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Top ETF Stories Of 2014 Worth Watching In 2015

The stock market across the globe has given mixed performances in 2014. While the Dow Jones Industrial Average crossed the 18,000 mark for the first time in mid December and the S&P 500 is on the verge of crossing the 2,100 level on the back of an accelerating job market and improving economic fundamentals, a number of international economies have either slipped into recession or are struggling to reignite growth. In particular, several events will likely spill over into 2015 and continue to impact the ETF world either in a positive or a negative way. Below, we have highlighted some of these events, which will hog investor attention in the New Year: Oil/Energy ETFs The broad energy space hit headlines all year round as oil price jumped to a fresh high in mid June and then took a reverse turn slipping to a multi-year low in December. While geopolitical tensions in Russia and insurgency in Iraq propelled the oil prices and the energy ETFs higher in the first half of the year, rising U.S. shale oil production, abundant supply, slowing global demand, no cut in OPEC output, and a strong dollar pushed them to lower levels in recent months. Whether the bear will continue to chase the energy space or will it turn around in 2015? This is THE question everywhere in the world. However, oil price is showing some strength in today’s trading session on concerns over the Libyan supply disruption. As a result, investors should definitely keep a close eye on ETFs that will largely be impacted by this development. In particular, the First Trust ISE-Revere Natural Gas Index Fund (FCG ) , SPDR S&P Oil & Gas Exploration & Production ETF (NYSEARCA: XOP ) , Market Vectors Oil Services ETF (NYSEARCA: OIH ) , United States Oil Fund (NYSEARCA: USO ) and United States Brent Oil Fund (NYSEARCA: BNO ) are some of the funds that could see huge volatility. FCG, having a Zacks ETF Rank of 5 or ‘Strong Sell’ rating, has stolen the show this year, plunging 41.2% while XOP and OIH lost about 28% and 24.2%, respectively and have a Zacks ETF Rank of 4 or ‘Sell’ rating. The future-based oil ETFs – BNO and USO – declined 47.8% and 41.7%, respectively. Russia ETFs Russian ETFs have seen horrendous trading this year thanks to several rounds of Western sanctions imposed on the country for invading Ukraine and the oil price collapse. The Russian ruble also saw a terrible decline against the greenback, losing about 50% since June. To combat the slide in the currency and reinvigorate growth, the Russian central bank has taken various measures. While direct currency intervention, minor rate hikes, and tightening supplies of the ruble did not bear any fruit, the central bank took a bold step this month by raising key interest rates rate from 10.5% to 17%, representing the steepest one-time hike in 16 years. The ruble has recovered slightly after the move but Russian economic growth still remains gloomy due to limited opportunities for investment, declining oil prices, rising inflation, weak deposit growth, soft earnings, falling consumer confidence and lack of growth drivers. Given this, Russia ETFs remained in investors’ eyes in the emerging/European market space in 2015. There are currently four non-leveraged ETFs targeting the Russian stocks – the Market Vectors Russia ETF (NYSEARCA: RSX ) , iShares MSCI Russia Capped ETF (NYSEARCA: ERUS ) , Market Vectors Russia Small-Cap ETF (NYSEARCA: RSXJ ) , and SPDR S&P Russia (NYSEARCA: RBL ) . All the products currently have a Zacks ETF Rank of 5 and are down in the range of 40-50% this year. U.S. Treasury ETFs While short-term Treasury ETFs have stayed almost flat this year, long-term products are leading the space. This trend is unlikely to continue next year as the Fed is on track to raise interest rates given a strengthening U.S. economy. Some market experts expect the first interest rate hike since 2006 sooner than expected in mid 2015, resulting in aggressive higher yields since 2009. According to the Wall Street message , 2015 would be disastrous for U.S. government bonds. In fact, the short end of the yield curve is rising faster than the long end and the spread between the 5-year and 30-year yields tightened to 109 bps from 220 bps at the start of the year, indicating that the yield curve is plateauing. As such, investors should take great precaution while trading in government bonds in the coming months. The three most popular Treasury funds – iShares 1-3 Year Treasury Bond ETF (NYSEARCA: SHY ) , iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) and iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ) are up 0%, 6.20%, and 22.14%, respectively. All these products have a Zacks ETF Rank of 3 or ‘Hold’ rating. SHY targets short end of the yield curve while IEF and TLT focus on mid-term and long-term government bonds, respectively. Bottom Line Investors should closely watch the developments in these spaces as we head into the next year and should tap opportunities as and when they come.

Best And Worst Bond ETFs Of 2014

The U.S. stock markets delivered a somewhat muted performance this year (at least when compared to 2013) with the S&P returning about 12% YTD gains. The towering market of last year turned into a market that saw fears about a global slowdown and its effect on U.S. corporate earnings, plummeting oil prices, sluggish growth in Japan, concerns of a triple dip recession in Europe and the outbreak of the Ebola virus that forced many investors to look for safety and shun risky assets. Needless to say, the above threats kept bond yields at the lower side throughout the year causing investors to hunt for income bets. While long-term bond ETFs were weak last year due to taper threats, short-term bond ETFs hit the brakes this year due to rising rate concerns. Despite the Fed’s repeated assertion of keeping the rates low for longer, the recent strength in economic data has led to concerns that the Fed could start raising rates after the first quarter of 2015 instead of the initial June or September 2015 timelines. This in turn has lowered the appeal for short-term bond ETFs giving leeway for long-term bond ETFs to score higher in the face of dwindling global growth and an oil price rout. Flight from risk has caused the yield on the benchmark 10-year Treasury note to hover around 2%. Amid such a situation, it would be interesting to note which ETFs were the leaders and laggards in the bond space during 2014: Winners Two bond ETFs – the PIMCO 25+ Year Zero Coupon U.S. Treasury Index ETF (NYSEARCA: ZROZ ) and the Vanguard Extended Duration Treasury ETF (NYSEARCA: EDV ) – soared this year having returned more-or-less 45%. ZROZ tracks the BofA Merrill Lynch Long U.S. Treasury Principal STRIPS index with effective maturity and effective duration of the fund being 28.99 years. On the other hand, EDV follows the Barclays U.S. Treasury STRIPS 20-30 Year Equal Par Bond Index. The fund has average maturity of 25.3 years and average duration of 25.0 years. The next best performers in the space comes in the form of the iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ) , SPDR Barclays Capital Long Term Treasury ETF (NYSEARCA: TLO ) and iPath US Treasury Long Bond Bull Exchange Traded Note (NASDAQ: DLBL ) . These long-term bond ETFs have returned about 25% each this year. SPDR Nuveen Barclays Build America Bond ETF (NYSEARCA: BABS ) – a long-term muni bond ETF too returned smartly (up 21.6%) in 2014. To beat the potential rise in U.S. inflation and rack up gains on the real return, long-term TIPS bond ETF, the 15+ Year U.S. TIPS Index Fund ( LTPZ), was in demand in 2014 and has added about 19.3%. In short, the trend clearly indicates the inclination toward long-term bond ETFs. Beyond the border, PowerShares DB Italian Treasury Bond ETN (NYSEARCA: ITLY ) added about 19% this year thanks to the extremely easy monetary policy. Losers Thanks to the flattening of the yield curve, the U.S. Treasury Steepener ETN (NASDAQ: STPP ) turned out as an acute loser in this space. The product tracks the returns of a notional investment in a weighted “long” position in relation to 2-year Treasury futures contracts and a weighted “short” position in relation to 10-year Treasury futures contracts. Bullish stance on 2-year Treasury made the product a loser. The product was down 18%. Apart from this, junk bond ETFs like Peritus High Yield ETF (NYSEARCA: HYLD ) lost about 13% as returns were great in the safe government bonds space. Needless to say, short-term bond ETFs like the S&P/Citi 1-3 Yr Intl Treasury Bond ETF (NASDAQ: ISHG ) were defeated in the race. The fund is down 10% this year. The fate was similar for the WisdomTree Barclays U.S. Aggregate Bond Negative Duration Fund (NASDAQ: AGND ) with a loss of about 8.5%. Road Ahead Having presented the scorecard of the year, we would like to note that the trend will be quite similar in the year ahead. However, like 2014, TIPS ETFs should be out of the betting list courtesy of a tepid inflationary outlook across the globe. Apart from the long-term government bonds, investors having a stomach for risk can also have a look at the long-term investment grade corporate bond ETFs to earn some regular income along with securing the portfolio. To do so, investors might tap the Long-Term Corporate Bond Index Fund (NASDAQ: VCLT ) , SPDR Barclays Capital Long Term Corporate Bond ETF (NYSEARCA: LWC ) and iShares 10+ Year Credit Bond ETF (NYSEARCA: CLY ) .

Should You Look For Value In Cash Flows?

Most deep-value investors look at the balance sheet and P/E multiples when they are hunting for bargains, a strategy taught by the godfather of value investing, Benjamin Graham . However, what strategies like these fail to take into account is cash flow. Glen Greenberg and Donald Yacktman are two respected value investors, both of whom invest not just with asset value in mind but also cash flows. This strategy has yielded results. Greenberg’s fund, Chieftain Capital Management achieved a compounded annual growth rate of 25% from 1984 through 2000, the S&P 500 achieved a return over 16% over the same period. Annual returns through 2010 were 18%. Greenberg uses a DCF model to make his investments but rather than the traditional DCF method, in the style of Graham, Greenberg looks for a margin of safety before investing. This margin of safety is a hurdle/discount rate of 20% for all potential investments when computing the DCF. The rate was lowered to 15% in order to reflect the interest rate environment. (click to enlarge) Adjusted cash flows Meanwhile, Yacktman uses an adjusted cash flow figure to value securities. Yacktman equates the forward rate of return with a company’s free-cash yield . He calculates this yield by computing the FCF, then adds in the cash he believes the business can generate through growth and adjusts for the effect of inflation. That figure is then divided by the stock price. Using this adjusted cash flow figure, Yacktman compares the stock’s forward rate of return with yields on long-term Treasuries. The wider the spread, the deeper the discount and the more attractive the stock is to Yacktman. DCF valuations for forecasting free cash flows: Not clear cut The use of a DCF valuation places less reliance on current market valuations. Instead, it emphasizes the full-information forecasting of free cash flows over a multi-period finite horizon. In comparison, PE models are dependent upon the fact that current earnings measures are good proxies for value, placing emphasis on current, not future value. Moreover, DCF calculations allow for the choice of an appropriate finite horizon, estimation of growth beyond the horizon, and in its standard implementation, estimation of an appropriate WACC and of the value of non-equity claims on the firm. In other words, the valuation is more comprehensive and provides a long-term valuation of the company that it not dependent upon wider market valuations. That being said, there is some evidence to suggest that price targets calculated using a P/E multiple, are more accurate that price targets computed using a DCF analysis. A study entitled “ Does valuation model choice affect target price accuracy? ” found that DCF models are used to justify higher price targets by optimistic analysts. Additionally, a study entitled, Valuation Accuracy and Infinity Horizon Forecast: Empirical Evidence from Europe , published within the Journal of International Financial Management and Accounting 20:2 2009, found that when calculating a DCF forecast, analysis’ tend to factor in an “ideal” long-term growth rate, which is just above the WACC: …Therefore, using this ‘‘ideal’’ growth rate leads to the determination of ‘‘ideal’’ Target Corporation (NYSE: TGT ) prices that respect the long-term steady-state assumptions… Therefore, it’s easy to conclude that if a DCF figure is used to calculate a price target, or identify value opportunities , a suitable, conservative set of figures should be used to compute the DCF in order to prevent optimistic forecasting. Disclosure : None.