Tag Archives: management

Stock Investors Bask In The Economic Slowdown’s Glow

Once more, the U.S. economy is flirting with trouble. On the other hand, euphoria on the high probability that the Fed will abstain from 2015 rate hikes has given hope that a 4th quarter rally may materialize. If investors push prices much higher from existing levels, they’d be back to exorbitant P/E and P/S multiples. The financial markets will only support extreme overvaluation if the Fed is in “stimulus” mode, as opposed to “de facto” tightening. By July of 2012, a wide range of indicators suggested that the U.S. economy was flirting with trouble. Job growth was decelerating. Business investment was deteriorating. Meanwhile, manufacturing via the ISM Manufacturing Survey (PMI) was flirting with contraction. Up until that moment in time, the Federal Reserve had already left rates at zero percent for three-and-a-half years. What’s more, they had already created trillions of electronic dollars to acquire government debts and push borrowing costs to unfathomable lows to ward off a double-dip recession (i.e., “QE1,” “QE2,” “Operation Twist”). However, the end of those programs seemed to show that the U.S.economy was still too fragile to stand on its own. Not surprisingly, leaked rumors about a more awe-inspiring economic jolt began taking over the July 2012 business headlines. Terms like “QE3, “QE Forever,” and “QE Infinity” had been making the rounds. Indeed, by September of 2012, The Fed had unleashed an open-ended bond buying program that rivaled anything investors had seen previously. Fast forward three years. Once more, the U.S. economy is flirting with trouble. The percentage of 25-54 year-olds (19.5%) that are out of work has risen sharply. (Retirees? College students?) Median household income is sagging. Business investment in research, plants, equipment and human resources development is virtually non-existent, with virtually all after-tax profits going to share buybacks and shareholder dividends. Non-revolving consumer credit has grown from 14.6 percent of after-tax income at the end of the recession (6/2009) to 18.7 percent (6/2015). And manufacturing via PMI? Falling throughout 2015 and hanging on by a thread (50.2), we’re right back to the type of environment that prompted previous calls for more quantitative easing (QE) “cowbell .” From an investment standpoint, the demand for U.S. treasury bonds in recent government auctions still points to risk aversion. Recall Monday’s 3-month T-Bill auction (10/5) where $21 billion had been acquired at 0%. Zero percent! It was the lowest yield for the 3-month T-bill on record . On Wednesday (10/7), another $21 billion went to auction on 10-year Treasury bonds. The high yield of 2.066% was the lowest since April. Equally worthy of note (no pun intended), the indirect bidding component that includes significant central banks acquired $13.1 billion (62.2%) – the second highest percentage on the record books. On the other hand, euphoria on the high probability that the Fed will abstain from 2015 rate hikes has given hope that a 4th quarter rally may materialize. For instance, the New York Stock Exchange (A/D) Line shows September’s successful retest of the August lows. Remember, it was the A/D Line that foreshadowed the dramatic sell-off in the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) before its mid-August arrival. Higher lows and higher highs on the A/D Line from here forward would likely signal a shift in attitude toward greater risk taking. Another trend that is worth watching? Consider the relationship between U.S. treasuries and crossover corporates – U.S. company bonds that straddle the line between low-end investment grade (Baa) and higher-rated “junk” (Ba). A rising price ratio for iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) : iShares Baa-Ba Rated Corporate Bond ETF (BATS: QLTB ) is a sign a of risk aversion. Granted, IEF:QLTB is still rising alongside its 50-day trendline. On the other hand, the fact that IEF:QLTB is lower than it was in August may be a sign that risk taking is on its way back. Put another way, a tightening in spreads between treasuries and crossover corporates would be a sign that investors might be looking for a return on capital again, rather than a return if capital alone. Indeed, the battle between risk-on and risk-off has reached a crossroad. Many of the significant stock ETF proxies – the SPDR S&P 500 Trust ETF ( SPY ), the iShares Russell 2000 ETF (NYSEARCA: IWM ), the V anguard FTSE All-World ex-U.S. ETF (NYSEARCA: VEU ), Vanguard FTSE Developed Markets ETF (NYSEARCA: VEA ) rest near resistance levels of 50-day moving averages. Similarly, the S&P 500 itself fights to reclaim the psychological level of 2000, while the Dow Industrials toils to climb back above a psychological level of 17,000. Keep in mind, though, analysts widely anticipate earnings and revenue declines for the third consecutive quarter . If investors push prices much higher from existing levels, they’d be back to exorbitant P/E and P/S multiples. And if recent history is any guide on investor comfort will overvalued equity valuations, investors would not take kindly to a 4th quarter rate hike campaign; that is, the financial markets tens to support extreme overvaluation when the Fed is in “stimulus” mode. A three-month stock celebration (Oct-Dec) may come down to these factors: (1) the Fed stays at the zero-bound, (2) the 10-year stays at 2%-2.25% to keep the credit bubble blowing, and (3) the earnings and revenue picture surprises at the flat-line, as opposed to disappointing with sharper than projected deterioration. In the meantime, pay attention to the market internals via the A/D Line as well as the spreads between treasuries and corporates. 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.

Notes On The SEC’s Proposal On Mutual Fund Liquidity

I’m still working through the SEC’s proposal on Mutual Fund Liquidity, which I mentioned at the end of this article : Q: Are you going to write anything regarding the SEC’s proposal on open end mutual funds and ETFs regarding liquidity ? A: …my main question to myself is whether I have enough time to do it justice. There’s their white paper on liquidity and mutual funds . The proposed rule is a monster at 415 pages , and I may have better things to do. If I do anything with it, you’ll see it here first. These are just notes on the proposal so far. Here goes: 1) It’s a solution in search of a problem. After the financial crisis, regulators got one message strongly – focus on liquidity. Good point with respect to banks and other depositary financials, useless with respect to everything else. Insurers and asset managers pose no systemic risk, unless like AIG they have a derivatives counterparty. Even money market funds weren’t that big of a problem – halt withdrawals for a short amount of time, and hand out losses to withdrawing unitholders. The problem the SEC is trying to deal with seems to be that in a crisis, mutual fund holders who do not sell lose value from those who are selling because the Net Asset Value at the end of the day does not go low enough. In the short run, mutual fund managers tend to sell liquid assets when redemptions are spiking; the prices of illiquid assets don’t move as much as they should, and so the NAV is artificially high post-redemptions, until the prices of illiquid assets adjust. The proposal allows for “swing pricing.” From the SEC release : The Commission will consider proposed amendments to Investment Company Act rule 22c-1 that would permit, but not require, open-end funds (except money market funds or ETFs) to use “swing pricing.” Swing pricing is the process of reflecting in a fund’s NAV the costs associated with shareholders’ trading activity in order to pass those costs on to the purchasing and redeeming shareholders. It is designed to protect existing shareholders from dilution associated with shareholder purchases and redemptions and would be another tool to help funds manage liquidity risks. Pooled investment vehicles in certain foreign jurisdictions currently use forms of swing pricing. A fund that chooses to use swing pricing would reflect in its NAV a specified amount, the swing factor, once the level of net purchases into or net redemptions from the fund exceeds a specified percentage of the fund’s NAV known as the swing threshold. The proposed amendments include factors that funds would be required to consider to determine the swing threshold and swing factor, and to annually review the swing threshold. The fund’s board, including the independent directors, would be required to approve the fund’s swing pricing policies and procedures. But there are simpler ways to do this. In the wake of the mutual fund timing scandal, mutual funds were allowed to estimate the NAV to reflect the underlying value of assets that don’t adjust rapidly. This just needs to be followed more aggressively in a crisis, and peg the NAV lower than they otherwise would, for the sake of those that hold on. Perhaps better still would be provisions where exit loads are paid back to the funds, not the fund companies. Those are frequently used for funds where the underlying assets are less liquid. Those would more than compensate for any losses. 2) This disproportionately affects fixed income funds. One size does not fit all here. Fixed income funds already use matrix pricing extensively – the NAV is always an estimate because not only do the grand majority of fixed income instruments not trade each day, most of them do not have anyone publicly posting a bid or ask. In order to get a decent yield, you have to accept some amount of lesser liquidity. Do you want to force bond managers to start buying instruments that are nominally more liquid, but carry more risk of loss? Dividend-paying common stocks are more liquid than bonds, but it is far easier to lose money in stocks than in bonds. Liquidity risk in bonds is important, but it is not the only risk that managers face. it should not be made a high priority relative to credit or interest rate risks. 3) One could argue that every order affects market pricing – nothing is truly liquid. The calculations behind the analyses will be fraught with unprovable assumptions, and merely replace a known risk with an unknown risk. 4) Liquidity is not as constant as you might imagine. Raising your bid to buy, or lowering your ask to sell are normal activities. Particularly with illiquid stocks and bonds, volume only picks up when someone arrives wanting to buy or sell, and then the rest of the holders and potential holders react to what he wants to do. It is very easy to underestimate the amount of potential liquidity in a given asset. As with any asset, it comes at a cost. I spent a lot of time trading illiquid bonds. If I liked the creditworthiness, during times of market stress, I would buy bonds that others wanted to get rid of. What surprised me was how easy it was to source the bonds and sell the bonds if you weren’t in a hurry. Just be diffident, say you want to pick up or pose one or two million of par value in the right context, say it to the right broker who knows the bond, and you can begin the negotiation. I actually found it to be a lot of fun, and it made good money for my insurance client. 5) It affects good things about mutual funds. Really, this regulation should have to go through a benefit-cost analysis to show that it does more good than harm. Illiquid assets, properly chosen, can add significant value. As Jason Zweig of the Wall Street Journal said : The bad news is that the new regulations might well make most fund managers even more chicken-hearted than they already are – and a rare few into bigger risk-takers than ever. You want to kill off active managers, or make them even more index-like? This proposal will help do that. 6) Do you want funds to limit their size to comply with the rules, while the fund firm rolls out “clone” fund 2, 3, 4, 5, etc? You will never fully get rid of pricing issues with mutual funds, but the problems are largely self-correcting, and they are not systemic. It would be better if the SEC just withdrew these proposed rules. My guess is that the costs outweigh the benefits, and by a wide margin. Disclosure: None

Avista Corporation: This Utility Is A Buy

Summary Power generation mix is nearly all clean energy. Dividend history is solid, management guidance for 4-6% growth going forward. Only moderate leverage; Avista hasn’t been on a borrowing spree like most utilities. Shares are just simply one of the top picks in the utility sector. Set it and forget it. Avista Corporation (NYSE: AVA ) primarily operates as a regulated utility business, with the majority of revenue derived from providing electric and natural gas services to customers in Washington, Idaho, and Oregon. While the company does serve some customers in Montana and Alaska (via the AERC acquisition), these operations, along with the non-utility businesses, are fairly immaterial to company earnings. Despite favorable generation capacity, healthy dividend growth, and favorable rate case filings, shares have largely tracked broader utility sector results. Are shares poised to outperform in the future? Favorable Power Generation Bucking the trend of utilities that are woefully behind the curve in emissions standards, Avista’s 1,800MW of generation capacity currently consists of 56% renewables and 35% clean burning natural gas. It isn’t a surprise that the company consistently wins awards for being one of the greenest power producers in the United States. This is a big positive for shareholders. My attraction to Avista and companies with such strong renewables mixes is not born out of liberal thinking but a mere acknowledgement that it is extremely unlikely that current federal and state regulations regarding emissions standards get dialed back. The company’s power generation portfolio simply makes regulatory overhang due to increased renewable standards from state regulators and the federal government a non-issue. If I’m an investor looking for steady income, I don’t want to see surprise jumps in capital expenditures to bring plants into compliance or bad press from dirty power generation [think PLM Resources’ San Juan Generating Station (NYSEMKT: PLM ) or Duke Energy’s (NYSE: DUK ) coal ash basin spills]. Fact is Avista’s power generation mix greatly exceeds even the strictest of mandates, including those set for implementation in 2035 or later. This should help investors sleep easier at night. Operational Results (click to enlarge) Utility revenue has been moving up slowly, primarily based on growth in residential and commercial consumers, while revenue from industrial customers has been weakening since the expiration and subsequent renewal at lower rates of some large customer contracts recently. Revenue can be volatile. This is because Avista often chooses to sell its excess natural gas when current wholesale market prices are below the cost of power generation using its natural gas plants. Years that see these sales generally see higher revenue (due to these sales) but lower profit and operating margins. Investors can use 2014 versus 2013 as an example. In 2014, Avista sold $43M less natural gas in the open market ($84M in sales versus $127M in 2013). So while revenue only expanded marginally (2.2%), operating income grew 10% due in part to better margins. Additionally, shrinking operations and maintenance costs in spite of growing revenues is also a compelling sign to me that management is keeping a close eye on costs. With incremental revenue gains being hard-fought in the utility sector, any expense reductions that yield operational efficiency gains should be lauded. Money In, Money Out (click to enlarge) Like I do with all utility analysis, I look to make sure that cash being spent does not greatly outweigh cash being generated from operations. Utilities in general have been on a spending spree in the past few years due to looming regulatory burdens and record low interest rates. Debt issuance has been both necessary and coincidentally quite cheap, leading utility management to feat on the smorgasbord of easy money. Avista’s overspending and subsequent debt issuance has been relatively mild in comparison, especially considering that the company raised $245M in cash from the sale of the Ecova business in 2014, with the majority of those proceeds used to offset common stock dilution. Total long-term debt raised between 2011 to the current period has been just $250M. Because of this, Avista’s net debt/EBITDA stands at 3.3x, making it one of the least leveraged utilities I’ve analyzed recently. Operational cash flow should grow during 2015-2017 through rate recovery increases while capital expenditures flatten in the $350M range. This should decrease the deficit we see in the cash flow analysis. Overall, I don’t see an alarming trend here that should worry investors. Conclusion With a current dividend yield of approximately 4%, shares are trading slightly higher than historical averages by approximately 5%. While many investors would elect to wait it out for shares to drop, in the grand scheme of things an investment strategy like that can make you miss out on some valuable opportunities. Establishing a half position and electing to buy on dips might be the better strategy. In my opinion, Avista’s diversified utility business is one of the safest available options in the publicly-traded utility sector. Shares, however, don’t seem to carry any real premium for this value. While I don’t own shares (I instead own shares in Calpine Corporation (NYSE: CPN ) and AES Corporation (NYSE: AES ) given my heavier risk appetite than most), I certainly would if I was an income investor, even at these prices. Management’s guidance of 4-6% dividend growth in the years to come is both manageable and ahead of most utility peers. I’ve looked at many picks in the utility sector in the current market, and very few of them appear to trade at or below fair value. Avista isn’t one of them. If you’re long, congratulations on holding a winner. If you aren’t and are an income investor, you should consider it.