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It’s A Risk Adverse World Out There

Summary Investors have been pulling back on the risk handle for some time now and shedding areas of their portfolio that may be susceptible to heightened volatility. The interesting thing about the high beta index is that it contains some very big winners this year. This has created a wide chasm between the so called “safe stocks” and “aggressive stocks”. Investors have been pulling back on the risk handle for some time now and shedding areas of their portfolio that may be susceptible to heightened volatility. Virtually anything connected to the energy or materials sectors has been torched this year. That extends to emerging market countries and high yield bonds , which have also felt the effects of the commodity crash. One of the more creative ways to view this trend is to look at the disconnect between high beta stocks and low volatility names. The PowerShares S&P 500 High Beta Portfolio (NYSEARCA: SPHB ) and PowerShares S&P 500 Low Volatility Portfolio (NYSEARCA: SPLV ) are two excellent indexes for this task. These two ETFs invest in a basket of 100 stocks within the S&P 500 universe that are showing the highest and lowest sensitivity to the benchmark over the last 12-months. Each stock within the portfolio is given an equal share (1%) of the asset allocation and the underlying holdings are evaluated and rebalanced on a quarterly basis. As you can see on the chart below, the divergence between the two has really accelerated over the last three months. SPLV is now trading within close proximity to all-time highs, while SPHB is quite near its 2015 lows. The interesting thing about the high beta index is that it contains some very big winners this year. Netflix Inc (NASDAQ: NFLX ) and Expedia Inc (NASDAQ: EXPE ) are both in the top 10 holdings of this fund and continue to show relative strength. Nevertheless, over one-third of the portfolio is made up of energy and industrial companies that have seen their share prices crater. Two of the worst have been Freeport-McMoRan Inc (NYSE: FCX ) and Chesapeake Energy Corp (NYSE: CHK ). By contrast, the low volatility sectors in SPLV are primarily geared towards financial and consumer staples names. Many of these stocks have either moved sideways in a plodding fashion or continued to buck the overall market malaise by heading higher. This has created a wide chasm between the so called “safe stocks” and “aggressive stocks”. On a year-to-date basis, SPHB is down -7.50% versus a 2.90% gain in SPLV. For comparison purposes, the benchmark SPDR S&P 500 ETF (NYSEARCA: SPY ) is up just 2.00% so far this year. While it’s easy to dismiss this divergence as simply a difference in index construction, I believe it also represents an excellent example of investor behavior and risk characteristics . High beta stocks are known to experience very rapid rallies during favorable market environments, but that also translates into quick breakdowns when the tide turns. Much of this fundamental risk versus reward has been forgotten or dismissed over the last several years as stocks march higher with very little in the way of volatility or fear. Earlier in the year, I transitioned a portion of the equity sleeve in my Strategic Income portfolio to the iShares MSCI U.S.A. Minimum Volatility ETF (NYSEARCA: USMV ). This fund takes a similar tact as SPLV by selecting a subset of stocks with lower overall price fluctuations than the broader market. These indexes are designed for more conservative investors that still want to participate in the upside of the market with less downside risk. One drawback to owning this fund in an income portfolio is that I am sacrificing some short-term yield by not owning a strict dividend-focused index. In addition, I could potentially miss out on a big rally in high yield or beaten down stocks. Yet based on the current market environment, I feel that this strategy is prudent to lower the beta of the portfolio and focus on total return. The Bottom Line In a true bear market or crisis situation, there is no such thing as a “safe stock”. Even low volatility indexes are going to experience sizeable declines as risk aversion sets in. However, that same risk is also rewarded during periods of cyclical strength in equities. By being proactive with your asset allocation and security selection, you can reduce your risk during unfavorable periods and take advantage of new opportunities when they fit your criteria. Disclosure: I am/we are long USMV. (More…) 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. Additional disclosure: David Fabian, FMD Capital Management, and/or clients may hold positions in the ETFs and mutual funds mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell, or hold securities.

High Beta Underperforming Low Volatility

As the market continues to trade sideways in its, seemingly, directionless trade, it is helpful to observe various intermarket relationships and technical indicators to see what exactly is driving returns and to check-up on the overall health of the market. One interesting dynamic of the market this year is the underperformance of high beta stocks in relation to low volatility stocks. In a typical bull market, high beta stocks outperform as market psychology shifts to a “risk on” mindset where cyclical companies (such as high beta and high growth stocks) are favored over non-cyclical companies that provide lower, more protected exposure. This has not been the case this year. High beta stocks have underperformed low volatility stocks measured by the ratio of the performance of the PowerShares S&P 500 High Beta Portfolio ETF (NYSEARCA: SPHB ) over the PowerShares S&P 500 Low Volatility Portfolio ETF (NYSEARCA: SPLV ) . As the ratio moves higher, high beta is outperforming low volatility and as the ratio moves lower, low volatility is outperforming high beta. The performance dispersion can partially be explained by the difference in sector weighting of these two ETFs. Given SPHB’s high beta, cyclical tilt, overweights in Energy and Industrials have been a big drag on performance. Conversely, SPLV has no Energy exposure and higher weightings to Consumer Staples and Health Care, two sectors that traditionally carry lower volatility and have outperformed the broader market this year. These are a few examples of why the low volatility strategy is outperforming not only high beta names this year, but has also caught up to the S&P 500. This being said, it is interesting to note that growth stocks are still outperforming value stocks in the same time period, shown by the relationship between the iShares S&P 500 Growth ETF (NYSEARCA: IVW ) and the iShares S&P 500 Value ETF (NYSEARCA: IVE ) . While this is not a new dynamic to this bull market, the amplified disparity in performance since the end of June is noteworthy as investors continue to favor companies with higher growth rates in this slow, bump along environment. High beta stocks may reverse trend and outperform the low volatility strategy should the market resume a trend to new highs, but until then, low volatility is in play. Share this article with a colleague

Long-Term Potential Not Enough To Change Hold Rating On Southern Company, For Now

Summary Company’s strategy of making hefty growth investments in renewable energy generation projects means it is well placed in capital intensive U.S. utility industry. Analysts anticipating a healthy sales growth rate of 2.10%for SO, above the industry median. Strong growth prospects of the company will grow its cash flow base. I reiterate my hold rating on Southern Company (NYSE: SO ) due to the prevailing construction-related challenges at two important power projects of SO. As a matter of fact, the Kemper and Vogtle project delays have restricted its near-term growth potentials, but in the long run, these projects along with SO’s ongoing renewable energy generation related projects will support its top and bottom-line growths. Given the healthy long-term growth potentials of SO, I believe its cash flows will remain reasonably strong in the years ahead, which will help it improve stock price performance by making increasingly healthy dividend payments to shareholders; SO offers a dividend yield of 4.7%. Near Term Concerns But Healthy Long-Term Waits for SO Over the past few years, the U.S. utility industry has gone through a transformational phase due to aggressive spending by utility companies in several infrastructural growth related projects. I believe the industry transformation is not over yet, because companies like SO, American Electric Power (NYSE: AEP ), Exelon (NYSE: EXC ) and Dominion (NYSE: D ) are still making hefty investments to develop and enhance power generation units. The following map shows the capacity and location of new power projects planned for 2015. (click to enlarge) Source: Minnpost.com SO has also been making capital expenditures to strengthen its power generation assets. In fact, SO has made all-time high growth investments in two major energy generation projects named Kemper and Vogtle, but both projects have been facing construction delays, which have increased construction costs for the company. As far as the 582MW Kemper project is concerned, the project was started with the intent to boost the company’s future growth potentials, but the constant delays and cost overruns at the Kemper construction site are weighing on SO’s profits. The company took the additional charge of $14 million (after-tax) during 2Q’15 due to an increase in the construction cost of the Kemper gasification-combined cycle project. In its efforts to cover these cost overruns, SO had previously signed a case for an interim rate hike of 18% for Kemper’s gasification plants in the state; the rate increase request is recently approved by regulators, which will allow the company to partially offset the increase in construction cost. Although SO’s management expects Kemper to be operational in the first half of 2016, if the project continues to be affected by project delays and cost overruns, I believe the recent rate hike will fail to cover the cost overruns in the longer run, thereby disrupting the company’s profitable margins. Moreover, SO’s plan to build two Vogtle nuclear power plants in Georgia is facing similar delays. Although the management has predicted a three-year delay in the Vogtle project, as per the government’s review, the project will be delayed longer than three-years, costing the company around $8.2 billion . Although issues related to Kemper and Vogtle are both key concerns for the company’s profits, with the commencement of their operations, both projects will act as vital sources of generating strong revenues, earnings and cash flows in the years ahead. Moreover, SO is working hard to grow its renewable energy generation portfolio to hedge against fossil fuel risk and to supply low-cost power to customers. In fact, there are many ongoing and upcoming solar energy generation projects by the company, which contain a strong upside for its future earnings and cash flows. As part of its plan to establish a strong renewable energy generation asset base, SO had acquired the Blackwell Solar facility. Although the acquired facility is currently under construction phase, with the completion of construction, the acquired facility will help the company serve around 11,000 homes. In addition, SO’s plan to construct a new 46MW solar energy generation facility at Marine Corps Logistic Base-Albany has been approved by regulators, which is expected to commence operations by the end of 2016. With this approval, the company’s subsidiary Georgia Power has attained 166MW of solar generation capacity on Georgian military bases. Given the fact that all of the abovementioned power generation projects of SO will improve its production capacity and optimize its power generation portfolio, I expect to witness strong revenues, stable cash flows and healthy earnings growth in the longer run. Analysts are also expecting that SO’s earnings will grow at a decent pace in the years ahead, as shown in the chart below. (click to enlarge) Source: Nasdaq.com Furthermore, SO’s management is also working to convert existing coal-based power generation plants to gas plants. The company has announced in a press release that its 120MW Gadsden plant in Alabama will be switched from a combination of natural gas and coal to entirely natural gas. Given the fact that SO has incurred around $3 billion over the last decade to meet regulatory standards regarding limitation of carbon dioxide emission from coal base plants, I believe the conversion of Gadsden plant on natural gas is a good step by the company, as this allows it to comply with regulations and will portend well for its profit margins in the long term. Investors Remain Rewarded at SO The company has been making healthy cash returns to its shareholders through dividends. Year-to-date in 2015, SO has returned around $34 million in the form of dividends to its shareholders. These healthy dividend payments have earned it an attractive dividend yield of 4.70% . Given the strong growth potentials of the company’s growth investments, I believe SO will have strong cash flows to carry on its policy of making hefty dividend payments in the years ahead. Analysts have also projected growth in the company’s book value per share and cash flow per share, as shown in the chart below. (click to enlarge) Source: 4-traders.com Risks Continuous increases in construction costs at Kemper and Vogtle plants will remain an overhang for the company’s profits in future. In addition, any laxness exhibited by the management during the operational stage of ongoing renewable energy generation projects will result in SO’s failure to report financial numbers as per the management’s plans. Furthermore, harsh weather conditions, unforeseen negative economic changes, strict government regulations and taxes to limit carbon dioxide emissions from nuclear units are key risks that might hamper the company’s future stock price performance. Conclusion Despite the current cost overruns and project delays at SO, the company’s strategy of making hefty growth investments in renewable energy generation projects makes me believe that it is well placed in the capital intensive U.S. utility industry. Analysts also view the company’s long-term growth prospects positively, as indicated by their anticipated healthy sales growth rate of 2.10% , which is well above the industry median of 1.80%. Moreover, the strong growth prospects of the company will grow its cash flow base, meaning more upside for its future dividends. Also, analysts have projected a decent next five-years growth rate of 3.55% for SO. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.