Tag Archives: income

Preparing For A Market Collapse, Part III

Summary U.S. equities are down but not cheap. They could fall further. It is time to prepare…. … In fact, it is always a good time to be prepared. This is the third in a series. You can read Part I and Part II for background. Since the series began, the S&P 500 (NYSEARCA: SPY ) is down over 10%; it could have much further to fall. What current shorts have the most asymmetric exposure? How can average investors see the need to short? Here are three specific short ideas followed by three ways for investors, including retail investors, to weigh when to short. China In terms of country exposure, China is among my favorite shorts. Artificial central bank stimulus drove the Chinese equity mania in early 2015. New equity buyers flooded into the market. These new investors purchased stocks using a record amount of margin debt. They had weak hands once the market direction turned around. The supply of new capital was finite. Eager new investors pushed up prices, but quickly pulled out of the market once prices declined. How do you short China? One way is to short Direxion Daily China Bull 3X Shares (NYSEARCA: YINN ). It is down over 70% since I first disclosed this idea, but it could drop much further over time. That being said, not all Chinese equities are expensive. While China is a big short idea overall, there are some small long ideas worth considering, such as Taomee (NYSE: TAOM ). Biotech Turning to sector exposure, biotech is another favorite short opportunity. This has been a hot sector, but one with market prices that are high, unstable, and precarious . It is down over 20% but remains overpriced. In the long term, it will probably decline substantially further. While biotech is a major short opportunity, one can find bargains in the wreckage. Depomed (NASDAQ: DEPO ) is one worth considering. Due to its drug prices, it is far less sensitive to political pressure than Horizon (NASDAQ: HZNP ) or Valeant (NYSE: VRX ). High Yield In the current credit environment, “high yield” is a bit of a misnomer. In fact, it borders on false advertising. This is one of my favorite types of securities to short because high yield is expensive enough that it does not cost too much if it maintains these rarified prices, and investors long this exposure will probably not hang in there if it begins to decline substantially. Retail investors (including not just a few on Seeking Alpha) who seek yield at any price have driven securities with the appearance of stable yield to zany prices. One security to consider is PIMCO High Income Fund (NYSE: PHK ). As of today, it trades at a 13% premium to its NAV. Down over 25%, it is still overpriced. Its price should continue to converge upon its value in the years ahead. If credit spreads widen from here, it could decline substantially. Should you own any broad-based bond exposure? At today’s prices, no. “HPHs [high priced helpers] frequently think of risk as a function of asset class along the lines of “cash is safe, stock is risky, and bonds are in the middle”. In reality, risk is never a function of asset class; it is a function of price. Thinking proxies such as asset class-based risk models are designed only to excuse HPHs from doing any fundamental analysis to determine value. They can’t make you safe because they can’t even define, let alone quantify, risk. If you are a 65-year-old retiree, a smart-sounding HPH might say that you should be 65% in bonds, with others arguing importantly that the right number is 70% or 60%. The right number is 0%. Alternatively, come up with an explanation of how the credit market is currently undervalued. I could, of course, be completely wrong, but the current credit market looks like an epic bubble. It is conventional to own a lot of bonds, but when the bubble bursts, you will conventionally lose a lot of money.” – Where Can I Find Safe Income For Retirement? Shiller P/E When to short? At the level of individual securities, the fundamental analysis and event analysis takes more time than most investors have to short stocks. In terms of shorting country markets, sectors, or parts of the capital structure, there are some readily-available resources that might be helpful in knowing when to short. For a quick heuristic on the market’s price, you might consider the Shiller P/E. This ratio is more indicative of value across business cycles because it is less impacted by fluctuating profit margins. The U.S. equity market’s Shiller P/E is currently over 43% above its historical mean of about 17. Market prices have rarely maintained such high multiples for long. For further reading on topics, including the Shiller P/E, you might like Rock Breaks Scissors: A Practical Guide to Outguessing and Outwitting Almost Everybody . U.S. equities are the fourth most expensive in the world according to this metric, behind only Japan, Ireland, and Denmark. Market Cap/GDP Market capitalization / GDP in the U.S. is another key metric. When it is high, it is a particularly important time to focus on short opportunities. Today, the U.S. market cap is about 112% of the U.S. GDP. Historically, from such lofty levels, subsequent total returns are typically less than 2% per year. The U.S. equity market is pricey on both metrics. Real returns are probably negative or too low to justify the risk. Incidentally, on both metrics, Russia is a bargain. Its Shiller P/E is about 5 and its market cap/GDP is about 18%, close to its historical minimum of 17% over the past 15 years. The inverse, leveraged Russian ETF (NYSEARCA: RUSS ) is down over 25% since our previous article on that opportunity. However, despite the move in price, it remains an attractive short. 7-Year Real Return Forecast GMO publishes a monthly chart comparing the estimated prospective annual real return over the subsequent seven years of various asset classes from current market prices. The comparison between the 6.5% long-term historical U.S. equity return and the returns from today’s levels is not favorable for today’s equity investors. Average returns will probably be around zero, with somewhat negative returns overall and only marginally positive returns for equities that GMO considers to be high quality. At least we have plenty of timber in Maine, so we have that one covered. Conclusion Part I covered the virtues of maintaining both sizing discipline and a cash balance. “Ordinary opportunity sets should lead to only ordinary position sizing, leaving extraordinarily large positions for only the rarest of opportunities. At a one percent position, one could conceivably find subsequent risk:reward opportunities to double down three times and still have a statistically diversified portfolio. Hyper-diversification accomplishes very little, but having a dozen truly uncorrelated positions accomplishes much of what correlation can offer. However, if one starts with a 5% position and doubles it three times on apparently better subsequent entry points, one is left with an over-concentrated or overleveraged portfolio.” “When everything is going horribly wrong, the comparative advantage of being more liquid than your marginal counterparty becomes extreme. So, while I do not know what the right amount of cash is, I am certain that it is better to have more. You should have more than whomever you are trading against when nothing is working in the markets. How much is that? I currently have 25% of my assets in easily accessible cash and am glad that I do. My percentage might be too low but I am virtually certain that it is not too high. Whatever opportunity cost that I pay in terms of diminished return can be quickly recouped during the next market collapse.” Part II covered some of my favorite company-specific short ideas. The ten disclosed short ideas declined from 2 to 35% since publication; none have yet to fully converge upon their intrinsic values. The average decline of 16% is over three times the S&P 500 ( SPY ) decline over the same period. The larger point is that a flexible mandate that allows one to go long or short creates an optimal environment for analytical rigor. “When someone is able to buy or short investment opportunities, he can first be analytical – gathering relevant facts, measuring value, and examining events that are likely to unlock or reveal that value. One need not be a fan, only an analyst. Regardless of whether or not you like what you are looking at, there is something to do either way. One can buy, one can short, one can ignore. One does not need to prejudge before reaching a conclusion informed by the relevant premises.” You can protect your capital by shorting expensive (and therefore risky) securities with exposures to China, biotech, and high yield credit as described above in Part III. Additionally, you can monitor the Shiller P/E ratio, the market cap/GDP, and the 7-year return forecast for a quick look at the market’s price. These tools are valuable additions to the toolkit of the prepared investor. Regardless of the specifics on how you choose to prepare for the possibility of a market crash, it is unlikely that the next half-century will look anything like the past. It is (barely) conceivable that it continues at the current pace and the S&P 500 races through 48,000. But even if it is possible, it is not a safe bet. When it comes to investing, I do not hope for or expect any single outcome. I do not hope or expect that my home will burn down either, but I still have fire extinguishers and plenty of insurance. None of this is a call to panic; it is a modest call to prepare. I would be perfectly happy to be wrong in my view that such preparation is both wise and timely. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

XLV: Offering Investors An Interesting Blend Of Defensiveness, Price Appreciation And Income Growth

Recent weakness in the Healthcare sector led me to look at XLV as a means to increase my exposure to a space in the market that I’m attracted to. XLV offers me yield, income growth, and exposure to the entire healthcare sector, including many growth-oriented companies that I likely otherwise wouldn’t have exposure to. I’m typically not a fan of ETFs or other funds due to expense ratios; however, XLV’s is a very low 0.15%. On Monday, in the midst of the market wide sell-off, the destruction in the healthcare sector, specifically, caught my eye. I’ve been overweight in healthcare for awhile now, feeling strongly that as science and technology improves, modern medicine will so too. When looking for reliable growth in the markets, healthcare seems like the safest best. What’s more, many of the more established companies in the sector have been generous in the past with their shareholder returns and offer investors strong dividend growth histories. Recently, there has been drama in the space with regard to the pricing of drugs in the market place. This issue has made it into a political theater, and now, the sector as a whole is trading in response to announcements, and even tweets, made by politicians. Personally, I like my stocks to trade on earnings releases based on fundamental ratios; however, I understand there there is regulatory worry in the space, especially when presidential candidates are coming out strongly against what’s being referred to as “price gouging” in the media. I get it, the recent events centered around Turing Pharmaceuticals and its purchase of and ensuing price hike of the drug Daraprim has caused quite a stir. Honestly, I’m somewhat impressed by the notoriety that this has gotten on Capitol Hill – it seems as though this issue, more so than any other in recent memory, has drawn bilateral support from both Democrats and Republicans. And now, this sense of ire is being directed at the industry as a whole. However, I think it’s important for investors and politicians alike to understand that the Turing situation, compared to something that many view as being rather similar – we’ll use Gilead’s (NASDAQ: GILD ) pricing of Solvaldi, which made big news with regard to potential congressional oversight last year, as an example – is a very different situation. There are many more potential companies and/or drugs that I could use here, but regardless, most of these situations are like comparing apples to oranges. While Gilead spent the time, energy, and financial resources to develop Solvaldi and its other hep C treatments (treatments that don’t merely treat, but cure a potentially deadly disease that causes pain and suffering worldwide), all Turing did was buy the rights to an existing drug and hike the prices. Some might see both situations and think to themselves, “Either way, the treatments are overpriced and this is immoral.” I, however, see them as quite different beasts, with one being quite a bit more justified than the other. Biotech companies put a lot of resources towards their pipelines, and when they’re successful in developing treatments, they ought to be rewarded. As terrible as it might sound, when financial incentive to create such treatments disappear, I imagine that the treatments will as well. Governments worldwide have enough of a hard time funding themselves as it is… I don’t see them doing nearly as good of a job with biotech R&D as the private sector has. Everything comes with a cost in life, and the way I see it, good health is something that is actually worth paying for (and investing behind). But all personal opinions aside, the biotech space is no stranger to dramatic attention by the news media. For years, it seems, the healthcare sector, namely the more volatile biotech names within who are responsible for developing breakthrough drugs and treatments, have been either darlings or devils in the market’s eyes. This attention has allowed for bubbles to form, and pop, and form again. This volatility leads to more attention, and it seems as though the cycle is never ending. In recent years, when these bubbles have burst, the ensuing weakness turned out to be a great buying opportunity for those with the stomach to brave the bloodshed. Now, looking at present weakness, I have to decide if this will be the case again, or if the tides really changing due to a potential political overhaul of the system as a whole. And if I decide that this dip is just that, a dip, I need to figure out when and how should I add to my exposure in the space. Before I go on any further, I will note that I am not a doctor of any sort. I try my best to stay up-to-date on the pipelines of the companies that I own in the space, understanding what each company is setting out to do and whether or not it seems to be achieving its goals from both a scientific and financial standpoint. Due to my limited understanding of the science involved in the inner workings of biotech companies, this can be very difficult for me, and I admit that I rely on third-party sources a lot of the time for my information. I’ve found sources that I trust, and my system has worked out thus far; however, I think it’s worth mentioning that this strategy adds another element of speculation into the overall equation, because my due diligence is sometimes influenced by outside resources. And it’s this point – the fact that I think that many, if not most, self-directed investors don’t have a very good understanding of the healthcare sector as a whole (especially the biotech space, which drives a lot of growth) – that led me to write this article. Although I don’t currently own any ETFs in my personal portfolio, I’m tempted to buy shares of the Health Care Select Sector SPDR ETF (NYSEARCA: XLV ) on recent weakness. The overarching, diversified nature of this ETF would help to cover my tracks a bit as I wander through the sector, somewhat uninformed, while still allowing me to reap the rewards that the space has traditionally had to offer. There are several reasons why I’m attracted to the idea of buying XLV. Namely, right now I’m seeing a lot of deals in the space, and I don’t have enough money to enter into positions with all of them. And what’s more, even if I did have enough money to buy shares in all of them, it’s likely that the commissions I paid to half or even full positions for my portfolio, would equal out to be greater than the 0.15 total expense ratio that one pays when owning shares of this sector SPDR ETF. XLV’s holdings are comprised of many companies that I respect. Sure, there are some that I wouldn’t purchase outright in the market. This is typically the reason that I don’t own ETFs – I’d rather approve of all of the companies that I have exposure to, than simply buying buckets of stocks that contain shares of mismanaged or stingy companies; however, in this case, there are many more positives than there are negatives, and the overall sum of the parts with regard to XLV has received a passing grade. Another reason is this: Because of the diversified nature of the XLV portfolio, I’m given exposure to many more growth-oriented companies than I would be when stock picking, while still receiving a decent yield with above-average growth. I say above average because looking back at annual dividend payments investors received from holding the S&P 500 tracking index (NYSEARCA: SPY ) and XLV, during the last 11 years – from 2005 to 2015 – the income stream of those investors holding XLV had an 8.84% CAGR, while the income stream of those holding SPY had a 6.62% CAGR. The way I look at this, buying XLV allows me to have exposure to growth companies like Regeneron (NASDAQ: REGN ) or Celgene (NASDAQ: CELG ) – two companies with exciting pipelines, but no dividends – while still generating portfolio income. Here is a list of the fund’s top 10 holdings: (click to enlarge) (Source: XLV website ) Now, the downside to this higher growth potential, from both a stock price and dividend payment standpoint, is that my starting yield is lower when buying XLV than it would be if I were to narrow down my selection and purchase shares of healthcare dividend stalwarts like Johnson & Johnson (NYSE: JNJ ), Merck (NYSE: MRK ), Bristol-Myers (NYSE: BMY ), or even the aforementioned GILD, which isn’t exactly a “dividend stalwart”, though it is a company that I’m very long on, and one that I believe will pay a large part in my personal portfolio’s income stream moving forward. Right now, XLV is offering investors a 1.50% index yield, which is much lower than the 2%, 3% or even 4% yields that can be found from rather reliable companies in this space. Anyone investing in this index has to weigh these two options: single stock ownership with a potentially higher yield, or a more diversified, industry-wide exposure with less initial yield, but relatively similar dividend growth potential and greater price appreciation potential. Medical degree or not, it doesn’t take a genius to see that the healthcare sector has drastically outperformed the S&P 500 in recent years. Looking back even 20 years, we see that this sector of the market has been a top performer. This is clearly shown in this graph, which is a year or so outdated; however, I think it still has a point to prove, and I couldn’t find another with more recent data that painted such a clear, broad picture of the markets. (click to enlarge) (Source: Bernstein ) Looking at a similar data set through a more narrow lens, we see that over the last 10 years, XLV has outperformed not only the S&P 500, but also some of its major components that I choose because of my own interest in them (and the fact that I assumed other dividend income investors might be interested in them as well) – Johnson & Johnson and Pfizer (NYSE: PFE ) – by a long shot. (click to enlarge) Here is another image that I came across when looking at long-term asset class return results; I find it interesting that in this graph, not only has healthcare found itself among the very top performers since 2011, but in 2008, when the bottom fell out of the market, the healthcare sector was defensive in nature as well, with the second best overall sector-wide performance, behind only consumer staples. It’s not often that one is able to find defensiveness, growth potential, and income/income growth all in the same spot; however, it seems that with healthcare, investors get the complete trifecta. (click to enlarge) (Source: Sector SPDR Website ) And speaking of income, I went ahead and put these graphs together to show interested investors that not only do they get strong stock price appreciation potential with XLV, but also strong income growth. I know I mentioned the CAGR before, but this gives a more complete version of the picture. Here is a chart showing XLV’s quarterly dividends since 2005 (the fund’s inception date is 1998, but I thought a 10-year data set would suffice). (click to enlarge) Although the payments are a bit sporadic and not exactly predictable on a quarter by quarter basis, the overall trend is clearly to the upside. Here is another image I put together, comparing XLV’s dividend growth to that of SPY. As you can see, growth for XLV has been more reliable, especially in tough times. (click to enlarge) So, in conclusion, after looking over XLV as a potential holding, I came away impressed. Obviously, everyone’s portfolio management strategy is different, though I’m starting to realize that having exposure to these low-expense sector ETFs could be beneficial for me, especially from a diversification standpoint, and I will likely begin including them into my holdings. I am not currently long XLV, though it is a stock that is sitting near the top of my current buy list once the market calms down a bit and I get more clarity of certain global and Fed-related issues that I’d like to see play out before putting cash that I’ve recently raised back into the markets. I invite any and all readers to perform their own due diligence on XLV, because I think that right now, with it trading down 8% on the month, interested investors might find an attractive entry point into the space. I should also mention that I chose to focus on XLV rather than the often-talked-about iShares Nasdaq Biotechnology ETF (NASDAQ: IBB ) because of the lack of yield associated with the latter. I like the growth potential of sector, and especially the biotech space within; however, I’d like to get some yield from my money invested, so XLV seemed like the perfect compromise. Those looking for more of a growth pure play may want to take a closer look at IBB while you’re at your XLV due diligence as well.

Invest In Utilities Since The Fed Remains Dovish

Summary Utility stocks are often discarded as boring but provide stable income through dividends. The Fed decided not to raise interest rates in their September meeting but indicate by the end of the year would be appropriate. Utilities should be held in a diversified portfolio as an alternative to long duration bonds. This was supposed to be the month. The first time since 2006 the Fed raised interest rates. It turned out to be another case of the Fed getting cold feet. After all, the rest of the world’s central banks continue with their easy monetary policy. The case has been made that 25 basis points won’t make a difference so why not raise rates? On the other side of the argument, if 25 basis points doesn’t make a difference, why risk blowing up the stock market over it? The Fed’s statement was dovish indicating that we could continue to see interest rates held near zero into next year. The market believes the Fed will not move this year as indicated by Bloomberg’s world interest rate probability monitor. Bloomberg currently shows the market indicating an 18% probability of a rate increase in October and 43% of an increase in December. These figures were at 44% and 64% respectively prior to the Fed meeting earlier this month. Yellen gave a speech last week stating she still believes it would be appropriate to raise rates by the end of the year. If the Fed is in fact data dependent, what will change in the next two and a half months in the data that will significantly change the Fed’s view that it’s time for liftoff? The answer is nothing. So investors continue on with no clarity from the Fed. The Fed presidents meet and decide not to raise rates and then the next week give speeches indicating that a rate increase would be appropriate. It makes no sense. Why utilities make sense now This confusion over the Fed lead me to the utility sector. The dividend yield of the S&P 500 Utilities index is currently 3.66% versus the 30 year treasury yield at 2.96%. That’s an extra 70 basis points in yield for holding utilities for just one year as compared to holding the treasury for 30 years. This is not a new trade as utility yields have been relatively attractive for some time. Utilities provide stable income for portfolios as they tend to trade more like bonds but I see less downside risk for utility stocks if the Fed were to raise rates. My thought is as rates increase, the cost of capital used for stock valuation will also increase which will lower stock prices. The safety of utilities will be a safe bet for stock investors as volatility increases around the rate increase. Stock investors will seek the stability of utilities which would increase the value of the sector and it should outperform. On the other side, if the Fed continues to keep rates low into next year, utilities provide a relatively decent yield as compared to bonds and much better than leaving money in the bank to lose value in real terms after factoring in inflation. Even if the Fed does raise rates, they have indicated the pace will be slow. Utility Index ETF’s provide better diversification An easy way to add utility exposure is to buy a utility index ETF such as (NYSEARCA: VPU ), (NYSEARCA: IDU ), or (NYSEARCA: XLU ). These funds provide exposure to the respective index the ETF tracks which pay around a 3.6% dividend yield (each fund yield is slightly different depending on holdings). Using an ETF is also an easy way to diversify your utility holdings so you don’t have concentrated exposure to one utility in case there are problems. There are many regulatory factors to consider with individual utility companies and the states they operate in. The capital structure of these companies and their subsidiaries can be pretty complicated as well. If you don’t have the time and patience to take a deep dive into an individual stock, then an ETF would be the way to go. PEG looks relatively attractive Looking at the relative value metrics of the utility sector and the stock that stands out to me is Public Service Enterprise Group (NYSE: PEG ). While PEG does not pay the highest dividend yield, the P/E and EV/EBITDA ratios are below the sector average. An important consideration for a utility is the dividend coverage ratio. PEG has a coverage ratio of 1.75x which is above the average of 1.42x. This is a direct result of the lower debt profile of PEG. With less income going towards interest payments and debt, this leaves more cash flow available for equity. The utility industry is characterized by high debt loads due to the considerable size of the capital expenditures required to maintain their plant assets. PEG has one of the most attractive debt profiles with just 26% total debt to assets and 69% debt to equity. Name Mkt Cap – USD EV/TTM EBITDA EV/EBITDA FY1 P/E Dividend Yield Average 26.02B 8.78 9.01 15.59 3.98% DUKE ENERGY CORP (NYSE: DUK ) 48.67 8.62 9.54 17.35 4.54% NEXTERA ENERGY INC (NYSE: NEE ) 45.41 9.27 10.13 17.96 3.08% DOMINION RESOURCES INC (NYSE: D ) 41.64 13.85 12.4 20.14 3.63% SOUTHERN CO/THE (NYSE: SO ) 40.09 10.97 9.88 16.22 4.84% AMERICAN ELECTRIC POWER (NYSE: AEP ) 27.47 8.67 8.68 15.37 3.79% P G & E CORP (NYSE: PCG ) 25.89 8.74 8.25 13.46 3.44% EXELON CORP (NYSE: EXC ) 25.42 5.81 7.37 10.93 4.20% PUBLIC SERVICE ENTERPRI 20.69 6.33 7.23 14.19 3.77% Source: Data from Bloomberg Conclusion While the Fed keeps investors confused about the timing of the first interest rate increase, it makes sense to remain defensive with portfolios. Lower inflation due to cheap oil means the Fed will be slow with the interest rate hike. Dividend paying utilities seem to be a better play versus other stock sectors as the stable income provides some downside protection while being a more attractive option to long duration bonds.