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The Stock Market’s Best Shot? A Fed Promise To Move Slower Than A Three-Toed Sloth

The U.S. economy is even more dependent on the consumer than it ought to be. And by extension, consumer credit as well as service-oriented business credit become more critical than they might otherwise be. And what affects credit more than the Federal Reserve? Until investors learn the what, when and why of Fed policy guidance, riskier assets will remain volatile. Consumers, as opposed to manufacturers, represent two-thirds of the U.S. economy. Indeed, Americans love to splurge. We buy sneakers, iPhones, home furnishings, real estate, cars, jewelry, concert tickets, and meals at our favorite restaurants. We even buy chew toys for our pets. Many of us, however, do not have enough cash saved up to acquire the things that we want when we want them. So we borrow. We satisfy our cravings through instruments of debt – credit cards, mortgages, “refis,” equity lines and school loans. Like consumers, there are scores of corporations that borrow more than they should and gorge when ultra-low interest rates beckon. How do companies do it? They issue low-yielding bonds to yield-seeking investors. Theoretically, companies can use the newfound dollars on research, development, marketing, equipment and human resources. In 2015, though, public corporations are spending an estimated 28% of their available cash on acquiring shares of their stock. That’s the highest percentage since 2007. Why do companies buy so much of their own stock in what the investing community calls “share buybacks?” Less stock in the marketplace limits supply, boosts the perception of profitability per share and artificially boosts buyer demand; prices tend to move higher. Stock prices rise in the early stages of accelerating corporate share buybacks. For instance, in the bull market of 2002-2007, public companies committed more and more of their total cash; the higher the prices moved, the less shares that corporate borrowed dollars could afford. As buybacks peaked in 2007, they rapidly descended during the 2008-2009 financial collapse. Now look at the current economic recovery since the 2nd quarter of 2009. Share buybacks have been on a strong upward trajectory, pushing stock market benchmarks to new heights. In fact, one of the big reasons that so many executives have been lobbying the U.S. Federal Reserve to hold off on hiking borrowing costs in September is because those costs would adversely impact the financing of stock buybacks at ultra-low bond yields. Are consumers and corporations the only groups that salivate over ultra-low interest rates? Hardly. The federal government debt is rapidly approaching $19 trillion. In particular, obligations have grown by approximately $8 trillion since the recovery’s inception – a pace that is more than twice as fast as the growth of the U.S. economy itself. That’s right. Uncle Sam is spending borrowed dollars at an alarming clip, guaranteeing that higher and higher percentages of total tax revenue will be used for debt servicing. (Recognize that nobody believes in the notion that debts could ever be paid back.) Why might this be troublesome at this particular moment? The Federal Reserve has wanted to hike borrowing costs as early as mid-September. And that means that Uncle Sam will likely be paying higher rates to service the interest charges on its treasury bonds very soon. What’s more, if the Federal Reserve hikes borrowing costs, consumers will have to pay more to service adjustable loans and mortgages; businesses will have to pay more to service the interest on corporate bonds. The probable result? The economy slows and possibly contracts such that Uncle Sam brings in less-than-anticipated tax revenue. Indeed, the Fed has been spooking markets with its desire to move toward “rate normalization.” If committee members spoke candidly about a more realistic intention – a plan to move no more than 1% off of the 0% anchor by the end of 2016 – there would be an end game that global investors could factor into decision making. Instead, there is fear that the Fed is misreading the tea leaves on the health of the U.S. economy as well as fear that the central bank would move to far in the wrong direction. Consider the manufacturing slowdown – the “less important” one-third of the U.S. economy. Does anyone doubt that U.S. manufacturing has suffered due to the global manufacturing slowdown and the outright recessions in places like Canada, Brazil and parts of the euro-zone? The recent jobs report by ADP confirms it. Of the 190,000 jobs created, 173,000 received the tag of “service-providing” whereas a meager 17,000 had been deemed “goods-producing.” Should we dismiss that oil giant Conoco Phillips is laying off 10% of its global workforce? What about critical metrics such as factory new orders and product shipments? The percentages for both are negative on a year-over-year basis. Global manufacturing woes did not just hit the investment markets in August; rather, the declines have been developing in key economic sectors since the fourth quarter of 2014. Every significant manufacturer-dependent sector in the exchange-traded investing world – iShares Dow Jones Transportations (NYSEARCA: IYT ), Industrials Select Sector SPDR (NYSEARCA: XLI ), Energy Select Sector SPDR (NYSEARCA: XLE ), Materials Select Sector SPDR (NYSEARCA: XLB ) – is down 10% or more year-to-date. It follows that the U.S. economy is even more dependent on the consumer than it ought to be. And by extension, consumer credit as well as service-oriented business credit become more critical than they might otherwise be. And what affects credit more than the Federal Reserve? Until investors learn the what, when and why of Fed policy guidance, riskier assets will remain volatile. Intra-day price swings of 300 points on the Dow? We should feel lucky if it remains that subdued. As regular readers already know, I began reducing client exposure to risk before the mid-August price plunge. We raised cash/cash equivalents in our accounts . Those levels are roughly 25% for moderate growth investors. The cash is there to reduce portfolio volatility, minimize depreciation in portfolios and provide opportunity to buy quality assets at lower prices. We also have 25% allocated to investment-grade income. Whereas moderate risk clients may typically have 65-75% in stocks, we gradually reduced that level to 50% across June and July. Our reasons for the tactical asset allocation shift? I presented them in ” A Market Top? 15 Warning Signs ” when the S&P 500 traded in and around the 2100 level. The 50% allocated to stock is spread across a variety of large-cap U.S. ETFs, including but not limited to, iShares S&P 100 (NYSEARCA: OEF ), Vanguard High Dividend Yield (NYSEARCA: VYM ), Health Care Select Sector SPDR (NYSEARCA: XLV ) and Vanguard Mid-Cap Value (NYSEARCA: VOE ). 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 website. ETF Expert content is created independently of any advertising relationships.

Head-To-Head: S&P 500 ETFs Vs. Dow ETFs

Fears of a hard landing in China slaughtered the global markets last week. China itself saw all its gigantic gains recorded this year going down the drains, and logged the largest one-day plunge since 2007 on August 24 daring all government-backed measures to contain the slide. Back-to-back shockers from China, be it currency devaluation or a six-and-half-year low manufacturing data for August spurred this panic-induced sell-off. The benchmark Shanghai Composite Index dropped 8.5% on Monday. Though China sought to restrain the rout by allowing the pension funds to invest about $97 billion in the market, there was hardly any relief in store. Also, lack of precision by the Fed on the policy tightening timeline roiled the market momentum. The fright among investors was so acute that other global markets followed the footsteps of China. The otherwise steadier U.S. stocks hurtled down, European markets crashed and the Asian stocks fell to a three-year low. Meanwhile, commodities plunged to a 16-year low level while the infamous oil touched a fresh six-and-a-half year low of below $40/ barrel. Emerging markets raised panic alarms leading to an exorbitant exodus in capital. Thanks to this massacre, the U.S. stocks futures logged their largest weekly decline since 2011 in the week ended August 21 and are expected to remain southbound until this jittery market calms down. All major U.S. indices remained in deep red and went into the correction zone , per analysts. The S&P 500 index is lost 12.5% from its May high on a broad-based global slowdown. Dow Jones Industrial Average plummeted about 14.6% (as of August 25) since it hit a high in May thanks mainly to a free fall in oil prices and now both have entered the correction mode. However, Dow was a relatively worse performer than the S&P 500. Momentum Gain However, to contain this slide, China slashed the one-year lending rate by 25 bps to 2.75%, the deposit rate by 25 bps to 1.75% and the reserve ratio by 50 bps to 18%. This, along with a bargain hunt, showered the much-needed gains on Wall Street. As a result, both S&P and Dow advanced close to 4% and captured the highest single-day gain in about four years. Below we highlight four S&P and Dow-based ETFs and analyze their performance and outlook. S&P 500 ETF SPDR S&P 500 ETF (NYSEARCA: SPY ) SPY seeks to track the S&P 500 Index before fees and expenses. The performance of the S&P 500 Index is considered a mirror image of the U.S. equities, as the index represents stocks of the 500 most-valued companies in the U.S. The $171.5 billion SPY has proportionate exposure in almost all sectors with maximum emphasis on Information Technology (20.0%). The sectors like Financials (16.8%), Health Care (15.5%), Consumer Discretionary (12.8%) and Industrials (10.0%) also make up double-digit allocation. The fund is highly liquid trading with over 115 million shares daily. It charges 9 bps in fees. The fund has very low company-concentration risk with no firm accounting for more than 3.6%. SPY is down about 5.3% this year and lost 6% in the last five trading sessions (as of August 26, 2015). The fund has a Zacks ETF Rank #3 (Hold). iShares Core S&P 500 (NYSEARCA: IVV ) This fund also looks to track the S&P 500 index and has AUM of around $68.5 billion. The fund is well spread out across sectors and security. IT, Financials, Health Care and Consumer Discretionary have double-digit exposure in the fund. The product is also devoid of company-specific concentration risks. The fund trades in volume of about 4.1 million shares a day while charges 7 bps in fees and expenses. The ETF lost about 5.7% in the last five trading sessions and 5.3% so far this year. The fund has a Zacks ETF Rank #3. DOW ETFs SPDR Dow Jones Industrial Average ETF (NYSEARCA: DIA ) DIA seeks to match the performance of the Dow Jones Industrial Average Index. The index is price weighted and measures the performance of 30 large cap stocks traded in the U.S. markets. Industrials, Financials, IT, Consumer Discretionary and Health Care all hold double-digit exposure in the fund. However, it is subject to company-specific concentration risks as it invests more than half of its portfolio in the top 10 holdings. This $11.1 billion-fund trades in large volumes of over 5 million shares daily and charges 17 bps in fees. It has lost over 8% so far this year and 6.1% in the last five trading sessions (as of August 26, 2015). The fund has a Zacks ETF Rank #3 with a Medium risk outlook. iShares Dow Jones U.S. ETF (NYSEARCA: IYY ) This $935 million-ETF also tracks the Dow Jones U.S. total market index. This fund has a proportionate exposure in almost all sectors with maximum emphasis on IT (19.0%), Financials (18.1%), Health Care (14.8%), Consumer Discretionary (13.4%), and Industrials (11.0%). Unlike DIA, this 1,255 stocks – fund invests less than 15% share in the top 10 holdings. Probably this is why the fund lost less than DIA. IYY charges 20 basis points as fees and shed 5.9% in the last five trading sessions and over 5.3% so far this year. Outlook Overall, the market may be a little uncertain, but such a sharp sell-off will open up the doors for future gains in the U.S. All four products went into an oversold territory indicating a turnaround. Moreover, latest rate cuts by China should also provide some boost to these equity indices. However, investors should also not that the current prices of the aforementioned ETFs are below their short- and long-term moving averages hinting at further bearishness. So, edgy investors might stay on the sidelines as of now and especially exercise caution when it comes to the Dow ETFs as this spectrum appears more volatile than the S&P 500. Original Post

Are You Selling The Drama Or Buying The Rally?

The critical concern at this juncture is to address whether or not new information genuinely makes risk taking more desirable. Have prospects for the global economy truly improved? If history teaches us that benchmarks tend to retrace half of their losses before retesting their lows – if you feel like you’ve been here before and you don’t choose to be scarred like that again – perhaps you might anticipate better buying opportunities in the weeks ahead. Mini-crash for equities ignites panic selling? Check. The commodity super-slump, ever-widening credit spreads, corporate sales recession and rapid deterioration in market internals throughout June and July assured a reassessment of risk. The brutality and swiftness of that risk reassessment was less destructive for those who respected the dozens of warning signs and acted proactively. Extremely oversold conditions and short covering spark panic buying? Check. As I explained on Tuesday after six days of relentless price depreciation, the S&P 500 had only closed on the lowest end of its 3-standard-deviation range (0.13% probability) on two other occasions – at the tail end of the eurozone sell-off (10/3/2011) and on Tuesday, 8/25/2015. That’s why I wrote in Tuesday’s article, ” Yes, you’re going to see higher prices in the immediate term. Relief rallies happen . ” On the other hand, corrections in other key historical periods (e.g., 1987, 1998, 2010, 2011, etc.) suggest that relief rallies are likely to be short-lived. Typically, stock prices bounce significantly off potential lows, then retest those lows a few weeks later. The S&P 500 SPDR Trust ETF (NYSEARCA: SPY ) plunged 16% in late July-early August of 2011. The exchange-traded index tracker went on to recover one-half (nearly 8%) in late August and September, but ultimately broke to new lows in early October. Similarly, the current correction for SPY came close to 12%. Should anyone be surprised in the vehicle’s ability to reclaim one-half (approximately 6%) of the erosion in price? If history teaches us that benchmarks tend to retrace half of their losses before retesting their lows – if you feel like you’ve been here before and you don’t choose to be scarred like that again – perhaps you might anticipate better buying opportunities in the weeks ahead . The critical concern at this juncture, however, is to address whether or not new information genuinely makes risk taking more desirable. For instance, have prospects for the global economy truly improved? Are corporations actually going to post top-line revenue increases in the 3rd quarter or blockbuster profitability in the 3rd quarter? Will the Federal Reserve’s timeline for tighter borrowing costs be compatible with real prospects for the U.S. economy? If the answers to these questions are “affirmative,” then stocks may be off to the races. Let’s start with the macro-economic backdrop. Is it possible that the seasonally adjusted, revised-and-re-revised GDP of 3.7% for the U.S. in Q2 is a game changer? Probably not. For one thing, the economic growth for the year is at 2.2% – the same low annualized rate that it has been throughout the six-year recovery. Second, the most respected forecasting arm of the Federal Reserve, the Atlanta Fed, anticipates 1.4% 3rd quarter GDP, which means decelerating activity. Last, but hardly least, the global economy is reeling, from debt-slammed Europe to commodity dependent Latin America to recession-wracked China. It follows that prospects for the global economy do not look substantially better, other than the hope and faith that investors may place in China’s multi-faceted stimulus efforts. Perhaps there is new data to suggest that corporations are growing their bottom line earnings per share that would justify a sustainable bullish stock uptrend. This does not look to be the case. According to S&P data compiled by the web log, Political Calculations, trailing 12-month earnings per share for the S&P 500 have declined from S&P analyst projections throughout 2015 from the projections analyst made three months ago (May 20, 2015), six months prior (February 15, 2015) and nine months earlier (November 13, 2014). Top-line revenue? The revenue recession began at the start of 2015 as the Dow Industrials posted sales declines in Q1 (-0.8%) and Q2 (-3.5%); analyst projections for sales declines are coming in at -4.0% for Q3. So new information on the global economic expansion is not particularly compelling. Meanwhile, companies do not appear to be enhancing their top or bottom lines, which does not help price-to-sales (P/S) or price-to-earnings (P/E) valuations. Why, then, would stock investors become enchanted by anything that has taken place in the last few days? Granted, President of the New York Fed, Bill Dudley, helped send stocks rocketing on Wednesday (8/26) with commentary that hiking the Fed’s overnight lending rate in September is looking “less compelling.” Anything that pushes off the possibility of higher debt servicing costs or higher financing costs excites stock bulls. Keep in mind, of course, nobody at the Fed has suggested that they would not raise interest rates here in 2015. It follows that the hope for a continuation of Fed accommodation – hope for a rate hike delay, a slower pace for rate hikes (e.g., every other meeting), and/or smaller increments (one-eighth of a point) – remains the best bet for stock bullishness. We are still proceeding with caution. Most of our clients have 50% exposure to domestic equity ETFs such as the iShares S&P 100 ETF (NYSEARCA: OEF ), the Health Care Select Sect SPDR ETF (NYSEARCA: XLV ), the iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ), the Vanguard Mid-Cap Value ETF (NYSEARCA: VOE ) and the Vanguard High Dividend Yield ETF (NYSEARCA: VYM ). In some instances, we have bought the dips on accidental high yielding dividend aristocrats like Wal-Mart (NYSE: WMT ). Investment grade bonds make up 25% of most portfolios with funds like the iShares 3-7 Year Treasury Bond ETF (NYSEARCA: IEI ) and the Vanguard Total Bond Market ETF (NYSEARCA: BND ). Most importantly, in May and June, when the S&P 500 regularly sat near the 2100 level, we raised our money market cash account levels . Those cash levels are still at 25%. The purpose? Cash reduces portfolio volatility during periods of market stress, limits the downside loss during sell-offs and provides opportunity to buy quality assets at lower prices. Even if I am wrong about the S&P 500 retesting its lows, we are unlikely to miss the bull train as we await a definitive confirmation of improving market internals . 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.