Tag Archives: income

Who’s Right, The Market Or The Fed?

Latest Fed guidance Expect 10, 0.25% rate hikes by December 2018. “Economic recovery” is underway and will continue at a moderate pace. Interest rates will “normalize” by 2019. (Where the Fed sees rates and when, 2 minutes 6 seconds) Source Federal Reserve 35+ trillion in open position face value tells us Expect a maximum of 3, 0.25% rate hikes by December 2018 Rates will not “normalize” this decade True economic recovery will take far longer than the most pessimistic of Fed guesstimates. A-C on the chart below shows the market’s expectations for rate hikes A) In January 2013 the market was pricing in 6, 0.25% rate hikes between June 2016 and December 2018 with the spread between the two deliveries (GEM16) and (GEZ18) at 1.50, position value 3,750.00 USD B) By November 2013, optimism for US economic recovery and rate normalization peaked with the market pricing in 10, 0.25% rate hikes between Jun. 16 (GEM16) and Dec. 18 (GEZ18) at 2.50, position value 6,750.00 USD C) Current rate hike expectations have dropped to less than 3, 0.25% hikes by Dec 18, with the spread at 0.6250, position value 1,562.50 USD D) If the market had faith in the Fed’s projections the spread between the Jun. 16 (GEM16) and Dec. 18 (GEZ18) deliveries would be 2.50 reflecting the Fed’s expected 10, 0.25% rate hikes by Dec. 18, position value 6,250 USD. Click to enlarge How to calculate the market’s expectations to 0.01% through March 2026. Use the quotes on this Exchange page To convert the contact delivery price into rate it represents take 100.00 – contract price = the rate. Example, 100.00 – the December 2016 contract price of 99.17 = an expected 3 month rate of 0.83% by Dec 18. To calculate expected rate increases between delivery months take the nearby delivery minus the forward delivery equals the expected rate change between delivery months. Example, June 2016 delivery trading at 99.3350 – December 2016 at 99.1700 = the expected increase in rates between June 2016 and December 2016 = 0.1650%. What U.S. price action tells us. The market’s perception of economic recovery is far worse than the Fed’s. Rates will not “normalize” during this decade. Fed and US fiscal policy makers creditability with the market is at a new low Eurozone market expectations are worse. A) In January 2013 the Eurozone expected an increase in the 3 month Euro Interbank Offered Rate (EuriBor) between Jun. 16 (IMM16) and Dec. 18 (IMZ18) of 0.6000%, position value 1,500.00 EUR B) By November 2013 optimism for Eurozone economic recovery and rate normalization peaked with an expected increase in the EuriBor rate between Jun. 16 (IMM16) and Dec. 18 (IMZ18) of 1.10%, position value 2,750.00 EUR C) Currently optimism for Eurozone economic recovery and rate normalization has hit a new low with an expected increase in the EuriBor rate between Jun. 16 (IMM16) and Dec. 18 (IMZ18) at 0.10%, position value 250 EUR. Click to enlarge Converting the contact price into rate increase/decrease works the same as the US. Use the quotes on this Exchange page to calculate today’s Eurozone rate expectations to the 0.01 through March 2022 3 Month Eurozone price action tells us The EuriBor rate is expected to move 0.0350% lower during 2016 The market sees only a 0.0700% rate increase between now and December 2018 The EuriBor rate will remain negative through December 2019 Eurozone rates will not “normalize” this decade United Kingdom, nearly the same A) In January 2013 the UK market expected an increase in UK 3 month rates between Jun. 16 (LZ16) and Dec. 18 (LZ18) of 1.20%, position value 3,000.00 GBP. B) By January 2014 optimism peaked with the market pricing in a 1.60% increase, position value 4,125.00 GBP. C) Currently UK price action says only a 0.30% increase, position value 750.00 GBP. Using the quotes on this exchange page conversions and expected increase/decrease work the same as the U.S. and Eurozone. Click to enlarge Global Stock markets Let’s skip all the subjective fundamental economic over analysis and look at the big picture price action. Price action is telling us uncertainty and doubt about economic recovery has now spread into the global equity markets. S&P 500 traded at the CME On the 16 year S&P chart below note the current volatility relative to the overall rate of change, the monthly moving average (green) has been violated, the majority of the price action is now below the average. Does this market still look like it’s in a healthy uptrend to you? Click to enlarge DAX traded at EUREX Increased volatility relative to the overall rate of change, the DAX has broken below the monthly moving average (green), the majority of the price action is now below the average with the long term trend appearing to be shifting from up to down. Click to enlarge Nikkei 225 traded at JPX Increased volatility, the market has broken below the monthly moving average (green), the majority of price action now remains below the average, the long term shifting from up to down. Click to enlarge Survival Put opinions aside, trade with the trend long or short. Learn new markets and strategies. Trade whatever market/sector has the highest return on risk Define risk on trades and for the duration of the trading period without wasting precious investment capital on option time premium to hedge risk. One example of defined risk trade using the Euro Stoxx 50 traded at EUREX Looking at the chart below is it really that hard to identify the current daily trend using the moving average (green) ? We’ve seen the break below the daily moving average and now majority of price action below the average. Click to enlarge On the weekly, a break below the weekly moving average (green) with the majority of the price action below the average. Click to enlarge Monthly, break below the monthly average (green), majority of the price action below the average. Click to enlarge The daily, weekly and monthly charts tell me short Common technical indicators say the same Click to enlarge Eurozone rate expectations sum up the economic fundamentals. The EuriBor is pricing in lower rates during 2016 with the EuriBor moving from the current negative 0.2550% to negative 0.2900% by December 2016. EuriBor traders are telling us loud and clear true economic recovery isn’t expected for the Eurozone in 2016. Structuring a defined risk trade shorting the Euro Stoxx 50 A) Short the Euro Stoxx 50 at 3,000, position value 30,000 EUR B) Write the 2,800 put collecting premium C) Using the collected premium purchase the 3,200 call to hedge risk. Click to enlarge Trade Summary Risk is defined on the trade and for the duration of the trading period This trade cannot be stopped out regardless of market volatility, the only thing needed to be profitable is anticipating the market’s overall direction correctly. The trade can be liquidated at any time , you do not need to hold the position to expiration. The only way the 3,000 short can be pulled away is at a 2,800 generating a gross profit of 2,000 EUR. If the market reverses and rallies to 3,800 losses above 3,200 are hedged by the 3,200 call with gross losses limited to 2,000 EUR. If the market stays the same and you’ve structured your trade correctly you should break even as you’ve collected as much time premium on the 2,800 put write against your 3,000 short as you’ve paid out for the 3,200 call to hedge. Effective “option collar” strategies are not limited to the international futures markets they can be employed in any market that has underlying option liquidity. Examples Baxter International Inc ( BAX ) – NYSE, Bank of America Corporation ( BAC ) – NYSE, General Electric Company ( GE ) – NYSE, SPDR S&P 500 Trust ETF ( SPY ) – NYSEARCA, iShares MSCI Emerging Markets ETF ( EEM ) – NYSEARCA, SPDR S&P Metals and Mining ETF ( XME ) – NYSEARCA, Pfizer Inc. ( PFE ) – NYSE, Apple Inc. ( AAPL ) – NASDAQ, SPDR Gold Trust ETF ( GLD ) – NYSEARCA, iPath S&P 500 VIX Short-Term Futures ETN ( VXX ) – NYSEARCA, Market Vectors Gold Miners ETF ( GDX ) – NYSEARCA, Ford Motor Company ( F ) – NYSE, Financial Select Sector SPDR ETF ( XLF ) – NYSEARCA, iShares China Large-Cap ETF ( FXI ) – NYSEARCA, Shares Russell 2000 ETF ( IWM ) – NYSEARCA, Let’s take a look how at how a “collared” position protected me in Apple AAPL I’m sure I wasn’t the only one caught long Apple AAPL at 130 USD in July 2015 I made the mistake of getting too attached to being long this stock from 75.00 USD and stayed long in July 2015 at 130.00 USD despite the daily trend telling me it was questionable. Click to enlarge The weekly was shaky Click to enlarge The monthly still up with only a few “bumps” against the moving average and no sustained price action below the average. Click to enlarge The technical indicators were deteriorating Click to enlarge Rather than reverse to short or liquidate my Apple position I maintained my long hedging it up with a collar shown A-C on the chart below. A) At the time I put down the collar AAPL was at 129.62 USD B) I wrote the 140.00 1 month call against my long C) Using the collected premium I purchased the 120.00 put Click to enlarge Price action got ugly quick, the market broke eventually taking out 110.00 USD, disappointing but tolerable as I had my 120.00 put hedge in place negating any losses below 120.00. I delivered my long at 120.00, had I not “collared” this position it could have been far worse, AAPL eventually violated 95.00 USD on the run lower and has not seen a sustained move above 120.00 since. Click to enlarge This Apple trade was yet another refresher course for me not to get too “attached” to a stock, to pay attention to price action and not fight market momentum. If you’re attached to your long shares or index positions (as I was too apple) you too might want to take a good hard look at the current price action and start “collaring up” positions to prevent a financial character builder. I don’t think anyone knows for sure where the high will be for the S&P 500 and Global Equity Markets. Click to enlarge What we do know for sure is when the S&P 500 and Global equity markets break the financial impact can be worse than a divorce and five kids in private school. Click to enlarge Using “collars” to control risk on directional trades has cut my stress level for these trades by 70%. ——————————————————————————- Additional information and definitions Trading intra-market rate spreads If you believe Fed creditability and “economic recovery” will continue to deteriorate you’d short the GEZ16 futures contract and go long the GEZ18 expecting the market to go from pricing in 2, 0.25% hikes between Dec. 16 and Dec. 18 to 0, 0.25% hikes or for the spread to potentially invert (-0.10) like it has in Europe and Asia. Each 0.01 contraction in the spread price from the current 0.50 = +25.00 USD and each 0.01 expansion -25.00 USD. If you believe the market is being more pessimistic than justified about economic recovery and, the Fed is more right about the rates they set than wrong, you’d go long the GEZ16 and short the GEZ18 expecting the spread to widen from the 0.50 (2, 0.25% rate hikes) to 1.00 (4, 0.25% hikes) and be more in line with the Fed’s expected 8, 0.25% hikes , spread = 2.00. Each 0.01 expansion in the spread from 0.50 = +25.00 USD, each 0.01 contraction = -25.00 USD Click to enlarge Eurozone intra-market rate spreads work the same as the US, if you think Eurozone economy will weaken further you’d short the IMZ16 and go long the IMZ18 expecting the spread to contract, if you believe the Eurozone is in better shape than what the market is telling us you’d go long the IMZ16 and short the IMZ18 expecting the spread to widen, each 0.01 = 25.00 EUR. Click to enlarge Difference between intra-market and inter-market spreads Inter-market spreads trade different contract markets for example, WTI against Brent crude oil, long 1,000 barrels of Brent QAN16 , short 1,000 barrels of WTI CLN16 expecting the spread to widen from 0.00, each 0.01 = 10.00 USD. Click to enlarge Platinum versus Gold is also a Inter-market spread example, long 2, 50 troy ounce Platinum contracts PLN16 , short 1, 100 troy ounce gold contract GCM16 expecting platinum to gain back lost ground against gold, each 0.10 = 10.00 USD. Click to enlarge The intra-market rate spreads mentioned in this report are trading the same contact market but different delivery dates , for example short 1 Jun. 16 US 3 month deposit GEM16 long 1 Jun. 21 3 month deposit contract GEM21 expecting the spread to widen, each 0.01 = 25.00 USD. Definitions 3 month rates or Eurodollar deposits are time deposits denominated in U.S. dollars at banks outside the United States. (There is no connection with the euro currency ). The term was originally coined for U.S. dollars deposited in European banks, but it’s expanded over the years to its present definition-a U.S. dollar-denominated deposit in any non US bank for example Tokyo or Beijing would be deemed a Eurodollar deposit. Futures open interest (contracts outstanding exceeds 10 trillion, Euribor is short for Euro Interbank Offered Rate. The Euribor rates are based on the average interest rates at which a large panel of European banks borrow funds from one another. The Euribor rate is considered to be the most important reference rates in the European money market. The interest rates do provide the basis for the price and interest rates of all kinds of financial products like interest rate swaps, interest rate futures, saving accounts and mortgages. Short Sterling prices are based on the British Bankers Association London Interbank Offered Rate (LIBOR) for three month sterling deposits in units of 500,000.00 GBP. 3-Month Sterling Futures are traded on the London International Financial Futures and Options Exchange, part of NYSE Euronext. Each contract is for Interest rate on three month deposit of £500,000 of 3-month Sterling. The Standard & Poor’s 500 , often abbreviated as the S&P 500, or just “the S&P”, is an American stock market index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ. The S&P 500 index components and their weightings are determined by S&P Dow Jones Indices. It differs from other U.S. stock market indices, such as the Dow Jones Industrial Average or the Nasdaq Composite index, because of its diverse constituency and weighting methodology. The “Composite Index”, as the S&P 500 was first called when it introduced its first stock index in 1923, began tracking a small number of stocks. 3 years later in 1926, the Composite Index expanded to 90 stocks and then in 1957 it expanded to its current 500. S&P 500 futures trading began in 1988 , e-mini contract 1997. The DAX ( Deutscher Aktienindex (German stock index)) is a blue chip stock market index consisting of the 30 major German companies trading on the Frankfurt Stock Exchange. Prices are taken from the Xetra trading venue. According to Deutsche Börse, the operator of Xetra, DAX measures the performance of the Prime Standard’s 30 largest German companies in terms of order book volume and market capitalization It is the equivalent of the FT 30 and the Dow Jones Industrial Average. The Nikkei 225 , the Nikkei Stock Average is a stock market index for the Tokyo Stock Exchange ((NYSE: TSE )). It has been calculated daily by the Nihon Keizai Shimbun (Nikkei) newspaper since 1950. It is a price-weighted index (the unit is yen), and the components are reviewed once a year. Currently, the Nikkei is the most widely quoted average of Japanese equities, similar to the Dow Jones Industrial Average. The Nikkei 225 Futures , introduced at Singapore Exchange (SGX) in 1986, the Osaka Securities Exchange (OSE) in 1988, Chicago Mercantile Exchange ((NASDAQ: CME )) in 1990, is now an internationally recognized futures index. The EURO STOXX 50 is a stock index future of Eurozone stocks designed by STOXX, an index provider owned by Deutsche Börse Group and SIX Group. Its goal is “to provide a blue-chip representation of Supersector leaders in the Eurozone”. It is made up of fifty of the largest and most liquid stocks. The index futures and options on the EURO STOXX 50, traded on Eurex, are among the most liquid futures contracts in the world Disclosure: I am/we are long AND SHORT POSITIONS IN THIS REPORT. 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.

The Fundamental Difference: Through A Lens Of Net Buybacks

By Jeremy Schwartz At WisdomTree, we believe that screening and weighting equity markets based on fundamentals such as dividends or earnings can potentially help produce higher total and risk-adjusted returns over a complete market cycle. One of the most important elements of a fundamental index is the annual rebalance process, where the index screens the eligible universe and then weights those securities based on their fundamentals. In essence, the process takes a detailed look at the relationship between the underlying fundamentals and price performance and tilts weight to lower-priced segments of the market. One way to illustrate the benefits of this approach for our earnings-weighted family is to compare the net buyback yield of the WisdomTree Earnings Index to a market cap-weighted peer universe. Below we look at how the net buyback yield changes when you screen and weight U.S. equity markets by firms’ profitability instead of market cap. Earnings Weighting vs. Market Cap Weighting Click to enlarge The WisdomTree Earnings Index consistently had a higher net buyback ratio than did a market cap-weighted universe consisting of the 3,000 largest securities by market cap. The WisdomTree Earnings Index averaged a net buyback yield of 2.2% over the period, compared to just 1.1% for the market cap peer universe. We believe that having an annual profitability screen for inclusion in the WisdomTree Earnings Index helps avoid speculative and unprofitable smaller-capitalization firms that have a tendency to raise capital by periodically issuing new shares. The earnings-weighted approach that tilts weight to more profitable firms can also be a reason the weighted average net buyback yield is higher. The chart below looks at the net buyback yield on a universe of the lowest price-to-earnings (P/E) ratio stocks within the 3,000 largest stocks by market cap and contrasts that with the net buyback yield on the highest P/E ratio stocks. Net Buyback Yield by P/E Ratio Click to enlarge If corporate America responds well to incentives, the higher-priced basket would issue more shares (given that their stocks are high priced and issuing more of them would be an effective way to raise growth capital) and the lower-priced basket would issue fewer shares or actually buy back shares to reduce their shares outstanding and thus power their earnings-per-share growth. What we see in the data is the higher-priced universe buys back fewer share, and instead issues more shares (having more companies with negative net buyback yields). Why Earnings Weight Going back to the WisdomTree Earnings Index in the first chart-weighting by Earnings Stream is essentially tilting weight from a market cap-weighted scheme to over-weight those companies with below average P/E ratios and to under-weight those companies with high P/E ratios. The Earnings Stream can be defined as earnings per share times shares outstanding or market cap x earnings yield (which is equivalent to 1/PE ratio). Tilting weight to the higher-earnings-yield stocks by earnings weighting thus is one effective way to tilt the net buyback yield balance in one’s favor. Companies reducing shares outstanding are essentially locking in earnings-per-share growth by reducing their share count, while companies that are issuing more shares are creating a higher hurdle to overcome to achieve earnings-per-share growth. There is a philosophical debate about the motivations for all the buybacks we are seeing today as well as fears that companies are failing to reinvest for future growth (or that they just see no growth opportunities, hence all the dividends and buybacks). One thing is clear to us from the data: the lower-priced stocks issue fewer shares, and the more expensive stocks issue more shares (and have lower net buyback yields). This can be especially true in the small-cap space, as we will discuss in a future blog post. The consistently greater-than 2% net buyback yields seen on the WisdomTree Earnings Index over the last five years, combined with 2% dividend yields on this basket today, provides critical valuation support and also helps explain why we think the earnings-weighted approach can add value over time. Jeremy Schwartz, Director of Research As WisdomTree’s Director of Research, Jeremy Schwartz offers timely ideas and timeless wisdom on a bi-monthly basis. Prior to joining WisdomTree, Jeremy was Professor Jeremy Siegel’s head research assistant and helped with the research and writing of Stocks for the Long Run and The Future for Investors. He is also the co-author of the Financial Analysts Journal paper “What Happened to the Original Stocks in the S&P 500?” and the Wall Street Journal article “The Great American Bond Bubble.”

The V20 Portfolio: Week 33

The V20 portfolio is an actively managed portfolio that seeks to achieve an annualized return of 20% over the long term. If you are a long-term investor, then this portfolio may be for you. You can read more about how the portfolio works and the associated risks here . Always do your own research before making an investment. Read the last update here . Note: Current allocation and planned transactions are only available to premium subscribers . Over the past week, the V20 Portfolio rose by 3.8% while the SPDR S&P 500 ETF (NYSEARCA: SPY ) increased by 0.4%. Portfolio Update Conn’s (NASDAQ: CONN ) was responsible for most of the gains this week, rising 15.8% from $10 to $11.58. There were no major events other than a credit facility amendment on Friday, so much of this rally can be attributed to shifting sentiment in the market. Some of the amendments relaxed covenants while others were more restrictive. Let’s go over the restricting amendments first. Distributing restricted payments (e.g. dividends, buybacks) will now require a 2.5x interest coverage ratio for two quarters. Borrowing base was reduced by $15 million, which will be waived if interest coverage ratio exceeds 2x for two quarters. Finally, margin on the loan was increased by 25 bps (i.e. making the revolver a bit more expensive). While none of the amendments were crippling, the amendment concerning restricted payments will prevent Conn’s from making any share repurchases in the coming months, as the interest coverage ratio was less than 2.5x for Q4. The positive amendments included eliminating the minimum interest coverage ratio covenant for Q1 and lowering the total coverage ratio to 1x from 2x. Overall, this was a slight setback as buybacks will not be a possibility in the near future. Last week we discussed how Intelsat (NYSE: I ) was buying back bonds at a discount. For whatever reason (possibly the increased likely hood of a rate hike), the bonds in question declined in value from $70s to high $60s. As such, Intelsat lowered its consideration accordingly, lowering the offer by around 500 bps. Our helicopter company was the portfolio’s major laggard. There was no major development. As discussed in last week’s update, the oil and gas division will continue to battle industry wide headwinds, though the recent bounce in commodities may cushion the fall. However, it is unlikely that revenue will suddenly recover to its previous level as the oil and gas industry overall is still at a cost cutting stage. The medical segment should continue to generate profits, as it will not be affected by the commodity downturn. Risk Management Due to additional capital being allocated to Conn’s and its subsequent rally, the position now accounts for more than 10% of the entire portfolio. For a position to account for such a significant portion, it must fulfill two criteria: high expected rate of return and low probability of permanent capital loss. As we’ve seen with Dex Media, even though the shares were undervalued, 100% of the investment will likely be written off. But by allocating a small amount of capital to this speculative position, it only had a tiny impact on the overall portfolio. Conn’s on the other hand fulfills both criteria. It is not under any significant financial distress and is still growing its business. While short-term results have dampened its profitability, its long-term outlook remains bright. Performance Since Inception Click to enlarge Disclosure: I am/we are long CONN, I. 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.