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U.S. Hires More Than Expected In Feb.: ETFs And Stocks To Buy

The U.S. labor market continued its strength with solid hiring in February, easily dodging the global slowdown and a tumultuous stock market. The economy added 242,000 jobs in February, much above the market expectation of 190,000. The majority of the additions were seen in healthcare, retail, bars and restaurants, and construction that more than offset the decline in the mining sector. Unemployment remained unchanged at an eight-year low of 4.9% while job gains for December and January were revised upward by a combined 30,000. However, average hourly wages unexpectedly dipped 0.1% after a strong 0.5% increase in January. This reflects the first monthly drop since December 2014 and lowered the year-over-year wage increase to 2.2% from 2.5% for January. The robust data eased fears of a recession in the U.S. and infused further signs of confidence into the economy. Investors’ sentiment thus turned toward risk-on trade once again. While a solid hiring number is strong enough to support the Fed’s gradual interest rates hike this year, tepid wage growth remains a matter of concern. Market Impact The news extended the U.S. stock market’s three-week winning streak seen this year. In particular, the Dow Jones Industrial Average climbed to over 17,000 for the first time since January 5 while the S&P 500 surpassed 2,000 during the trading session but closed at a lower level. Yields on two-year and 10-year Treasury bonds soared to one-month high levels but fell at the close. On the other hand, U.S. dollar remained volatile given that the solid pace of hiring was tarnished by a drop in average hourly wages. Given this, we have highlighted three ETFs and stocks that will be the direct beneficiaries of job gains and see smooth trading in the days ahead. ETFs to Buy PowerShares DB USD Bull ETF (NYSEARCA: UUP ) A healing job market and the resultant improving economy will pull in more capital into the country and lead to appreciation of the U.S. dollar. UUP is the prime beneficiary of the rising dollar as it offers exposure against a basket of six world currencies – euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. This is done by tracking the Deutsche Bank Long US Dollar Index Futures Index Excess Return plus the interest income from the fund’s holdings of the U.S. Treasury securities. In terms of holdings, UUP allocates nearly 57.6% in euro and 25.5% collectively in the Japanese yen and British pound. The fund has so far managed an asset base of $830.6 million while sees an average daily volume of around 1.6 million shares. It charges 80 bps in total fees and expenses, and lost 0.3% on the day following the jobs report. The fund has a Zacks ETF Rank of 2 or “Buy” rating with a Medium risk outlook. SPDR Homebuilders ETF (NYSEARCA: XHB ) Solid labor market fundamentals along with affordable mortgage rates will continue to fuel growth in a recovering homebuilding sector, creating a buying opportunity in homebuilders and housing-related stocks. In addition, slower and gradual rate hikes will not impede the growth prospect of the sector, at least in the short term. The most popular choice in the homebuilding space, XHB, follows the S&P Homebuilders Select Industry Index. In total, the fund holds about 37 securities in its basket with none accounting for more than 5.21% share. The product focuses on mid-cap securities with 67% share, followed by 24% in small caps. The fund has amassed about $1.5 billion in its asset base and trades in heavy volume of more than 3.7 million shares. Expense ratio comes in at 0.35%. XHB added 0.2% on the day and has a Zacks ETF Rank of 2 with a High risk outlook. SPDR S&P Retail ETF (NYSEARCA: XRT ) Retail will also benefit from accelerating job growth though soft wage growth points to reduced spending power. XRT tracks the S&P Retail Select Industry Index, holding 100 securities in its basket. It is widely spread across each component as none of these holds more than 1.78% of total assets. Small-cap stocks dominate about three-fifths of the portfolio while the rest have been split between the other two market cap levels. XRT is the most popular and actively-traded ETF in the retail space with an AUM of about $617.2 million and average daily volume of around 4.4 million shares. It charges 35 bps in annual fees and gained 0.5% on the day. The product has a Zacks ETF Rank of 1 or “Strong Buy” rating with a Medium risk outlook. Stocks to Buy Though several sectors will benefit from healthy hiring, the direct beneficiary is the staffing industry. The industry bodes well at least for the near term given its superb Zacks Industry Rank (in the top 11%) at the time of writing. Investors seeking to ride out the optimism could look at a few top-ranked stocks handpicked by us using our Zacks Stock Screener . These stocks have a Zacks Rank #1 (Strong Buy) or #2 (Buy), a Growth or Value Style Score of B or better, and an above-average industry earnings growth of 13.7%. Cross Country Healthcare, Inc. (NASDAQ: CCRN ) Based in Boca Raton, Florida, Cross Country is a leading healthcare staffing services’ company which primarily focuses on providing nurse and allied, and physician staffing services and workforce solutions. The stock is expected to deliver year-over-year earnings growth of 26.9% in fiscal 2016. It shed 1.2% in Friday’s trading session and currently has a Zacks Rank #2 with a Growth Style Score of “A”. TrueBlue, Inc. (NYSE: TBI ) Based in Tacoma, Washington, TrueBlue is a leading provider of staffing, recruitment process outsourcing, and managed services in the United States, Canada and Puerto Rico. The company’s earnings are expected to growth 48.4% year over year in fiscal 2016. TBI gained 0.7% on the day and has a Zacks Rank #1 with a Value Style Score of “B”. Insperity, Inc. (NYSE: NSP ) Based in Kingwood, Texas, Insperity provides an array of human resources and business solutions to enhance the performance of small- and medium-sized businesses in the United States. The company has an incredible earnings growth projection of 53.8% for fiscal 2016. The stock was down 0.2% in Friday’s session and has a Zacks Rank #1 with Growth and Value Style Scores of “A” each. Original post

Is Security Analysis Dead? Why Ben Graham Eventually Embraced Efficient Markets

Could the man who literally wrote the book on security analysis actually have thrown it all away? If you’re a value investor, or have already requested free net net stock picks , you’ve undoubtedly heard of the father of value investing himself, Benjamin Graham . Most investors come to Graham through the writings of Warren Buffett, and for good reason. Buffett has continuously called Graham the biggest investing influence in his life, so it’s only natural to pay homage to the legendary teacher. But Graham was also a legendary investor and prolific writer, producing two of the best investment books books ever written: Security Analysis and the Intelligent Investor. Both went on to become long running series. What many value investors are less aware of, however, is that in one of the last seminars given before his death, Graham actually rejected the idea that detailed security analysis added much value. Those comments were made available in an article titled “A Conversation With Benjamin Graham,” published in the Financial Analyst Journal, and are definitely surprising given Graham’s focus on dissecting a firm’s financial statements to uncover superior value investment opportunities. What exactly did he mean? What changed? The Death of Security Analysis The first thing you should recognize is that Graham still favored buying common stocks as part of an investment portfolio. In his words, “[The] investment value and average market price [of common stocks] tend to increase irregularly but persistently over the decades, as their net worth builds up through the reinvestment of undistributed earnings–incidentally, with no clear-cut plus or minus response to inflation.” A decent assessment of stocks in general, and it’s easy to see why. Given that stocks provide, on average, a higher average return than pretty much any other asset class, Graham was well justified in his assessment. But while Graham liked the idea of buying stocks, he also revealed a decided shift on how he viewed the practical use of detailed analysis. In his words, “I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook “Graham and Dodd” was first published; but the situation has changed a great deal since then. In the old days any well-trained security analyst could do a good professional job of selecting undervalued issues through detailed studies; but in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost. To that very limited extent I’m on the side of the “efficient market” school of thought now generally accepted by the professors.” It’s shocking that Graham could be seen on the side of the efficient market crowd, given that he based his career on the ability of individual investors to make above average returns using his value investing techniques. When it came to institutional investors in general, Graham described another devastating handicap. “…institutions have a relatively small field of common stocks to choose from–say 300 to 400 huge corporations–and they are constrained more or less to concentrate their research and decisions on this much over-analyzed group.” Give the ocean of analysts and mutual funds that are now choking the investment world, if Graham was right in 1976 when he made those remarks, things have only gotten worse. Yet, a number value investors have forged great track records since 1976, suggesting another path to great returns. Ben Graham’s New Path Forward Graham spent a lot of his investing life learning about securities and studying a wide range of investing strategies. It should be no surprise that Ben Graham’s shift towards believing in efficient markets still left open the possibility for great investment success. “…the typical investor has a great advantage over the large institutions. ………most individuals can choose at any time among some 3000 issues listed in the Standard & Poor’s Monthly Stock Guide. Following a wide variety of approaches and preferences, the individual investor should at all times be able to locate at least one per cent of the total list–say, 30 issues or more–that offer attractive buying opportunities” Professional investors often have to manage billions of dollars in a single fund, and most funds are well over $100 Million USD. Because of that, these managers only ever have a small pool of stocks to pick from. In comparison, individual investors can choose among far more investments, including the stocks of tiny companies that professional investors just can’t touch. This means that small private investors face much lower competition if they stick to small, mirco, and nano cap stocks. But how did Graham think a small investor should capitalize on this? “The individual investor should act consistently as an investor and not as a speculator. This means, in sum, that he should be able to justify every purchase he makes and each price he pays by impersonal, objective reasoning that satisfies him that he is getting more than his money’s worth for his purchase–in other words, that he has a margin of safety, in value terms, to protect his commitment.” Ben Graham clarifies, “[I recommend] a highly simplified [strategy] that applies a single criteria or perhaps two criteria to the price [of a stock] to assure that full value is present and that relies for its results on the performance of the portfolio as a whole–i.e., on the group results–rather than on the expectations for individual issues.” Benjamin Graham’s suggestion for a value strategy is exactly what many investors today call “quantitative value investment strategies,” or “mechanical” strategies. He continues, “The investor should have a definite selling policy for all his common stock commitments, corresponding to his buying techniques. Typically, he should set a reasonable profit objective on each purchase–say 50 to 100 per cent–and a maximum holding period for this objective to be realized–say, two to three years. Purchases not realizing the gain objective at the end of the holding period should be sold out at the market.” Graham’s recommended buy and sell strategy is much simpler than the strategy he used to favor, thorough analysis in the hopes of uncovering unrecognized value. According to Ben Graham’s comments, investors can forget about industry and competitive analysis, or even income and balance sheet assessments, in favor of buying a diversified group of stocks based on simple metrics. Ben Graham did also have something to say about the sort of metrics that investors should be looking for. His favorite, in his words, “…[this] technique confines itself to the purchase of common stocks at less than their working-capital value, or net-current-asset value, giving no weight to the plant and other fixed assets, and deducting all liabilities in full from the current assets. We used this approach extensively in managing investment funds, and over a 30-odd year period we must have earned an average of some 20 per cent per year from this source.” Graham used to buy 100s of “working-capital value,” or net net, stocks to fill out his portfolio yet was able to earn returns in excess of 20% per year. That’s a great record, but as I’ve written to those who’ve requested free net net stock picks , by using the growing body of research covering net nets to focus on the best possible opportunities investors should be able to earn even better returns. That’s the approach that I’ve adopted, and it’s worked quite well. As Graham describes, “…we found it almost unfailingly dependable and satisfactory in 30-odd years of managing moderate-sized investment funds. ………I consider it a foolproof method of systematic investment–once again, not on the basis of individual results but in terms of the expectable group outcome.” What other endorsement do you need? Ben Graham’s Net Net Stock Problem There is a well known problem when it comes to buying net nets, however. They tend to dry up as markets advance. This has been a problem for people who insist on only investing in their own domestic market. Graham’s experience was no different. “For a while, however, after the mid-1950’s, this brand of buying opportunity became very scarce because of the pervasive bull market. But it has returned in quantity since the 1973-74 decline. In January 1976 we counted over 300 such issues in the Standard & Poor’s Stock Guide–about 10 per cent of the total.” I started Net Net Hunter to solve this very problem. By branching out to friendly international markets, investors can widen the pool of available investment candidates enormously. This is the same technique legendary Canadian value investor Peter Cundill employed during his career. But by looking internationally, investors don’t just find more net nets, they can also significantly improve the quality of the net nets in their portfolio. So while Ben Graham gave up on detailed security analysis at the end of his life, he by no means abandoned hope that small investors can beat the market by significant margins if they play their cards right. When it comes to your own portfolio, you have a tremendous advantage over the pros if you’re willing to look at tiny companies and buy a diverse group of ugly, beaten down, stocks such as Graham’s famous net nets. 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.

Now May Be A Good Time To Invest In High Quality Stocks – Here’s Why

To someone like me who has a long-held belief in the efficacy of value investing, the idea of investing in “quality” seems counterintuitive. After all, what makes value investing provide excess returns if not the “yuck factor” that causes investors to underprice value stocks? On the surface, quality investing seems to be the opposite of value investing. However, many famous investors include some notion of quality in their investing criteria, including some value investors. Warren Buffett has cited good returns on equity, consistent earnings power, and low debt as elements that he considers, and is famous for saying that “it is far better to buy a wonderful business at a fair price than to buy a fair business at a wonderful price.” Over the past several years, academic researchers have been finding that quality matters, both as a stand-alone factor and in conjunction with other factors, particularly value. For example, in an influential paper entitled ” Quality Minus Junk ,” AQR’s Asness, Frazzini and Pedersen (2014) found that “a quality minus junk (QMJ) factor that goes long high-quality stocks and shorts low-quality stocks earns significant risk-adjusted returns in the U.S. and across 24 countries.” Their definition of quality involves quite a number of attributes, including profitability, growth, safety, and payout. In a widely cited 2012 paper , Novy-Marx found that a relatively simple measure of quality, gross profits to assets, provided “roughly the same power as book-to-market predicting the cross-section of average returns.” (Book-to-market is perhaps the most widely recognized value factor.) Kozlov and Petajisto (2013) describe high earnings quality as “one of the most robust long-term patterns documented in the literature (e.g., Sloan , 1996, and Fama and French , 2008).” Studying the period 1988 to 2012, they found that quality had a higher Sharpe ratio (0.69) than either value (0.56) or the market (0.25). Using a composite quality factor combining profitability, accruals, and leverage, they found that after controlling for market, size, and value (the Fama-French three-factor risk model), a long-short alpha of 7.8% per year was achieved. Impressive results. Theories to explain why high-quality stocks offer investors excess risk-adjusted returns vary. Novy-Marx describes quality investing as “the other side of value” in that both value investors and quality investors seek to acquire assets undervalued by other investors. Value investors count on the fact that the poor profitability of value firms tends to mean-revert to some extent over time. Quality investors count on the superior profitability of quality firms to persist, and profit from the fact that investors tend to underappreciate, and underprice, high quality firms. The growing popularity of quality as a factor is reflected in the success of several ETFs that use various measures of quality as the focus of their portfolio construction. Of those focused on the U.S. stock market, the largest and most liquid include: PowerShares S&P 500 High Quality Portfolio (NYSEARCA: SPHQ ) iShares MSCI USA Quality Factor ETF (NYSEARCA: QUAL ) Market Vectors Morningstar Wide Moat ETF (NYSEARCA: MOAT ) This paper will focus on SPHQ because, at least at present, it is my preferred quality factor play. While QUAL is the largest and most liquid of the three, it uses a sector-neutral index. Although in a sense that makes it a “purer” play on quality, in my opinion, by neutralizing the sector tilts that would otherwise result, the quality effect is somewhat diluted. MOAT takes its strategy from the Warren Buffett philosophy of buying companies with a “wide moat” that protects the corporation’s franchise value. This factor is a variation on quality, certainly, but I find that the underlying index upon which the ETF is based has not generated as much alpha (defined below) as that of SPHQ. My methodology for analyzing an ETF focuses on its underlying benchmark index, which often has a much longer history than the live ETF performance record. (I use only passively managed ETFs that adhere closely to their benchmark indexes.) By subtracting the expense ratio from the historical return of the index, I can create a set of pro-forma ETF returns that are an excellent representation of how the ETF would have performed back in time. This provides much more data with which to analyze the risks and evaluate the risk-adjusted returns of an ETF. This methodology is also particularly handy when an ETF changes its benchmark index, as SPHQ is planning to do. As of March 18, 2016, the underlying index for SPHQ will change from the S&P 500 High Quality Rankings Index (Bloomberg: SPXQRUT) to the S&P 500 Quality Index (Bloomberg: SPXQUT). This means that the actual live performance history of SPHQ is of limited value in predicting how it will behave in the future: the past performance of the new index is much more valuable. The “old” index is based upon the time-honored S&P Quality Rankings System, which has been around since 1956. S&P’s methodology document does not offer much detail, but simply states that the Quality Rankings System “attempts to capture the growth and stability of earnings and the dividends record” over a 10-year period, adjusted “for changes in the rate of growth, stability within long-term trends and cyclicality.” Got that? The obfuscation probably indicates that the actual details of the methodology have evolved over the past 60 years. The “new” index is much more transparent. The methodology document says that the new quality score “is calculated based on three fundamental measures, return on equity, accruals ratio and financial leverage ratio.” The three fundamental ratios are defined as follows: • Return on Equity (ROE). This is calculated as a company’s trailing 12-month earnings per share divided by its latest book value per share. • Accruals Ratio. This is computed using the change of a company’s net operating assets over the last year divided by its average net operating assets over the last two years. • Financial Leverage Ratio. This is calculated as a company’s latest total debt divided by its book value. By the way, two of these three attributes, ROE and leverage, are the same attributes that QUAL uses in its definition of quality. The third QUAL attribute, earnings variability, makes it somewhat similar to the “old” S&P Quality Ranking. By using accruals as its third factor, the new SPHQ will be tied more closely to the work of Sloan (1996) among others, showing that investors systematically over-emphasize the accrual components of GAAP earnings and under-emphasize the cash components, which are much more sustainable. This may help explain why the historical alpha of the index (defined below) is so high. My analysis of the risk-adjusted returns for SPHQ’s new benchmark index starts by measuring the sensitivity of its returns to four risk factors that capture much of the risk common to most ETFs: Stock market risk (MKT), as measured by the S&P 500 Index Bond market risk (LTB), as measured by the 10 Year Treasury Benchmark Index Currency risk (DLR), as measured by the U.S. Dollar Index Commodity risk (OIL), as measured by the West Texas Intermediate Crude Oil Index Click to enlarge SPHQ’s new index goes back to December 31, 1994, but I need some history in order to estimate its risk factor sensitivities (often called betas) using exponentially weighted multiple regressions. Consequently, the graph above starts on December 31, 2000. Of the four risk factors, equity market beta (labeled MKT in red) is its only consistently significant risk factor sensitivity. Its historical equity market sensitivity has generally been between 70% and 100% (or a beta of .7 to 1.0) which is about as I would have predicted. The other three risk factors are not consistently significant, but interest rate sensitivity (LTB) does pop up occasionally. The next graph (below) tracks the cumulative return of SPHQ’s new index (in black), and disaggregates it into return due to each of the four risk factor sensitivities and residual return, which is what I call “alpha.” Most of the index’s return is explained by its equity market sensitivity (red), as expected for an index with a MKT sensitivity of 70% to 100%. (To calculate the return from MKT sensitivity, I multiply the index’s previous month-end MKT sensitivity times the monthly price return of the S&P 500. I use the same methodology for the other three risk factors.) The residual return (orange) is the total return minus the return from the four risk factor sensitivities. Residual return, or alpha, is what I want to maximize in my portfolios. Click to enlarge SPHQ’s new index has generated an average alpha of about 3.17% per year since 2000, with a standard deviation of 3.68%, and a return/risk ratio of 0.86. Those are very impressive statistics for a single factor portfolio. Even if my estimates of MKT beta are too low, using a MKT beta of 1.00 would still result in an average alpha of 1.88% per year. Most ETFs, and their benchmark indexes, have no discernible alpha: their return is entirely explained by risk factor sensitivities. Both the power of and the persistence of the risk-adjusted excess return for SPHQ’s new benchmark index are impressive. To be sure, there is a risk that some of the historical alpha is a random artifact of the time period tested. Also, there is some risk that the construction of the index was influenced to some extent by “what worked” over this time period. Even if the good people at S&P were only following the academic literature, the academic researchers themselves are no doubt somewhat guilty of “data snooping,” since that is a bias that no one can completely escape. Academic researchers read the research of others and are thus influenced by that information. However, S&P is applying the same Quality Index methodology not only to the S&P 500, but also to 15 other headline indexes around the world, which somewhat reduces the risk that it was unduly influenced by “what worked” for the S&P 500 alone. Also, based on my research, there seems to be no indication that the quality factor has become so popular that its valuation is stretched. (By comparison, for example, the low volatility factor seems to have been bid up to the point where some caution is warranted.) Finally, my research indicates that returns to the quality factor are positively associated with equity market volatility, which has been higher than average and may provide a bit of a boost to the return of the quality factor. Historically speaking, the later stages of bull markets have been good times to emphasize quality. In short, now may be a good time to invest in quality, and SPHQ is a good way to do it. Disclosure: I am/we are long SPHQ, QUAL, MOAT. 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: My long and short positions change frequently, so I make no assurances about my future positions, long or short. The information contained in this article has been prepared with reasonable care using sources that are assumed to be reliable, but I make no representation or warranty regarding accuracy. This article is provided for informational purposes only and is not intended to constitute legal, tax, securities, or investment advice. You should discuss your individual legal, tax, and investment situation with professional advisors.