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Weak Wages And Weaker Manufacturing, But How ‘Bout Those Rate Hike Expectations!

When half of the employed folks make less than what it takes to support one’s self, the wage growth required for a stronger economy cannot suddenly appear. Rather, increases in consumption must rely entirely on low-rate debt binging. Crafting a positive spin on the economy should not be a substitute for frank discussions on the actual state of affairs. I started working at the age of 13. I wanted to be productive. I wanted to make money. Gardener, golf caddy, food deliverer, waiter, bartender, entrepreneur, researcher, analyst, writer, planner, adviser, money manager – I probably spent as much time cursing and complaining as I did whistling. Nevertheless, thirty five years of work contributed to my well-being as well as the well-being of others. Will people from my generation (“Gen X”) leave the workforce anytime soon? Not if we intend to maintain our lifestyles. In fact, Gen Xers aren’t slated to begin retiring in earnest until 2030. We may have grown up as apathetic slackers, yet studies routinely demonstrate that those born between 1961 and 1981 are exceptionally industrious. (Good looking too.) So why are Gen Xers and post-World War II baby boomers leaving the workforce at an accelerated pace during this economic recovery? For example, today’s jobs report celebrated the creation of 223,000 new jobs in June and a 5.3% unemployment rate, while barely mentioning that 432,000 civilian workers disappeared from the labor force altogether. At present, a record 93.6 million of the U.S. working-aged population are no longer in the picture, resulting in the employment rate/participation rate hitting 1977 levels of 62.6%. It actually gets worse. There are roughly 100 million Americans out of 160 million Americans considered by the Bureau of Labor Statistics ( BLS ) as fully employed. Yet it has been estimated that 1/2 of those 100 million earn less than $15,000 annually as part-timers or self-employed workers. Should we really be declaring an annual income of $15,000 as sufficient for a spot in the full-time work column? Houston, we’ve got a problem. And I’m not even referring the planned layoffs across the oil and gas space. For one thing, when half of the employed folks make less than what it takes to support one’s self, let alone support children or elderly family members, the wage growth required for a stronger economy cannot suddenly appear; rather, increases in consumption must rely entirely on low-rate debt binging. Can you say, low rates for longer? Secondly, crafting a positive spin on the economy should not be a substitute for frank discussions on the actual state of affairs. Specifically, popular media outlets like the Associated Press have little business calling a tepid jobs report “solid.” In the absence of any month-over-month wage growth? In spite of downward revisions to job growth in prior months? With employment gains only keeping up with population gains? Indeed, the Associated Press even acknowledged that the employment rate/workforce participate rate fell because people out of work gave up on the pursuit and no longer count in the unemployed tally. How exactly is this a topnotch turn of events? There are two key ramifications of today’s data from the BLS as well as ancillary manufacturing data from the U.S. Census Bureau. First, the idea that the dollar can only move higher in light of China uncertainty and euro-zone complications is flawed. Expectations for the timing and the extent of rate hikes by the Fed continue to diminish with every lackluster economic presentation. Since the dollar had already priced in the end of quantitative easing in the U.S. and the eventual beginning of eurozone quantitative easing, I’m more inclined to expect the dollar via the PowerShares DB USD Bull ETF (NYSEARCA: UUP ) to end 2015 very near where it is today. Next, prominent sector investments like industrials and transports will continue to underperform. Simply stated, factory orders have fallen in nine out of the last 10 months; the seasonally adjusted year-over-year decline in factory orders is 6.3%. Strong dollar excuses notwithstanding, this type of data is entirely recessionary. In fact, it’d be difficult to find a period where the weakness in demand for U.S. manufactured goods was this low and it wasn’t associated with economic recession. As I have discussed on many prior occasions, one does not necessarily need to pare back core positions like the iShares S&P 100 ETF (NYSEARCA: OEF ). Not unless one is employing a disciplined approach to risk reduction . Still, if you have been holding onto an allocation to the Industrial Select Sector SPDR ETF (NYSEARCA: XLI ) or the iShares Transportation Average ETF (NYSEARCA: IYT ), consider taking profits. Technical analysis of the sectors suggest further erosion of price, and neither the BLS employment data nor the U.S. Census Bureau manufacturing data indicate a quick turnaround. 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.

Industrial ETF: XLI No. 6 Select Sector SPDR In 2014

Summary The Industrial exchange-traded fund finished sixth by return among the nine Select Sector SPDRs in 2014. The ETF was especially strong in the fourth quarter of last year, when it advanced 7.06 percent. However, seasonality analysis indicates the fund could be weak in the first quarter of this year. The Industrial Select Sector SPDR ETF (NYSEARCA: XLI ) in 2014 ranked No. 6 by return among the Select Sector SPDRs that cut the S&P 500 into nine sections. On an adjusted closing daily share-price basis, XLI grew to $56.58 from $51.27, an increase of $5.31, or 10.36 percent. Therefore, it trailed its sibling, the Utilities Select Sector SPDR ETF (NYSEARCA: XLU ), and parent proxy, the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) by -18.38 and -3.11 percentage points, in that order. (XLI closed at $54.93 Tuesday.) XLI also ranked No. 6 among the sector SPDRs in the fourth quarter, when it behaved better than SPY by 2.16 percentage points and worse than XLU by -6.13 points. And XLI ranked No. 4 among the sector SPDRs in December, when it led SPY by 0.23 percentage point and lagged XLU by -3.59 points. Figure 1: XLI Monthly Change, 2014 Vs. 1999-2013 Mean (click to enlarge) Source: This J.J.’s Risky Business chart is based on analyses of adjusted closing monthly share prices at Yahoo Finance . XLI behaved better in 2014 than it did during its initial 15 full years of existence based on the monthly means calculated by employing data associated with that historical time frame (Figure 1). The same data set shows the average year’s weakest quarter was the third, with a relatively small negative return, and its strongest quarter was the fourth, with an absolutely large positive return. Consistent with this pattern last year, the ETF had a small loss in Q3 and a large gain in Q4. Figure 2: XLI Monthly Change, 2014 Versus 1999-2013 Median (click to enlarge) Source: This J.J.’s Risky Business chart is based on analyses of adjusted closing monthly share prices at Yahoo Finance. XLI performed worse in 2014 than it did during its initial 15 full years of existence based on the monthly medians calculated by using data associated with that historical time frame (Figure 2). The same data set shows the average year’s weakest quarter was the third, with an absolutely large positive return, and its strongest quarter was the fourth, with an absolutely larger positive return. It also shows there is a historical statistical tendency for the ETF to struggle in January. Figure 3: XLI’s Top 10 Holdings and P/E-G Ratios, Jan. 13 (click to enlarge) Note: The XLI holding-weight-by-percentage scale is on the left (green), and the company price/earnings-to-growth ratio scale is on the right (red). Source: This J.J.’s Risky Business chart is based on data at the XLI microsite and FinViz.com (both current as of Jan. 13). The World Bank Group became the latest economic observer to offer evidence of a slowdown in the growth of gross domestic product on this planet in the Global Economic Prospects report it released Tuesday. In its most recent semiannual report, the international financial institution based in Washington estimated GDP grew 2.6 percent in 2014, compared with its forecasts of 2.8 percent last June and 3.2 percent last January: Global growth in 2014 was lower than initially expected, continuing a pattern of disappointing outturns over the past several years. Growth picked up only marginally in 2014, to 2.6 percent, from 2.5 percent in 2013. Beneath these headline numbers, increasingly divergent trends are at work in major economies. While activity in the United States and the United Kingdom has gathered momentum as labor markets heal and monetary policy remains extremely accommodative, the recovery has been sputtering in the euro area and Japan as legacies of the financial crisis linger, intertwined with structural bottlenecks. China, meanwhile, is undergoing a carefully managed slowdown. Disappointing growth in other developing countries in 2014 reflected weak external demand, but also domestic policy tightening, political uncertainties and supply-side constraints. In its GEP report, the World Bank also cut its forecasts of GDP growth in 2015, to 3.0 percent from 3.4 percent, and in 2016, to 3.3 percent from 3.5 percent. The conditions underlying these cuts in the World Bank’s forecasts appear likely to have deleterious effects on the earnings of many of XLI’s constituent companies (i.e., those with major exposures to the global economy). This is especially so given the bias divergence in monetary policy at major central banks around the world and its impact on currency-exchange rates, as discussed in “PowerShares QQQ’s 2014 And Fourth-Quarter Performance And Seasonality.” At this late stage of the economic/market cycle, the valuations of XLI’s top 10 and other holdings seem unlikely to function as tailwinds for the ETF’s price appreciation in the foreseeable future (Figure 3). However, the numbers on the S&P 500 industrial sector reported by S&P Senior Index Analyst Howard Silverblatt Dec. 31 suggest it is not hideously overvalued, with its P/E-G ratio at 1.37: not cheap to the likes of me, not dear to the likes of normal people. Disclaimer: The opinions expressed herein by the author do not constitute an investment recommendation, and they are unsuitable for employment in the making of investment decisions. The opinions expressed herein address only certain aspects of potential investment in any securities and cannot substitute for comprehensive investment analysis. The opinions expressed herein are based on an incomplete set of information, illustrative in nature, and limited in scope. In addition, the opinions expressed herein reflect the author’s best judgment as of the date of publication, and they are subject to change without notice.

Generating Alpha With A 2015 Model Portfolio

Summary 2015 will be a volatile year, and only the great stock pickers will come out significantly ahead. Don’t look for the needle in the haystack. Just buy the haystack! Taking the Jack Bogle approach might be the best way to mitigate risk and avoid unnecessary volatility. The first (and only) email request sent to SAFoundationalResearch@gmail.com was a request to create a model portfolio against the S&P 500. The weightings below are what we recommend for 2015: S&P 500 Recommendation Equity Sectors Weight Weight Difference Consumer Discretionary 12.0% 12.0% 0.0% Consumer Staples 9.9% 10.9% 1.0% Energy 8.3% 10.3% 2.0% Financials 16.5% 18.0% 1.5% Heathcare 14.5% 16.0% 1.5% Industrials 10.4% 8.9% -1.5% Information Technology 19.7% 19.7% 0.0% Materials 3.2% 3.2% 0.0% Telecom 2.3% 0.0% -2.3% Utilities 3.2% 1.0% -2.2% We fundamentally believe that 2015 will be a volatile year, and only the great stock pickers will come out significantly ahead. That being said, this portfolio will take the Jack Bogle approach and will strictly purchase SPDR ETFs. “Don’t look for the needle in the haystack. Just buy the haystack!” – Jack Bogle Some other rules for this $100,000 model portfolio: Opportunity to rebalance quarterly (but not required) Must be within +/-3% of the sector benchmark Must be at least 80% invested at all times Recommended $100,000 Model Portfolio Ticker Price as of Jan 2, 2015 Number of Shares Consumer Discretionary Select Sector SPDR ETF (NYSEARCA: XLY ) 72.15 166 Consumer Staples Select Sector SPDR ETF (NYSEARCA: XLP ) 48.49 224 Energy Select Sector SPDR ETF (NYSEARCA: XLE ) 79.16 130 Financial Select Sector SPDR ETF (NYSEARCA: XLF ) 24.73 727 Health Care Select Sector SPDR ETF (NYSEARCA: XLV ) 68.38 233 Industrial Select Sector SPDR ETF (NYSEARCA: XLI ) 56.58 157 Technology Select Sector SPDR ETF (NYSEARCA: XLK ) 41.35 476 Materials Select Sector SPDR ETF (NYSEARCA: XLB ) 48.58 65 Utilities Select Sector SPDR ETF (NYSEARCA: XLU ) 47.22 21 Cash 244.31 244.31 After this article, Foundational Research will post a series of articles for each sector and the respective industries. Below are some highlights on half of the sectors: Technology Sector Highlights We remain cautious on the technology sector, and recommend an equal weight. Although the sector, as measured by the XLK, has outperformed the broader market in 2015, much of that is due to AAPL, which accounts for more than 16% of the XLK index. We also believe the shift to cloud computing will have a negative impact on earnings for most large-cap technology companies, especially over the next few years, when the highest switching over/expenditure costs are expected. Valuations are also higher than they used to be, with overall tech trading at a 22% premium to the 5-year median P/E and a 70% premium to trough valuation, but the Technology sector still trades at a -9% discount to the S&P 500. Telecommunications Sector Highlights News flow continues to be almost exclusively negative in the telecommunications sector. Pricing is likely to continue to be a problem in wireless, and the wireline business is in secular decline. The negative pricing/promotion backdrop in wireless accelerated this past year. While the competitive condition may take a seasonal respite early this year following the holidays, the intermediate-term prospects in this regard is for more of the same, in our opinion. That is, more brutal competition. Energy Sector Highlights The downturn in crude oil prices and the prices for oil & natural gas-related stocks accelerated to the downside over the two quarters. Demand continued to suffer from weak economic conditions and/or slowing economic growth, particularly in the eurozone and China. At the same time, investors were spooked by ongoing strong oil production growth from US unconventional basins and the recovery of disrupted output from Libya. There was also the risk that the sanctions on Iran might be reduced or eliminated, potentially opening the way for increased production (approx. +500,000-700,000 barrels/d). Finally, OPEC was not able to come to an agreement to cut production to balance the market, leading to a sizeable drop in oil prices the day after Thanksgiving. We believe that the share prices have over-reacted to the crude oil price drop. Historically speaking, whenever energy stocks have lead decline for six months, they then lead for the following six months. “This time is different” often leads investors astray. Industrial Sector Highlights We are concerned that reductions to oil & gas capital spending budgets will have an outsized impact on the machinery and electrical equipment industries. There appears to be an expectation that better consumer spending trends following cheaper gasoline prices will spur further capital spending from the consumer discretionary sector. This may be the case, but we’d expect any pickup in capex from the discretionary sector to take time, while the cuts from the oil & gas complex will be more immediate. Additionally, sales into the oil & gas complex are among the most profitable for our companies, and will be difficult to replace (even if there is a pickup in consumer discretionary capex). Consumer Discretionary Highlights The market weight recommendation on the consumer discretionary sector reflects a more balanced view of the tailwinds and headwinds facing the group over this year. Fairly significant 2014 underperformance in the group has led to more reasonable relative valuations of late, and that, coupled with falling gas prices (a potential benefit to the consumer) and easing top line/margin comparisons in F15 have resulted in a more balanced risk/reward. That being said, many near-term macro data points remain mixed (i.e. jobs, housing, food commodity costs) and could keep a lid on overall earnings growth, which prevents a more constructive view on the group, for now. Material Sector Highlights Downstream is the new upstream. While we retain our neutral recommendation on the complex, we favor downstream/processed/refined-related commodity companies that benefit from the decline in upstream pricing. The perfect storm of increased production, stemming from higher prices, followed by slowing demand growth has resulted in a backdrop where many upstream commodities are in “oversupply.” The stronger United States dollar is only adding fuel to the fire. We would remain positioned in those commodities that benefit from falling inputs and oligopolic behavior. Our two preferred commodities are steel and aluminum, with the former capitalizing on falling iron ore prices, and the latter on falling power prices. We would avoid copper and iron ore where we have yet to see price support, as the cost curve continues to decline. Consumer Staples Highlights The third-quarter earnings results certainly did not encourage us to change our view. The operating environment remains challenging for packaged goods companies, especially so for food companies, yet the consumer staples sector continues to make new highs. Investors seem to continue to seek out yield, and probably even more so, stability, as we move toward year-end. Category growth remains sluggish in developing markets, and has slowed in emerging markets. The currency headwinds have intensified for many companies. Domestic attempts to drive volume with more promotions have not been as successful as in the past. The debate continues as to whether there has not been enough innovation or the consumer is still in a constrained in spending mode – we believe it has. Healthcare Highlights We continue to believe the Patient Protection and Affordable Care Act (ACA) will be a positive force in healthcare for the next 3-5 years, with some potential ramifications that need to be watched. As we approach year 2 of the expansion part of the law, Republicans have taken control of the Senate, and the Supreme Court has decided to review another case relating to the legislation. Scientific breakthroughs are creating a cornucopia of new biopharmaceuticals for unmet or poorly served medical needs. The demographics of the major industrialized nations, including North America, Europe, and Japan, are changing to larger populations of elderly patients, who are major consumers of drugs. Utilities Highlights We see nothing operationally wrong with the Utilities sector. The reach for yield has caused share prices to increase. Without a capex increase, and with prices as high as they are, we believe they will not appreciate any further. The last time the Utilities sector lead the market over the course of a year, as it did in 2014, it only returned 1% total return the next year. Over the next few weeks, we will go in-depth on each sector, so please remember to “Follow” us to not miss anything!