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Short-Selling 101

With the stock market falling for the next few weeks, or even months, it’s time to rehash how to profit from falling markets one more time. There is nothing worse than closing the barn door after the horses have bolted. No doubt, you will receive a wealth of short selling and hedging ideas from your other research sources and the media at the next market bottom. That is always how it seems to play out. So I am going to get you out ahead of the curve, putting you through a refresher course on how to best trade falling markets now, while stock markets are still only 3% short of an all time high, and unchanged on the year. Market’s could be down 10% by the time this is all over. That is my line in the sand! There is nothing worse than fumbling around in the dark looking for the matches after a storm has knocked the power out. I’m not saying that you should sell short the market right here. But there will come a time when you will need to do so. So here are the best ways to profit from declining stock prices, broken down by security type: Bear ETFs Of course the granddaddy of them all is the ProShares Short S&P 500 Fund (NYSEARCA: SH ), a non-leveraged bear ETF that is supposed to match the fall in the S&P 500 point for point on the downside (see prospectus ). Hence, a 10% decline in the (NYSEARCA: SPY ) is supposed to generate a 10% gain the in the SH. In actual practice, it doesn’t work out like that. The ETF has to pay management operating fees and expenses, which can be substantial. After all, nobody works for free. There is also the “cost of carry,” whereby owners have to pay the price for borrowing and selling short shares. They are also liable for paying the quarterly dividends for the shares they have borrowed, around 2% a year. And then you have to pay the commissions and spread for buying the ETF. Still, individuals can protect themselves from downside exposure in their core portfolios through buying against it. Short-selling is not cheap, but it’s better than watching your gains of the last seven years go up in smoke. Virtually all equity indexes now have bear ETFs. Some of the favorites include the PSQ , a short play on the NASDAQ (see prospectus ), and the DOG , which profits from a plunging Dow average (see prospectus ). My favorite is the RWM , a short play on the Russell 2000, which falls 1.5X faster than the big cap indexes in bear markets (see prospectus ). Leveraged Bear ETFs My favorite is the ProShares Ultra Short S&P 500 (NYSEARCA: SDS ), a 2X leveraged ETF ( prospectus ). A 10% decline in the generates a 20% profit, maybe. Keep in mind that by shorting double the market, you are liable for double the cost of shorting, which can total 5% a year or more. This shows up over time in the tracking error against the underlying index. Therefore, you should date, not marry, this ETF or you might be disappointed. 3X Leveraged Bear ETFs The 3X bear ETFs, like the UltraPro Short S&P 500 (NYSEARCA: SPXU ), are to be avoided like the plague ( prospectus ). First, you have to be pretty good to cover the 8% cost of carry embedded in this fund. They also reset the amount of index they are short at the end of each day, creating an enormous tracking error. Eventually, they all go to zero, and have to be periodically redenominated to keep from doing so. Dealing spreads can be very wide, further added to costs. Yes, I know the charts can be tempting. Leave these for the professional hedge fund intra day traders they are meant for. Buying Put Options For a small amount of capital, you can buy a ton of downside protection. For example, the April $182 puts I bought for $4,872 allowed me to sell short $145,600 worth of large cap stocks at $182 (8 X 100 X $6.09). Go for distant maturities out several months to minimize time decay and damp down daily price volatility. Your market timing better be good with these, because when the market goes against you, put options can go poof, and disappear pretty quickly. That’s why you read this newsletter. Selling Call Options One of the lowest risk ways to coin it in a market heading south is to engage in “buy writes”. This involves selling short call options against stock you already own, but may not want to sell for tax or other reasons. If the market goes sideways, or falls, and the options expire worthless, then the average cost of your shares is effectively lowered. If the shares rise substantially they get called away, but at a higher price, so you make more money. Then you just buy them back on the next dip. It is a win-win-win. I’ll give you a concrete example. Let’s say you own 100 shares of Apple (NASDAQ: AAPL ), which closed on Friday at $95.13, worth $9,513. If you sell short 1 July, 2016 $100 call at $1.30 against them, you take in $130 in premium income ($1.30 X 100 because one call option contract is exercisable into 100 shares). If Apple close2 below $100 on the July 15, 2016 expiration date, the options expire worthless and you keep your stock and the premium. You are then free to repeat the strategy for the following month. If closes anywhere above $100 and your shares get called away, you still make money on the trade. Selling Futures This is what the pros do, as futures contracts trade on countless exchanges around the world for every conceivable stock index or commodity. It is easy to hedge out all of the risk for an entire portfolio of shares by simply selling short futures contracts for a stock index. For example, let’s say you have a portfolio of predominantly large cap stocks worth $100,000. If you sell short 1 June, 2016 contract for the S&P 500 against it, you will eliminate most of the potential losses for your portfolio in a falling market. The margin requirement for one contract is only $5,000. However if you are short the futures and the market rises, then you have a big problem, and the losses can prove ruinous. But most individuals are not set up to trade futures. The educational, financial, and disclosure requirements are beyond mom and pop investing for their retirement fund. Most 401ks and IRAs don’t permit the inclusion of futures contracts. Only 25% of the readers of this letter trade the futures market. Regulators do whatever they can to keep the uninitiated and untrained away from this instrument. That said, get the futures markets right, and it is the quickest way to make a fortune, if your market direction is correct. Buying Volatility Volatility (VIX) is a mathematical construct derived from how much the S&P 500 moves over the next 30 days. You can gain exposure to it through buying the iPath S&P 500 VIX Short Term Futures ETN (NYSEARCA: VXX ), or buying call and put options on the VIX itself. If markets fall, volatility rises, and if markets rise, then volatility falls. You can therefore protect a stock portfolio from losses through buying the VIX. My latest on the VIX is available here . Selling Short IPOs Another way to make money in a down market is to sell short recent initial public offerings. These tend to go down much faster than the main market. That’s because many are held by hot hands, known as “flippers,” and don’t have a broad institutional shareholder base. Many of the recent ones don’t make money and are based on an, as yet, unproven business model. These are the ones that take the biggest hits. Individual IPO stocks can be tough to follow to sell short. But one ETF has done the heavy lifting for you. This is the Renaissance IPO ETF (see prospectus ). Buying Momentum This is another mathematical creation based on the number of rising days over falling days. Rising markets bring increasing momentum, while falling markets produce falling momentum. So selling short momentum produces additional protection during the early stages of a bear market. BlackRock has issued a tailor made ETF to capture just this kind of move through its iShares MSCI Momentum Factor ETF (NYSEARCA: MTUM ) ( prospectus ). Buying Beta Beta, or the magnitude of share price movements, also declines in down markets. So selling short beta provides yet another form of indirect insurance. The PowerShares S&P 500 High Beta Portfolio ETF (NYSEARCA: SPHB ) is another niche product that captures this relationship. The Index is compiled, maintained and calculated by Standard & Poor’s and consists of the 100 stocks from the SPX with the highest sensitivity to market movements, or beta, over the past 12 months. The Fund and the Index are rebalanced and reconstituted quarterly in February, May, August and November. (See prospectus .) Buying Bearish Hedge Funds Another subsector that does well in plunging markets are publicly listed bearish hedge funds. There are a couple of these that are publicly listed and have already started to move. One is the Advisor Shares Active Bear ETF (NYSEARCA: HDGE ) ( prospectus ). Keep in mind that this is an actively managed fund, not an index or mathematical relationship, so the volatility could be large. Oops, Forgot to Hedge Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Best And Worst Q2’16: All Cap Growth ETFs, Mutual Funds And Key Holdings

The All Cap Growth style ranks eighth out of the twelve fund styles as detailed in our Q2’16 Style Ratings for ETFs and Mutual Funds report. Last quarter , the All Cap Growth style ranked seventh. It gets our Neutral rating, which is based on aggregation of ratings of 17 ETFs and 547 mutual funds in the All Cap Growth style. See a recap of our 1Q16 Style Ratings here. Figures 1 and 2 show the five best and worst rated ETFs and mutual funds in the style. Not all All Cap Growth style ETFs and mutual funds are created the same. The number of holdings varies widely (from 13 to 2185). This variation creates drastically different investment implications and, therefore, ratings. Investors seeking exposure to the All Cap Growth style should buy one of the Attractive-or-better rated ETFs or mutual funds from Figures 1 and 2. Figure 1: ETFs with the Best & Worst Ratings – Top 5 Click to enlarge * Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity. Sources: New Constructs, LLC and company filings Five ETFs are excluded from Figure 1 because their total net assets are below $100 million and do not meet our liquidity minimums. Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5 Click to enlarge * Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity. Sources: New Constructs, LLC and company filings PNC Large Cap Growth Fund ( PEWIX , PEWCX ) and Catalyst/Lyons Hedged Premium Return Fund (MUTF: CLPFX ) are excluded from Figure 2 because their total net assets are below $100 million and do not meet our liquidity minimums. iShares Core US Growth ETF (NYSEARCA: IUSG ) is the top-rated All Cap Growth ETF and Eaton Vance Atlanta Capital Select Equity Fund (MUTF: ESEIX ) is the top-rated All Cap Growth mutual fund. IUSG earns an Attractive rating and ESEIX earns a Very Attractive rating. Calamos Focus Growth ETF (NASDAQ: CFGE ) is the worst rated All Cap Growth ETF and ACM Dynamic Opportunity Fund (MUTF: ADOAX ) is the worst rated All Cap Growth mutual fund. CFGE earns a Neutral rating and ADOAX earns a Very Dangerous rating.. Gilead Sciences (NASDAQ: GILD ) is one of our favorite stocks held by MNNYX and earns a Very Attractive rating. Gilead has grown after-tax profit ( NOPAT ) by 39% compounded annually since 2005. Over the same time, Gilead has increased its return on invested capital ( ROIC ) from 37% in 2005 to a top-quintile 88% in 2015. Over the past five years, Gilead has generated a cumulative $26 billion in free cash flow . Despite the operational successes, GILD remains undervalued. At its current price of $88/share, GILD has a price-to-economic book value ( PEBV ) ratio of 0.6. This ratio means that the market expects Gilead’s NOPAT to permanently decline by 40%. However, if Gilead can grow NOPAT by just 4% compounded annually for the next five years , the stock is worth $183/share today – a 107% upside. DexCom (NASDAQ: DXCM ) is one of our least favorite stocks held by KAUBX and earns a Dangerous rating. Over the past decade, DexCom’s NOPAT has declined from -$37 million to -$54 million. The company’s ROIC has been negative in every year since IPO and is currently a bottom quintile -28%. Nevertheless, DXCM is priced as though the company will achieve high levels of profitability. To justify its current price of $64/share, DXCM must immediately achieve 5% pre-tax margins (from -13% in 2015) and grow revenue by 31% compounded annually for the next 17 years . We feel it should be clear just how overvalued DXCM is at the current price. Figures 3 and 4 show the rating landscape of all All Cap Growth ETFs and mutual funds. Figure 3: Separating the Best ETFs From the Worst Funds Click to enlarge Sources: New Constructs, LLC and company filings Figure 4: Separating the Best Mutual Funds From the Worst Funds Click to enlarge Sources: New Constructs, LLC and company filings D isclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, style, or theme. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Forget Broader Retail; Bet On Online Retail ETFs

Retail earnings in the first-quarter earnings season and retail sales data for April were completely diverging, with the former mauling investor sentiment and the latter ushering in sweet surprises. The reason for this deviation was disappointing results from several traditional brick-and-mortar operators, while web-based shopping surged. In a nutshell, consumers’ purchasing pattern is changing. Department stores like Macy’s (NYSE: M ), Kohl’s (NYSE: KSS ), J.C. Penney (NYSE: JCP ), Nordstrom (NYSE: JWN ) and many others soured investor mood this earnings season. With this, while many started to wonder if consumers are running short of cash and doubt economic well-being, a 1.3% jump in retail sales (sequentially) in April cleared all misconceptions. As per Trading Economics , sales growth was witnessed in 11 out of the 13 major categories. Sales at motor vehicle and parts (up 3.2%), gasoline stations (2.2%) and non-store retailers (2.1%) were the major growth drivers. In fact, April retail sales beat economists’ forecast of a 0.8% rise . Online Retailers Crushing Earnings Estimates The online e-commerce behemoth Amazon (NASDAQ: AMZN ) came up with stellar Q1 results. The company trumped the Zacks Consensus Estimate on both lies by wide margins. Higher-than-expected results were credited to increased demand for quick-turnaround delivery and gadgets like the Kindle and Echo as well as a fast-growing cloud computing business. Another top player in this field, eBay Inc. (NASDAQ: EBAY ), beat on both lines. In fact, the company partnered with BigCommerce to benefit online retailers. Chinese e-commerce giant Alibaba Group’s (NYSE: BABA ) revenues came in higher than our estimate, though profitability was a letdown. This clearly explains online-retailers’ edge over the mall-based retailers. Inside the Rise of Online Retailers As of now, online retail sales make up one-tenth of total retail and about 5% of annual e-commerce revenue in the U.S. The space is developing fast with the increased usage of smartphones and other mobile Internet devices. As per Statista , in 2013, 41.3% of global internet users had purchased products online; the figure is expected to grow to 46.4% by 2017. More than the U.S., the real growth opportunities lay in the underpenetrated emerging markets. Forget Retail, Be Bullish on Online Retail This situation makes it crucial to have a pure-play online ETF. Amplify Exchange Traded Funds thus launched a new product, namely the Amplify Online Retail ETF (NASDAQ: IBUY ), about a month ago. Except this, it is hard to get targeted exposure to online retail. But several consumer discretionary and internet funds serve this idea to a large extent. Below, we highlight all of them in detail. IBUY in Focus This new fund holds about 44 stocks and charges 65 bps in fees. The fund is heavy on the U.S. (75%), followed by China (8%). The fund’s top three holdings are Overstock.com (NASDAQ: OSTK ), Del and Wayfair (NYSE: W ). No stock accounts for more than 3.39% of the portfolio. Emerging Markets Internet & Ecommerce ETF (NYSEARCA: EMQQ ) The fund gives exposure to the internet and ecommerce sectors of emerging economies. Its top three holdings are Tencent ( OTCPK:TCEHY ) (8.47%), Alibaba (8.36%) and Naspers ( OTCPK:NPSNY ) (6.8%). The fund charges about 86 bps in fees. Since Goldman sees a boom in the Chinese internet segment, this ETF is worth a look given its notable exposure to the Chinese e-commerce segment. Apart from these two, investors can also look at the First Trust Dow Jones Internet Index ETF (NYSEARCA: FDN ), with considerable exposure on Amazon (11.93%) and eBay (3.69%). Among the broad retail ETFs, the VanEck Vectors Retail ETF (NYSEARCA: RTH ) deserves a look, as it invests about 15.43% weight in Amazon. Original Post