Tag Archives: management

Monitoring Your Portfolio’s Dollar Sensitivity

By Tripp Zimmerman At WisdomTree, we continue to believe one of the most important themes impacting the global markets has been the strengthening U.S. dollar-and this is a trend we expect to continue for some time. As a result of the recent dollar strength, many U.S. multinationals with global revenue streams have reported currency headwinds as part of their earnings statements over the past year. This has hurt their performance compared to European and Japanese exporters, who have benefited from the weakening of the yen and the euro, respectively, against the U.S. dollar. This relative performance advantage is no surprise to us, because our research shows that these foreign markets actually performed better when their home currencies depreciated than when they appreciated. 1 Given this historical relationship and relative valuations, we continue to advocate for Japanese and eurozone exporters. But how should investors position their U.S. allocations? U.S. Corporations Continue to Warn about Dollar Strength “Sales by U.S. companies were $26.4 billion in the fiscal nine months of 2015, which represented an increase of 0.8% as compared to the prior year,” Johnson & Johnson (NYSE: JNJ ) reported. “Sales by international companies were $25.9 billion, a decline of 13.5%, including operational growth of 1.1%, offset by a negative currency impact of 14.6% as compared to the fiscal nine months sales of 2014.” 2 The Coca-Cola Company (NYSE: KO ) reported that over the most recent three months “fluctuations in foreign currency exchange rates decreased our consolidated net operating revenues by 8 percent. This unfavorable impact was primarily due to a stronger U.S. dollar compared to certain foreign currencies, including the South African rand, euro, U.K. pound sterling, Brazilian real, Mexican peso, Australian dollar and Japanese yen, which had an unfavorable impact on our Eurasia and Africa, Europe, Latin America, Asia Pacific and Bottling Investments operating segments.” 3 Determining Your Dollar Sensitivity WisdomTree believes currency sensitivity is an important factor that will continue to impact returns going forward, so to monitor the performance of this new factor, WisdomTree has created two new rules-based Indexes: The WisdomTree Strong Dollar U.S. Equity Index (WTUSSD) – This Index selects companies that generate more than 80% of their revenue from within the U.S. and then tilts its weight toward stocks whose returns have a higher correlation to the returns of the U.S. dollar. The WisdomTree Weak Dollar U.S. Equity Index (WTUSWD) – This Index selects companies that generate more than 40% of their revenue from outside the U.S. and then tilts its weight toward stocks whose returns have a lower correlation to the returns of the U.S. dollar. Since the inception of these Indexes, the U.S. dollar has strengthened 2.95% against a diversified basket of developed and emerging market currencies, leading to a performance advantage of 1.72% for WTUSSD compared to WTUSWD. 4 To try to understand what is behind this performance difference, we chart the median earnings and sales growth for the most recent quarter compared to the same reporting quarter one year ago, for both Indexes and the median for the entire universe. Year-over-Year Median Earnings and Sales Growth (click to enlarge) Strong Dollar Companies Displayed Higher Growth- The median earnings and sales growth for constituents of WTUSSD was more than 6% and 7% higher, respectively, compared to constituents of WTUSWD. We believe constituents of WTUSSD, or companies that generate more than 80% of their revenue domestically, tend to be less impacted by a strong-dollar environment-they aren’t focused on selling their goods and services abroad, and their import costs decrease with the rising purchasing power of the dollar. How Long Can This Persist? We have recently published a research paper, What a Rising U.S. Dollar Means for U.S. Equities White Paper , in which we illustrated the declining competitiveness of U.S. exports by graphing a ratio of exports of the U.S. economy over imports. As the U.S. dollar strengthened, the ratio of exports over imports weakened. Historically, we found that the impact can have a lag of around 36 months, so if history is any guide, we may not have seen the worst impact on exporters yet. At WisdomTree, our base case is still for a strengthening U.S. dollar, which may provide a continued headwind to U.S. multinationals with global revenue, but, depending on investors’ views, they can use the above Indexes to track the performance of either basket. Sources WisdomTree, Bloomberg. Johnson & Johnson quarterly earnings report, 10/30/15. Johnson & Johnson had a 1.21% weight in the WisdomTree Weak Dollar U.S. Equity Index as of 11/13/15. The Coca-Cola Company quarterly earnings report, 10/28/15. The Coca-Cola Company had a 0.71% weight in the WisdomTree Weak Dollar U.S. Equity Index as of 11/13/15. WisdomTree, Bloomberg, 5/29/15-11/13/15. U.S. dollar performance against a diversified basket of developed and emerging currencies is represented by the Bloomberg Dollar Total Return Index. Important Risks Related to this Article Investments in currency involve additional special risks, such as credit risk and interest rate fluctuations. Tripp Zimmerman, Research Analyst Tripp Zimmerman began at WisdomTree as a Research Analyst in February 2013. He is involved in creating and communicating WisdomTree’s thoughts on the markets, as well as analyzing existing strategies and developing new approaches. Prior to joining WisdomTree, Tripp worked for TD Ameritrade as a fixed income specialist. Tripp also worked for Wells Fargo Advisors, TIAA-CREF and Evergreen Investments in various investment related roles. Tripp graduated from The University of North Carolina at Chapel Hill with a dual degree in Economics and Philosophy. Tripp is a holder of the Chartered Financial Analyst designation.

Understanding Covered Call CEFs

Barron’s recently had a favorable write up on closed end funds that one way or another use a covered call strategy as a means of providing income. The article proposes that volatile markets like now are a good environment for this niche and that the call premium can help mitigate the impact of large declines. I think both points are flat out wrong. The history here is that they do well in rising markets. By Roger Nusbaum, AdvisorShares ETF Strategist Barron’s recently had a favorable write up on closed end funds that one way or another use a covered call strategy as a means of providing income. Where the article focused on CEFs, the yields can be quite high because of the leverage that CEFs often use as well as returning capital, when necessary to maintain a payout. It is also worth noting that there are traditional funds that sell calls and ETFs that sell calls and puts too for that matter. I wrote about these quite a few times in the early days of Random Roger. The history of them shows long stretches where they do very well then long periods where they get pounded and then repeats. Based on chart below they got crushed in 2008 and the dividends were cut on many of them and neither the prices or payouts have recovered since. The article tries to make the case that volatile markets like now are a good environment for this niche and that the call premium can help mitigate the impact of large declines. I think both points are flat out wrong. The history here is that they do well in rising markets. The chart from Google Finance captures a whole bunch of them over a ten-year period. I removed the symbols for compliance reasons but finding funds in this space should be easy to do. If you play around with the time periods you will see they did very well in 2006 and far into 2007, 2009 well into 2010 and then a three year run from 2012-2014. As mentioned the got crushed during the bear market, did badly in 2011 and are having mixed results in 2015. (click to enlarge) I would have no expectation that these funds can buffer a stock market decline. These are income vehicles but they track the equity market higher to an extent (they correlate but don’t keep up) and I would bet they get hit hard in the next bear market but probably not as hard as 2008. Part of the equation in 2008 was a shutting down of bond markets which impacted CEFs in terms of accessing leverage. I don’t expect that to repeat but I would want sell in the face of a bear market as a 30% decline seems plausible for these funds in a down 40% world. Obviously there would be income vehicles to keep in a bear market but I don’t think these are one of them. Where they do well, then do poorly, they will do well again, maybe after the next bear market maybe sooner but anyone interested in this space probably needs to be willing to be tactical and be willing to sell after a period of their doing well. Interest rates have a very good chance of remaining inadequate for many years even if the Fed does hike rates this month. Attempting to be tactical is not right for everyone but I do think that the way investors get their yield will probably include market segments that require a more active and tactical approach.

2 Screens To Avoid Bad Investments

Summary There’s no way to avoid all investments that end up performing poorly, but there are two screens that can avoid some of them: past price performance and hedging cost. We applied those two screens to a list of top investor picks three months ago, and the ones that passed both screens significantly outperformed the others. We elaborate on the two screens, and discuss why they work. We conclude with a suggestion to consider applying these screens to guru picks, and to consider diversifying or hedging to limit risk. A Bad Fall For Top Investor Picks In a late August article (“Best Q2 Picks From Top Investors”), Seeking Alpha premium contributor and hedge fund manager Chris DeMuth, Jr. highlighted what he felt were the best stocks top investing gurus such as Warren Buffett, Carl Icahn, and Seth Klarman (Klarman pictured below; image from DeMuth’s article) added or increased their weightings of in the second quarter. On the whole, these picks have performed poorly over the last three months. In hindsight, this is consistent with the narrowness of the current bull market, one dominated by the “FANGs”, Facebook (NASDAQ: FB ), Amazon (NASDAQ: AMZN ), Netflix (NASDAQ: NFLX ), and Google (NASDAQ: GOOG ), as John Authers noted in a recent Financial Times column. But what’s interesting is the divergence in performance between two groups of these stocks. The first group includes the guru picks that passed two screens to be included in a Portfolio Armor hedged portfolio, and the second group includes the guru picks that didn’t. One of those screens is simple enough you can run it without any specialized tools. We’ll detail both of the screens below, but first, here’s a look at how the two groups of guru picks have performed over the last three months. Guru Picks Portfolio Armor Included, 3-Month Returns: Advance Auto Parts (NYSE: AAP ), -14.43% Precision Castparts (NYSE: PCP ), +1.19% Cigna Corporation (NYSE: CI ), – 1.75% Danaher Corp (NYSE: DHR ), +10.83% Humana (NYSE: HUM ), -8.16% Perigo (NYSE: PRGO ), -16.2% Shire (NASDAQ: SHPG ), -8.5% Time Warner (NYSE: TWC ), -2% Average 3-month return: -4.88% Guru Picks Portfolio Armor Rejected, 3-Month Returns: SunEdison (NASDAQ: SEMI ), -32.06% SunEdison (NYSE: SUNE ), -71.15% Williams (NYSE: WMB ), -40.8% Baker Hughes (NYSE: BHI ), -6.83% Office Depot (NASDAQ: ODP ), -24.33% Altera (NASDAQ: ALTR ), +5.94% Icahn Enterprises (NASDAQ: IEP ), +0.54% Brookdale (NYSE: BKD ), -29.6% T-Mobile (NASDAQ: TMUS ), -6.47% Average 3-month return: -22.75% Screening Out The Worst-Performing Picks In an article published in early September (“Investing Alongside Buffett, Klarman, And Other Top Investors While Limiting Your Risk”), we entered each of the guru stock picks above into Portfolio Armor’s hedged portfolio construction tool. That tool works differently depending on whether you enter your own securities or not. If you don’t enter your own securities, the tool populates your portfolio with the securities with the highest potential returns, net of hedging costs, in its universe (its universe consists of every stock and exchange traded product with options traded on it in the U.S.). If you do enter securities, as we did with those guru picks, the tool performs two screens on the securities you enter before attempting to calculate potential returns for them. Screen #1: Most Recent 6-month Performance V. Long Term The first screen is one you can easily do yourself. The tool looks at how the ticker performed over the most recent six months and compares that to the average six month performance of the security over the long term (ten years, if a stock has been around that long; if not, it uses the long term returns of an industry competitor as a proxy; for exchange-traded products it uses since-inception returns if it hasn’t been around for ten years). The tool will reject any security with a negative return over the last six months, unless the average six month return of the security over the long term is greater than the absolute value of the most recent six months return. To illustrate this, let’s look at one of the guru picks that failed this screen, SunEdison . Below is a chart, via Yahoo, showing the performance of SUNE over the 6 months prior to when Portfolio Armor rejected it for inclusion in that September hedged portfolio: (click to enlarge) SUNE was down 48% over the six months prior to early September. The only way it would have made it past this screen is if its average 6-month performance over the last 10 years was greater than 48%, and, as you might guess, that wasn’t the case, so SUNE failed the first screen. Screen #2: Hedging Cost Since SUNE failed the first screen, it was eliminated. An example of a stock that passed the first screen, but failed the second, was Williams . WMB was down 3.25% over the most recent six month period as of early September, but its average 6 month performance over the previous 10 years was 4.81%, so it passed the first screen. But it was too expensive to hedge against a greater-than-9% decline over the next six months using an optimal static hedge, so it was rejected. We explained how to find optimal hedges in a previous article , if you’re willing to do the work manually, or you could use an automated tool such as our hedging app . Why These Two Screens Work Although these two screens don’t eliminate all poor-performers, they work to eliminate some of the worst performers. They both employ what New Yorker columnist James Surowiecki termed the wisdom of crowds : Large groups of people are “smarter” than an elite few, no matter how brilliant — better at solving problems, fostering innovation, coming to wise decisions, even predicting the future. The large group of people in screen #1 is the stock market, and the large group of people in screen #2 is the option market; the elite few are the top investors who picked the stocks. Conclusion If you’re going to buy gurus’ stock picks, consider buying ones that pass these two screens. And since these screens don’t eliminate all poor-performers, consider limiting your stock-specific risk by diversifying or hedging.