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Perception Vs. Reality And Emotion Vs. Reason

If I were to tell you that: The price of oil would decline beneath $30 dollar a barrel before Iran had economic sanctions lifted from $90 per barrel a year ago, increasing global disposable income by over $3 trillion dollars Monetary authorities would all maintain easy monetary policies with the supply of capital far outstripping demand for capital The Fed funds rate was 0.375% and was on hold for now Bank earnings, liquidity and capital ratios continue to improve The dollar remained strong and capital flows accelerated from abroad helping to push 10 year bond yields below 2.0% That there would be 3 million new jobs created in the U.S in 2015 alone with growth in wages of 2.6% year on year GNP would continue to expand between 2-2.5% led by the consumer without inflationary pressures and profits, x-energy and materials, would continue to increase China expanded by over 6.8% in 2015 despite major headwinds policy changes and would expand by over 6.0% in 2016 M & A would reach new heights and remains strong Private equity valuations and the number of new issues cooled There is a change occurring in national elections everywhere away from the establishment (look at Taiwan) Japan and the Eurozone would maintain excessive monetary ease India would continue to grow around 7% Bearish sentiment was at a multi-month high and the market was selling at 15 times earnings then; and finally, Change was happening everywhere for the better. Then, would you predict a rising stock market, excluding energy and material stocks, or a falling one? There is a major disconnect between perception and reality in the marketplace today as emotions are overcoming reason. Whose view of the global economy would you consider most relevant and on the mark: Jimmy Dimon, Chairman of JP Morgan Chase, or a market pundit/news commentator? I suggest that you read for yourself the transcripts of earnings conference calls, as the media has been taking many comments out of context. We participate in at least three conference calls a day during earnings season to gain a true perspective of what is happening in the real world. This is a period of excessive volatility. It creates tremendous opportunities to capitalize on inefficiencies in the marketplace. Each long investment in our portfolio has superior management and is going through positive change which will lead to more revenue and volume growth; enhanced global competitiveness; higher returns on revenues and capital; increased free cash flow to be used for reinvestment in growth and enhancing shareholder value; and finally, each one has a current yield over 3%. But, change does not happen overnight so you need patience and liquidity to let it unfold. For example, I owned GE for 18 months, purchased at $19 per share, before the marketplace woke up and began to re-evaluate the stock. It took Nelson Peltz’s filing to turn the light bulb on for investors. His cost is $27. We are still in the early stages of GE’s transformation. As I say, this is a market of stocks, not a stock market. Unfortunately, electronic/technical/systematic trading takes no prisoners and can override fundamentals over the short-term. Stop thinking as a trader and start thinking as an investor! Don’t buy for next quarter’s earnings but focus instead on the next few years’ volume and revenue growth, competitive position, the mix of business, operating margins and returns, cash flow, especially free cash flow, and valuations. We want multiple ways to win on each investment while protecting our downside too. We are global investors with a global perspective. Let’s take a look at the key data points by region that occurred last week: The United States takes center stage as the largest economy in the world. It appears that fourth quarter GNP growth slowed significantly from the third quarter and follows a similar pattern that has existed for several years with one strong quarter followed by a weaker one with overall growth remaining in the 2-2.5% range without inflation and led by the consumer. Jimmy Dimon, Chairman of JPM mentioned on the 4th quarter earnings call last week that he sees continued strong growth by U.S. consumers; GNP growth between 2 and 3%; continued good business demand for loans; continued strong M & A as his book is full; continued improvement in credit quality; maximum write-downs for energy loans at $750 million with oil prices around $30 per barrel and max write down exposure to the materials sector of $200 million out of a total loan portfolio of $837 billion and total assets on $2.4 trillion; continued growth in deposits and decent growth overseas. JPM has little exposure to China, which he mentioned is slowing but still showing above average economic growth. It’s quite amazing that JPM recorded record earnings despite a relatively flat yield curve. The heads of Citi (NYSE: C ), PNC , WFC and USB echoed his comments. I was on each call. Growth in the United States continues to be led by the consumer (over 68% of GNP) as the production sectors, including energy and materials, remain comparatively weak. Data points to reinforce this view include: University of Michigan consumer confidence index rose to a 7 month high of 83.3; the gauge of expectations six months out increased to 85.7; retail sales fell 0.1% in December and rose only 2.1% over the prior year (lower gasoline sales penalized this number); manufacturers sales and shipments fell 2.8% compared to a year ago while inventories rose 1.6% therefore the inventory/sales number rose to 1.32; producer prices fell 0.2% in December but rose 0.1% excluding food and energy; consumer comfort index rose to a 3-month high of 44.2; import prices fell 1.2% in December and 8.2% over the last year and finally the Beige Book was reported last Wednesday which supported an improving labor market, “slight to moderate growth” in consumer spending, weakness in manufacturing penalized by a strong dollar, additional problems in the energy patch and finally, little sign of wage pressures and minimal price pressures. I believe that the U.S economy will expand in the low end of 2-2.5% this year, inflation will run under 1.5% and the Fed will raise rates two times or less in 2016. Policy will remain accommodative. Watch the national elections as the status quo is out and change is in the air for D.C., too. Chinese Premier Li Keqiang confirmed that China’s economy grew close to 7.0% in 2015 which is still quite amazing considering all the changes going on to stem past excesses and shift emphasis to consumption/services (40% of the economy) from production/exports (60% of the economy). China finished with over $3 trillion in foreign reserves and is still generating $50-$55 billion in trade surpluses per year. China’s consumer and economy has also benefitted greatly from lower energy prices. Change is hard but I applaud their government who has a five-year plan to build a stronger and sounder foundation for the future. The Asian infrastructure bank was launched this week. I expect China to grow at 6-6.5% in 2016. China is on the path towards joining the established global economic leaders with policies to back it up. Did you happen to notice what Haier was willing to pay for GE’s appliance business to become a true global competitor? Ten times trailing EBITDA vs. 7 times, which Electrolux had previously offered. Export growth in the Eurozone and Japan are suffering from changes in global trade patterns and weakness in demand. Both the ECB and BOJ are maintaining incredibly easy monetary policies but there is a limit to what that can accomplish. There is a pressing need for more regulatory and financial reform to stimulate growth in both areas. Did you notice that Germany ran a record budget surplus of $13.14 billion? The government has earmarked $6.5 billion to cover migration related costs. Regulatory, budgetary and financial change is in the air to support and stimulate growth. Here comes Iran on the global energy markets. Iran complied with the terms of its international agreement to curb nuclear development. Therefore sanctions were lifted on Saturday and $50 billion in frozen cash was released. Iran can begin trading with the rest of the world including selling oil. I believe that much of the recent decline in oil below $30 per barrel factored in Iran selling an incremental 1-1.5 million barrels per day on the marketplace by mid-year 2016. Global production currently exceeds global demand by 1.5 million barrels per day and storage is already full to the brims. It has not helped to have unusually warm weather in parts of the world curbing demand growth. Industrial commodity prices have continued to weaken, too, in concert with oil, despite reductions in production, capacity and inventory levels. If the world continues to grow even at 2.5-3%, industrial commodity prices will begin to rise as inventory levels are drawn down. I expect dividend cuts even at the strongest companies but that is a positive at this point, not a negative. Expect many bankruptcies in the energy/industrial commodity and materials markets. The financially strong companies as well as private equity funds will buy these hard assets at 3 to 5 times EBIDTA offering great value and returns on their investment even at these depressed prices as the debt gets extinguished. The reality is that the outlook for global growth is not all that bleak although it may not reach historical rates of gain. On one hand, the global consumer is the huge beneficiary of lower energy prices and low inflation but on the other hand, those countries/companies that are resource- or production-based will suffer. While price determines value, I like to invest where the wind is at your back which is the U.S. where consumption is nearly 70% of GNP compared to a much lower level in Europe, China, Japan, and most emerging markets. It is very difficult to see a recession in any of the major industrialized countries but growth will stay sub-par until there are regulatory and financial changes to stimulate growth as the most of the gains from monetary ease are behind us and depreciating one’s currency is never the answer. Don’t let the pundits fool you. A strong dollar is good for many reasons. Right now the stock markets are being controlled/manipulated by the electronic/systematic technical traders rather than investors. Fear is everywhere and capitulation may have already occurred. It does not help to hear Larry Fink, head of BlackRock, say that the market can decline near term but will increase even more later in the year. That is talk of a trader rather than an investor and argues for passive management over active management. The bottom line is that I see value everywhere and no recession. If you believe the economy will slow for an extended period of time and won’t pick up much as we move through 2016, then buy the global pharmaceuticals and consumer staple stocks. But if you see growth, albeit slow, for an extended period of time, then look at industrials, too, and eventually, some financially strong commodity companies. Banks as a group are just cheap under any scenario. It is amazing that JPM had record earnings with such a flat yield curve and that is very telling. It goes for the other major banks, too. Volatility, confusion and fear create opportunity. We love it! There is more to say but that is enough for today. Look at the facts and take out all of the emotion before making any decisions. Invest, don’t trade. So remember to review the facts; step back and reflect; consider proper asset allocation; maintain excess liquidity and control risk; do in-depth independent research on each investment and…Invest Accordingly!

Guggenheim Defensive Equity: Another Defensive ETF That Failed Miserably To Do Its Job

As the equities markets are crashing all over the planet, more conservative players look to play defense by considering defensive investments and related exchange traded funds to hedge against the current correction. Defensive Stocks and Sectors During market downturns, high volatility and economic uncertainties, many investors use a risk aversion strategy by rotating to defensive sectors through buying defensive stocks and ETFs to shelter from the storm. Defensive Stocks and Sectors are those deemed non-cyclical and not very dependent on the overall economic cycle. The traditional sectors considered defensive are utilities, consumer staples and healthcare. After all, consumers cannot easily manage without gas and electricity, soap and toothpaste and of course their medicine. Other sectors deemed defensive are the telecom sector and the US real estate REIT sectors. Part of what makes defensive stocks and sectors appealing is their relatively higher and “safer” dividend which caters to investors wanting equity exposure but less risk. DEF Fund Description The Guggenheim Defensive Equity ETF (NYSEARCA: DEF ) seeks investment results that correspond to the performance, before the Fund’s fees and expenses, of the Sabrient Defensive Equity Index (the “Defensive Equity Index”). The Fund invests at least 90% of its total assets in US common stocks, American depositary receipts (“ADRs”) and master limited partnerships (“MLPs”). Guggenheim Funds Investment Advisors, LLC (the “Investment Adviser”) seeks to replicate the performance of the Defensive Equity Index which is comprised of approximately 100 securities selected from a broad universe of global stocks, generally including securities with market capitalizations in excess of $1 billion. For more information about this ETF click here . ETF methodology and Sector Allocation Index selection methodology is designed to identify companies with potentially superior risk/return profiles to outperform during periods of weakness in the markets and/or in the American economy overall. The Index is designed to actively select securities with low relative valuations, conservative accounting, dividend payments and a history of outperformance during bearish market periods. The Index constituents are well-diversified and supposed to represent a “defensive” portfolio. The sector allocation of this ETF is as follows: DEF Dividend and Fees DEF pays a respectable dividend of 3.31% and charges an acceptable management fee of 0.65%. The Perfect Defensive ETF? At first glance, DEF looks like a pretty diversified ETF, positioned within the right sectors to hedge against economic downturns in its focus on traditional defensive stocks, including utilities, real estate and consumer defensive. With its highly regarded investment advisor Guggenheim and an investment strategy that seems logical, DEF might even look like the perfect defensive ETF, as its name suggest, but is it really? Performance of DEF in the past 30 days The following chart depicts the performance of DEF against the S&P 500 index tracked by the SPDR S&P 500 ETF (NYSEARCA: SPY ) during the past 30 days ending Friday January 15, 2016: Click to enlarge As noted on the chart above, DEF utterly failed as a defensive ETF as it tumbled 6.4% when the S&P 500 Index fell 8.4%. Let us compare the performance of DEF against the average performance of the five defensive sectors: Source ycharts.com The failure of DEF is even more evident based on the above table as DEF tumbled by 6.4% against an average decline of 4% for the five main sectors considered to be defensive. So what went wrong with this ETF which seems to tick all the right boxes? In order to understand what went wrong we have to dig a little deeper. Three reasons DEF failed to do its job as a defensive ETF Geographical allocation issues A high 9.3% geographical exposure to the Asian market, of which about one-third relating to emerging markets. The allocations include countries such as Singapore, Taiwan, Japan and Asian emerging markets, all of which are very sensitive to China and took a large hit from the Chinese stock market crash. Stocks in this category include Telekomunik Indonesia (NYSE: TLK ), Japanese Nippon Telegraph & Tele (NYSE: NTT ), and Korean SK Telecom Co (NYSE: SKM ). Direct exposure to China (China Mobile (NYSE: CHL ), China Petroleum & Chemicals (NYSE: SNP ), and Chunghwa Telecom (NYSE: CHT )). About 2% is allocated to South American markets which are highly dependent on commodities and tend to be more sensitive to economic and market volatility and uncertainty. Stocks in this category include Banco De Chile-ADR (NYSE: BCH ) and Mexican Grupo Aeroportuario PAC-ADR (NYSE: PAC ). Sector Allocation issues The Fund has a high 8.2% exposure to the energy sector including oil and gas Master Limited Partnerships. These sectors got hammered the past month. DEF holds indeed high risk stocks for the current environment, such as National Oilwell Varco (NYSE: NOV ) and Targa Resources Partners (NYSE: NGLS ). A 3.2% exposure to the basic material sector which has been diving for the past two years, as commodity prices reached multi-year lows on concerns of a China slowdown. Stocks in the ETF include AGL Resources (NYSE: GAS ) and Syngenta AG (NYSE: SYT ). A very high exposure of 14.5% to the telecom sector proved to be too much for a defensive ETF, as the sector plunged 7.6% to become one of the ugliest defensive plays for the past month. Stocks in the ETF include Verizon (NYSE: VZ ), Frontier Communications (NASDAQ: FTR ), NTT Docomo and Vodafone (NASDAQ: VOD ). Passive Investing Strategy The most notable problem with DEF Fund lays in the fact that it uses a “passive” or “indexing” investment approach which makes it vulnerable as economic conditions change. DEF does not have a dynamic system in place to exclude currently risky sectors which once used to be considered safe, such as the oil sector and commodities sector, or to limit exposure to disfavored regions and countries. Conclusion Guggenheim Defensive Equity DEF – don’t get fooled by its name! The same can be said about other Defensive ETFs which may seem right at first glance. Investors should still do their due diligence and closely examine how the underlying assets are invested before putting money at work. Special note I am currently sharing on Seeking Alpha additions to my high-yield “Retirement Dividend Portfolio” (target yield 6% to 9%), with the latest one: Hedging My High Dividends with German Exposure . Follow me for future updates!

The Stock Market Is Getting More Expensive

One of the most underrated but among the most valuable skills required to succeed in stock market investing is resilience i.e., the ability to properly adapt to stress and adversity – either in the market, or in the businesses one is owning. How easily can you bounce back from a market crash? What would be your reaction to a sharp decline in your stocks’ prices? How many ‘surprises’ can you withstand in quick succession? How safe are your overall finances in light of extreme stress on the equity component of your portfolio? These are extremely important questions you must ask yourself every time you are looking at your portfolio, or looking to spend cash to buy more stocks. Surprisingly, despite its importance, resilience is least talked about by stock market investors and experts alike, and rarely considered an important mental model in investment decision making. Most of the time, we build our lives, our jobs or businesses around today, assuming that tomorrow will be a lot like now. Resilience, which is the ability to shift and respond to change, comes way down the list of the things we often consider. And yet, a crazy world is certain to get crazier. Jobs aren’t steady anymore. The financial market has gotten more volatile. The Earth is warming, ever faster. And the rate and commercial impact of natural disasters around the world is on growing exponentially. Hence the need for resilience, for the ability to survive and thrive in the face of change. Stock Market is Getting More Expensive Certainly I am not talking about stock valuations here. Because, if that were to be the case, the BSE-Sensex’s valuation – if you go by P/E – is now cheaper at 18x trailing 12-months earnings as compared to 23x just six months ago. Noted financial writer George J.W. Goodman – who used the pen name of Adam Smith – wrote this in his wonderful book, The Money Game – If you don’t know who you are, this is an expensive place to find out. By “this”, Smith meant the stock market. The people who bought commodity, infrastructure, or real estate stocks in 2006 and 2007 because they thought they had a high tolerance for risk – and then lost 95% over the next one year (some such stocks are down 95% even after eight years) – know just how expensive the stock market can be. While speculating on such stocks, they seemingly failed to answer the questions around their levels of resilience. And thus many ended up betting their houses and other people’s money on stocks that were destined to go down the drain. Something similar has happened to the guys who were utterly charmed by “moats” and forgot the subtle difference between paying up and overpaying over the last two years. A lot of such moated darlings are down between 30% and 50% over the past six months. Those who would have borrowed money to invest in such stocks are sitting on even bigger losses and much bigger dents to their egos. You see, knowing more about who you are as an investor can make you a fortune – or save you one. Knowing how resilient you and your portfolio are to severe market downturns also solves that purpose. Can You Handle Mr. Market Well? If you have been glued to financial media or online portfolio trackers, fixated on the sight of falling stock prices over the past few days and weeks, then this should tell you something about yourself that has enormous long-term importance – you probably have too much in stocks even as you don’t have the resilience to see your portfolio value declining (and that’s why you are checking stock prices so frequently). If you feel distressed by a decline of a few hundred points on the BSE-Sensex, then you are kidding yourself if you think you can withstand a drop of a few thousand points when it comes. Benjamin Graham, the father of value investing, divided investors into two types in his book The Intelligent Investor – defensive and enterprising. The defensive investor, Graham wrote, wants to avoid “serious mistakes or losses” and seeks “freedom from effort, annoyance and the need for making frequent decisions.” On the other hand, the enterprising investor, as per Graham, is willing “to devote time and care to the selection of securities that are both sound and more attractive than the average.” So, if you are an enterprising investor, then you should observe the stock market carefully in the hope that a substantial fall will present bargains. But if you are a defensive investor, you should observe yourself carefully. If you are not nearing retirement and have many years to invest and thus ability to see through a few big downturns; If you are not investing on borrowed money; If you are investing your own money, not other people’s money; If you do not owe a lot of money by way of loans, and have sufficient disposable income that prevents you from selling your stocks to meet your needs; and If you have seen through past market crises without much psychological upheavals… …you have adequate resilience to manage any major stress that the stock market may present you now. However, if you do not meet any or most of the above criteria, then beware. Reconsider your decision to be in stocks directly. Else, maybe, trim back on your stocks to create the much needed financial cushion so that any big decline does not become an even more expensive way for you to find out who you are. Remember what Keynes said – Markets can remain irrational longer than you can remain solvent.