the market, it can look like a lousy investment option. But long-term performance suggests it isn’t. For example, the CEF’s trailing annualized 25-year return through December 2014 was around 12% compared to 9.5% for the S&P 500 Index, according to the fund. It held a similar, though not quite as large, edge over the trailing 20-year period, too. Over shorter periods, however, it has generally lagged. For example, over the trailing 1-, 3-, 5-, 10-, and 15-year periods through October Central Securities lags the broader market. The shortfall narrows materially the further back you go. For example, over the trailing 15 years, Central Securities’ annualized net asset value total return, which includes reinvestment of distributions, was roughly 4%. Over that same span the S&P’s total return was 4.5% or so. Over the trailing year through October, however, Central Securities was down roughly 1% while the S&P was up about 5%. Percentage wise, that’s a huge rift. But the backdrop is critical. VUG and VTV offer up a similar disparity. So, in some ways, Central Securities is doing what you’d expect. Moreover, leading into 2000, roughly 15 years ago, the market has been dominated by cycles of boom and bust. We are currently in an up cycle, in my opinion, highlighted once again by tech darlings sporting extreme valuations. In other words, not much has changed since the turn of the century. And that’s left a closed-end fund like Central Securities out of step. The long, long term But the thing to keep in mind about Central Securities is that it’s been in business since 1929. So it doesn’t think in days, months, or years. It thinks in decades… or longer. For example, three of its top-10 positions were purchased in the 1980s and one was bought in the 1990s. Yet another was added in 2000. That doesn’t mean it won’t buy and sell stocks when it sees opportunities, but when it buys a company it often holds for a long time (the other half of the top 10 were purchased in 2007 or later). Such long holding periods are not the norm in the fund world. So, almost by design, Central Securities is out of step. According to the fund : Our approach is to own companies that we know and understand, which we believe reduces risk. We also consider the integrity of management to be of paramount importance. We try to find new investments available at a reasonable price in relation to probable and potential intrinsic value over a period of years into the future and then hold them through the inevitable market ups and downs. If you think that sounds like something you’d expect out of Warren Buffett’s mouth, you’d be right. So why now? The interesting thing about Central Securities right now is its nearly 20% discount to net asset value. That’s fairly wide for this fund, which has a 10-year average discount closer to 16%, according to the Closed-End Fund Association-a level at which it traded when I last looked at the fund earlier this year. If you look back over the fund’s history on a quarterly basis 20% is a relatively infrequent number to see. Which helps explain why the fund repurchased roughly 775,000 shares through the first nine months of the year. The average price on those purchases was around $21. Central Securities’ shares have recently been trading hands below $20. If you are looking for a value-focused fund with a long-term history of success, this might be a good option for you. Just be prepared to hold for a long time and to handle being out of step with the market for sometimes lengthy periods. But when value comes back into favor, which history suggests it will, this fund’s willingness to stick to its knitting should shine through. The caveats But that doesn’t mean it’s right for everyone. For starters, if you are an income investor, the fund only pays semi-annually. And the distribution has varied greatly over time. So you can’t really count on Central Securities for income. It does have a lot of unrealized capital gains in the portfolio, which isn’t surprising given its penchant for owning stocks for long periods of time. However, that doesn’t mean it will sell them just to fund a distribution, only that it could do so if it wanted. Another wrinkle here is that the CEF’s largest holding is The Plymouth Rock Company, a non-traded insurance company. That one position makes up nearly 20% of the portfolio. That means management is pricing a huge chunk of the portfolio by itself. It has a system in place for that, but Central Securities does not own a diversified portfolio. It’s worth noting that The Plymouth Rock Company has been actively buying back its shares. Central Securities, for example, sold 6,000 shares in the third quarter, leaving it with over 28,400 shares worth a total of $109 million at the end of the quarter. CET has a massive unrealized gain in this one investment, since the initial cost was only about $700,000. Which helps explain why Central Securities has pretty much told The Plymouth Rock Company that it is willing to sell, but only a little at a time and only if the price is right. So this issue is likely to get smaller as time goes on. (A shout out to Papaone for digging that nugget out of a Plymouth Rock report.) Whether or not a concentrated portfolio and difficult to gauge dividends are reasons to bypass Central Securities is really going to be based on your investment preferences. But I would say conservative income-focused investors would probably be best off looking elsewhere if you are trying to replace a paycheck. However, Central Securities is well worth a deep dive if you are looking for a value-focused fund that has proven it won’t change its stripes and see the income it throws off as a side benefit and not the main show.

XLU: This Sector Is Unhappy About Higher Rates

The Federal Reserve is expected to raise its benchmark lending rate in coming months. Utilities stocks have thus trended lower due to their bond-like qualities, and dependence on debt financing. As the Fed tightens its policy, XLU presents an attractive short opportunity. While the stock market as a whole may not correct due to the U.S. rate increase, Utilities Select Sector SPDR (NYSEARCA: XLU ) will likely show weakness. The utilities sector is heavily dependent on interest rates for two reasons. First, utilities use a lot of debt financing to run its operations. This means that when interest rates rise, their debt servicing costs increase, and thus weigh on bottom line growth. Another factor is that utilities companies are generally slow growing, and thus return earnings to shareholders in the form of a dividend to attract investment. This aspect gives utilities stocks, as well as the broader XLU a bond-like asset quality. Therefore, when interest rates rise, share prices of utilities stocks decline. The chart below shows the correlation between the U.S. 10-year Treasury yield compared to XLU over the last five years. As the Federal Reserve began slashing its lending rate as a result of the financial crisis, the 10-year yield fell from over 3.6%, to a bottom of 1.375%. This drastic decline was the catalyst for a sharp move higher in XLU, as well as broader U.S. equity markets. When the Fed made it evident in 2013 that it was planning on ending its stimulus measures, interest rates rose, while XLU consolidated tightly, but then utilities resumed their uptrend as an actual rate hike was found to be years away. Now, however, as markets prepare for an actual U.S. lending rate, XLU is experiencing volatility again, and has underperformed the broader market throughout 2015. With the Fed likely hiking rates over the next few months, utilities companies, such as– NextEra Energy (NYSE: NEE ), Duke Energy (NYSE: DUK ), Dominion Resources (NYSE: D ), Southern (NYSE: SO ), and American Electric Power (NYSE: AEP )-have all begun to trend lower. Their operating environment looks to become more challenging amid higher rates, while investors find the sector’s dividends less attractive relative to higher prevailing interest rates. For this reason, XLU and its component companies look to be interesting short opportunities in coming months as the Fed tightens policy measures. (click to enlarge)