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U.S. Factory Activity Rebounds: 3 Mutual Fund Picks

Manufacturing in the U.S. expanded for the first time in six months in March, fueled by a surge in new orders. The outlook for manufacturing looks encouraging, thanks to a tempering strength of the dollar and a recent rise in oil prices. Industrial production in the U.S. had been under intense pressure for quite some time after a stronger dollar increasing prices of export-oriented goods compared to those priced in other currencies, which eventually weighed on sales. A continuous decline in oil prices also had a negative impact on the energy sector. Energy companies had to trim spending on big-ticket factory goods including drilling equipment. But, as these headwinds are no longer strong enough, The Goldman Sachs Group, Inc. (NYSE: GS ) believes that the manufacturing recession in the U.S. may be over. Regional surveys on factory activities in Philadelphia, New York, Richmond, Kansas City and Chicago also showed marked progress in March. Record factory orders data in January too showed a release from the slump. Banking on this buoyancy, it will be prudent to invest in funds that are exposed to the industrial sector. These funds not only boast strong fundamentals but also provide stellar returns over a long investment horizon. Before we handpick some good funds, let’s take a look at the latest data: Manufacturing Outlook Improves The Institute of Supply Management said that its manufacturing index increased to 51.8% in March from 49.5% in February, indicating growth in manufacturing for the first time since Aug. 2015. Any reading above 50 is a positive indicator to customers’ orders and factory production. Twelve out of 18 industries surveyed by the index posted growth. Additionally, new orders were strongest since 2014, while a measure of production activity reached a 10-month high. The ISM’s New Orders Index rose to 58.3% in March compared with 51.5% reported for February, which showed growth in new orders for the third successive month. The ISM’s Production Index also went up to 55.3% in March from 52.8% in February, indicating growth in production last month for the third straight month. Bradley Holcomb, chairman of the ISM factory survey, said that these readings showed that manufacturing is “moving in the right direction” and there is “every reason to be confident” about the manufacturing sector in the next few months. He added that customer inventories are low and exports are improving. Export orders in March rose to 52% from 46.5% in February, the highest reading since Dec. 2014. Regional Data Looks Solid According to Morgan Stanley (NYSE: MS ), on an ISM-weighted basis, the average of the Philadelphia Fed, Empire State, Richmond Fed and Kansas City Fed manufacturing surveys rose to 51.5 in March from 47 in February. Separately, manufacturing activity in the Philadelphia area turned positive in March for the first time in seven months, while factory activity in the New York region expanded for the first time since last July. Meanwhile, manufacturing activity in the Chicago area rebounded last month, another sign that manufacturing is starting to recover from difficult times. The Chicago PMI gained 6 points to 53.6 in March banking on an uptick in production and employment. 3 Mutual Funds to Ride the Manufacturing Wave Economic activity at U.S. manufacturing companies grew in March for the first time since last summer as indicated by the ISM manufacturing index. The economy was able to shake off the adverse effects of a stronger dollar and slump in oil prices. While a stronger dollar had made export-oriented goods expensive, lower oil prices hindered growth in energy sectors. Based on encouraging readings on factory activity, it seems that manufacturing is on resurgence. Harm Bandholz, chief U.S. economist at UniCredit Bank AG, said that “the rebound in the sentiment data avoids a self-fulfilling negative spiral” and it means “manufacturing will be less of a drag on the economy.” Add to this factory orders’ advance of 1.6% in January, its strongest increase since last June and you know why the manufacturing collapse is now over. In this scenario, it will be wise to invest in mutual funds that have significant holdings in the industrial sector. Here we have selected three industrial mutual funds that boast a Zacks Mutual Fund Rank #1 (Strong Buy) or #2 (Buy), have given positive 3-year and 5-year annualized returns, offer minimum initial investment within $5000, carry a low expense ratio and possess no-sales load. Fidelity Select Defense & Aerospace Portfolio (MUTF: FSDAX ) invests the majority of its assets in securities of companies involved in the manufacture and sale of products or services related to the defense or aerospace industries. FSDAX has 96.97% of its holdings in the Industrials sector. FSDAX’s 3-year and 5-year annualized returns are both at 11.7%. FSDAX carries a Zacks Mutual Fund Rank #1 and the annual expense ratio of 0.79% is lower than the category average of 1.33%. Fidelity Select Industrial Equipment Portfolio (MUTF: FSCGX ) invests a major portion of its assets in securities of companies principally engaged in the manufacture or service of products for the industrial sector. FSCGX has 95.94% of its holdings in the Industrials sector. FSCGX’s 3-year and 5-year annualized returns are 9.1% and 7.7%, respectively. FSCGX carries a Zacks Mutual Fund Rank #1 and the annual expense ratio of 0.77% is lower than the category average of 1.33%. Fidelity Select Industrials (MUTF: FCYIX ) invests a large portion of its assets in securities of companies primarily involved in the development, distribution or sale of industrial products or equipment. FCYIX has 94.37% of its holdings in the Industrials sector. FCYIX’s 3-year and 5-year annualized returns are 10.1% and 9.5%, respectively. FCYIX carries a Zacks Mutual Fund Rank #2 and the annual expense ratio of 0.78% is lower than the category average of 1.33%. About Zacks Mutual Fund Rank By applying the Zacks Rank to mutual funds, investors can find funds that not only outpaced the market in the past, but are also expected to outperform going forward. Pick the best mutual funds with the help of Zacks Rank. Original Post

When Graham Found Momentum

Originally published on March 9, 2016 The enterprising investor may confine his choice to industries and companies about which he holds an optimistic view, but we counsel strongly against paying a high price for a stock (in relation to earnings and assets) because of such enthusiasm. – Benjamin Graham Popularity is fleeting. For some, it only lasts the proverbial “15 minutes”. For others, it drags on longer than any rational person can comprehend. We see this in people and things. It explains why fads come and go. It eventually ends because there are not enough new eyeballs to replace the ones that lose interest, or something newer and shinier comes along to draw our attention away. Ben Graham noticed this popularity effect on stocks and briefly covered it in The Intelligent Investor : Here we found – contrary to our investment philosophy – that companies that combined major size with a large good-will component in their market price did very well as a whole in the 2 1/2 year holding period. (By “good-will component” we mean the part of the price that exceeds the book value.) Graham separated stocks into several groups based on a single factor to see how each performed over a 30-month period between December 1968 and August 1971. Each group held a basket of 30 stocks. The group in question held the largest stocks with the highest price-to-book value. Our list of “good-will giants” was made up of 30 issues, each of which had a good-will component of over a billion dollars, representing more than half of its market price. The total market value of these good-will items at the end of 1968 was more than $120 billions! Basically, these were the “most expensive” large caps trading over 2x book value. I think it’s a safe guess that the price-to-book was much higher. Yet, despite the “expensive” price tag, the group outperformed all other tests and beat the market by about 15% for the period. Here’s Graham’s explanation for why: A fact like this must not be ignored in work on investment policies. It is clear that, at the least, a considerable momentum is attached to those companies that combine the virtues of great size, an excellent past record of earnings, the public’s expectation of continued earnings growth in the future, and strong market action over many past years. Even if the price may appear excessive by our quantitative standards the underlying market momentum may well carry such issues along more or less indefinitely. It is difficult to judge to what extent the superior market action shown is due to “true” or objective investment merits and to what extent to long-established popularity. No doubt both factors are important here. I think Graham’s explanation does a good job of describing potential drivers behind the momentum factor. Put simply, people like to buy stocks that are going up and avoid whatever’s going down. And if they feel good about stocks, they’re willing to pay more. He goes so far as to say it’s something investors might consider. It’s just not something he’d consider, since it goes against everything he believes. In most situations, value investors are doing the opposite. They’re buying when stocks are most unpopular and selling as popularity takes over. The popularity effect becomes the selling opportunity for value investors and buying opportunity for anyone willing to exploit the momentum factor. Note: Graham doesn’t list the 30 stocks in the “goodwill giants” group. Based on the few mentioned in the book – IBM Corp. (NYSE: IBM ), Xerox, Polaroid – and the time frame, I’m guessing several fit the Nifty-Fifty mold. For those who don’t know, The Nifty-Fifty were a select group of high-growth stocks that reached a “buy at any price” popularity (much like the dot-com stocks of the late ’90s, except the Nifty-Fifty had actual earnings). The shiny thing was high earnings growth that initially got people’s attention, popularity and momentum drove prices higher. In some cases, investors were paying P/E multiples of 50x and higher. For a while, anyway, it worked… until it didn’t. What seemed like a great idea in ’68 became a terrible one in ’73 when the market crashed.

The Double Edged Sword Of Trend Following ETFs

I’ve always been a big proponent of following the major trends in the market to serve as guideposts for sizing the stock allocation of my portfolio . Trend lines like the infamous 200-day moving average have never been a perfect predictor of stock market direction. However, using these types of technical indicators can serve as a useful tool for making incremental adjustments over time. Pacer ETFs is a relatively upstart company in the exchange-traded fund world that operates a suite of TrendPilot ETFs designed to automate the trend following process. Their lineup includes a range of well-known U.S. and European indexes with several hundred million in combined assets under management. The largest and most popular fund in their mix is the Pacer TrendPilot 750 ETF (BATS: PTLC ), which is based on the Wilshire U.S. Large-Cap Index. This includes a diversified basket of 750 large-cap stocks that aims for broader exposure than the stalwart S&P 500 Index. PTLC currently has $336 million in total assets and enough consistent daily trading volume to be considered liquid for most investor’s purposes. It also charges an expense ratio of 0.60%, which is on the high side for a typical ETF but not necessarily abnormal for a quasi-active approach. The basic premise behind PTLC is to participate when the stock market is going up and move to cash (or treasury bills) when it is going down. They accomplish this through a systemic, rules-based methodology that indicates when a positive or negative trend is established using the 200-day simple moving average. In an uptrend, PTLC owns 100% stocks. The fund then moves to 50% stocks and 50% treasury bills when the index falls below the trend line for five consecutive days. It then uses a final confirming indicator to move to 100% treasury bills if the simple moving average falls lower than its prior reading for five days. The process starts over again once the index regains its 200-day moving average on the upside. Simple. Logical. Automated. Sounds easy right? The obvious advantage of this strategy is that it is designed to keep your money safe during a prolonged bear market such as we experienced in 2008. Multiple months or even years of persistent selling pressure can be avoided by having your capital protected near the top quartile of a new down cycle. The goal is also to get you back into the market at a much lower point and with more starting capital than if you had held your way through on the downside. However, this trend following system also becomes a hindrance during periods of sharp corrections and subsequent rapid recoveries like we have experienced over the last year. The constant gyration from bullish to bearish momentum and back again creates a counter-productive effect on the strategy. When comparing PTLC versus the Schwab U.S. Large-Cap ETF (NYSEARCA: SCHX ) since inception, you can see how the trend following strategy moves to cash prior to the upswing in both 2015 and 2016. This means that you miss out on the recovery phase and end up rapidly falling behind the more conventional index. SCHX purely follows the Wilshire U.S. Large-Cap Index without the trend following component. The time period involved here is admittedly quite short and a proper analysis should be done over multiple cycles of the market. Nevertheless, it should be observed that this recent trading pattern does not sit well with a trend following strategy built to follow a long-term moving average . It may also result in some investors becoming frustrated with the timing component and jumping ship just prior to the market rolling over once again. The trend following ETF is ultimately doing exactly what its creators set out for it to do. The more recent price action should be considered a known risk of this type of enhanced index rather than a failure of the strategy altogether. The lesson is that there is always a double edged sword of opportunity cost that must be considered when you move to the safety of cash. This same risk is entrenched with the use of stop losses or physical sell orders for individual ETFs and stocks as well. They call it getting “whipsawed” and it is certainly an uncomfortable feeling when you are on the wrong end of it. 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. Additional disclosure: David Fabian, FMD Capital Management, and/or clients may hold positions in the ETFs and mutual funds mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell, or hold securities.