Tag Archives: seeking-alpha

Allocating Assets When The Fed Talks Out Of Both Sides Of Its Mouth

One year ago, each of the 17 members of the Federal Reserve provided an expectation of where the fed funds rate would be at the end of 2015. The average came in at 1.1%. Here in mid-June, the average expectation for committee members for the end of the year now registers 0.45%. If the party is set to rage on, then, shouldn’t investors aggressively allocate dollars in U.S. equities? Not from my vantage point. One year ago, each of the 17 members of the Federal Reserve provided an expectation of where the fed funds rate would be at the end of 2015. The average came in at 1.1%. That might have required four to five rate hikes this year alone. By March, the expected year-end rate dropped to 0.65%. Perhaps two or three rate increases, then? Nope. Here in mid-June, the average expectation for committee members for the end of the year now registers 0.45%. The financial markets have even less conviction about a 2015 increase to the cost of borrowing. Investors via fed funds futures are only pricing in a 22% chance that the Federal Reserve raises the benchmark rate in September and a 62% probability of a rate liftoff at the central bank’s December meeting. Personally, I imagine one face-saving hike this year – a one-n-done to say that they did it. Nevertheless, nobody will be removing much of the alcoholic punch from the the party’s punch bowl anytime soon. Diminished expectations have not been confined to 2015 alone. Fed forecasts for year-end 2016 have dropped from roughly 1.9% to 1.6%. For 2017, they’ve moved down to 2.9% from 3.1%. And that’s not all that the Fed has downgraded. As recently as three months earlier, the institution anticipated 2015 economic growth at 2.3%-2.7%. Yesterday, committee members revealed an assessment of a lethargic 1.8% to 2.0%. Wait a second. Haven’t chairwoman Yellen and her colleagues been prattling on about economic acceleration since last year? Haven’t they been stressing transitory factors to explain every bit of weakness, while simultaneously pointing to improvements wherever they can be emphasized? With one side of its collective mouth, committee members are talking up the economy’s advances. With the other side, it currently believes that the economy will grow even slower than its post-recession growth rate of approximately 2.1%. Keep in mind, our 2.1% post-recession performance is historically weak under normal circumstances. Since 6/2009, though, America received $7.5 trillion in stimulus by the U.S. government; we received $3.75 trillion in electronic dollar equivalents by the Federal Reserve. In other words, unprecedented fireworks only enabled the economy to grow at a lethargic pace. Meanwhile, based on what the Fed members report outside of the media spotlight, they anticipate additional cooling off here in 2015 (circa 1.8%-2.0%). Is it any surprise that stocks would rocket on the probability of fewer anticipated rate hikes alongside a less vibrant economy ? Heck, the Fed successfully talked down the U.S. dollar, kept bond yields from extending their recent tantrum and sent the SPDR Gold Trust ETF (NYSEARCA: GLD ) back above 50-day moving average. If the party is set to rage on, then, shouldn’t investors aggressively allocate dollars in U.S. equities? Not from my vantage point. Successful investors tend to sell complacency, rather than purchase more of it. And “risk-on” investors have become incredibly complacent with respect to sky high valuations as well as Fed accommodation. Understand the real reason that the Fed is even talking about raising short-term rates at all. The monetary policy authorities need to bolster the Fed’s arsenal before the next recession, external shock and/or “black swan” event. They are no longer capable of moving from a 5% fed funds rate range down to 1% or 0%. Instead, we’re now talking about maybe – possibly, someday – getting up to 3% before going back to 0% rate policy and a 4th iteration of quantitative easing (“QE4”). In truth, I doubt that the Fed will ever be able to move beyond 1% before reversing course. Japan has spent the last 15 years stuck at 0.5% or less. That has everything to do with our reliance on zero percent rates and asset purchases with currency credits (“QE”) for six years. Japan made the same error in judgment. Admittedly, the Fed has been marvelously successful at persuading businesses to buy back their stock shares; they’ve convinced pensions, money managers, mutual funds and real estate investors to stay engaged, enhancing the “wealth effect” for the wealthiest among us. (Yes, that includes me.) On the other hand, I have seen the same excesses throughout the decades. I witnessed firsthand what happened to Taiwanese equities in 1986 when Taiwan R.O.C. opened its doors to outside investors. The irrationally exuberant run-up met its panicky demise the following year. I warned investors to have an exit approach to the insanity of dot-com euphoria in the late 1990s; I offered the same warnings leading up to the 2007-2009 financial collapse. In essence, you do not have to be sitting 100% in cash. We still remain invested in core positions such as the Vanguard Mid-Cap Value ETF (NYSEARCA: VOE ), the iShares S&P 100 ETF (NYSEARCA: OEF ) and the Vanguard High Dividend Yield ETF (NYSEARCA: VYM ). Yet we have also raised 10%-25% cash in our portfolios (depending on client risk tolerance) as stop-limit loss orders have hit on both bond and stock positions. We let go of energy investments that did not pan out. We stopped out of longer-term bonds earlier this year. And Germany via the iShares Currency Hedged MSCI Germany ETF (NYSEARCA: HEWG ) is no longer in the mix of any client. The result? More cash for future buying opportunities. And that buying opportunity is likely to be far more consequential than a 3% pullback. With only a few exceptions, we believe it is far more sensible to wait for the real deal – a 10%-plus correction and/or a 20%-plus bear. 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.

Not If, But When – A Breakdown Of MSCI’s Decision On China’s Onshore Equity Market

Summary On June 9th, MSCI stated that onshore Chinese equities will be added to their broad-based international indices. We believe investors should consider taking a position in the onshore markets today as international investment increases and China implements policies to sustain the onshore market rally. Three issues need to be resolved before immediate inclusion can take place. MSCI, a leading provider of index solutions globally, announced on Tuesday, June 9th that onshore Chinese equities will be added to their broad-based international indices upon the resolution of three outstanding issues. We previously wrote about the potential impact of this inclusion. As an MSCI client, KraneShares, along with several dozen mutual fund families and institutional brokers, attended MSCI’s Index Review Seminar, which was held the morning after the announcement. MSCI’s message at the seminar was clear; investors need to proactively prepare for the coming changes. Changes like the one MSCI announced on June 9th are rare, but when they happen they have historically driven performance in the affected economies. For example, in 2012 MSCI announced that it would include the United Arab Emirates in its emerging market index between 2012 and 2014; when the UAE’s inclusion was implemented, the MSCI United Arab Emirates IMI Index rose 238%1. This dwarfs the 130% rise the onshore Chinese markets have achieved since the rally began in the second quarter of 20142. We believe the onshore markets still have room to grow. Beyond MSCI’s decision, the recent surge in China’s onshore markets is backed by meticulous structural developments that have been decades in the making. We have listed a few examples of these developments below: Raising Domestic Consumption China’s policy makers are prioritizing increased domestic consumption in order to alleviate export dependency to the European Union and United States. Evidence of the policy’s success can be seen in China’s Year over Year retail sales data. According to China’s National Bureau of Statistics, retail sales in May increased 10.1% to $390 billion. The numbers indicate that China is catching up to well-established domestic markets like the United States. Additionally, the strong stock market has a trickle-down wealth effect on domestic consumption allowing Chinese investors to spend more freely. Stock Investing Replaces Housing China’s household savings rate is the third highest in the world at 51% of its GDP3. This rate is 300% higher than that of the United States4. Due to limited investment options in China, housing has traditionally been one of the most popular investment vehicles for Mainland Chinese citizens, which in return supported China’s urbanization policy. With housing softening, savings are finding a new home in the stock market. In fact, 4.4 million new onshore brokerage accounts have been opened by Chinese investors this year5. Monetary Policy China’s central bank has started to ease monetary policy. There have been two interest rate cuts and several adjustments to the reserve requirement ratio, which is the minimum amount of customer deposits that commercial banks must hold in reserve before making loans. The reserve requirement ratio was cut to 19.5% this year from 20% in 20146. More bank requirement cuts and targeted monetary policy are likely as policy makers continue to support growth. However, we do not believe that there will be more interest rate cuts because China’s leadership wants to keep the renminbi, RMB, stable ahead of the International Monetary Fund’s decision on the RMB’s inclusion into its basket of reserve currencies. Unlocking Shareholder Value in State Owned Enterprise Historically, China’s State Owned Enterprises, SOEs, have been undervalued compared to their privately owned counterparts. Unlocking shareholder value in state owned enterprises is a top policy in China today. This will take the form of increased mergers and acquisitions like the recent merger of China South Railroad with China North Railroad to form CRRC, one of the largest train manufacturers globally. Removing inefficiencies should raise the return on equity for State Owned Enterprises versus their private equivalents. We envision reform to heavily emphasize traditional sectors including industrials, basic materials and energy. One Belt, One Road Recently, China implemented the One Belt, One Road policy, which links Chinese manufacturers to Europe, Asia, Africa and the Middle East through improved overland transportation linkages and maritime port and logistic facilities. This spearheaded the launch of the Asia Infrastructure Investment Bank, AIIB, to help finance this policy. Debt Deleveraging China heavily restricted Initial Public Offerings and secondary offerings in the onshore markets for several years. Chinese companies had to rely on issuing debt to raise capital due to this limiting environment. The strong performance of the stock market allows new companies to list and for legacy companies to issue new shares. Proceeds can be used to pay down debt. The MSCI decision overview As the inclusion of the onshore market into MSCI broad indices has become a matter of when not if, China’s leadership is preparing its economy for massive inflows of foreign capital. Currently, China’s Securities Regulatory Commission, CSRC, is working with MSCI to address the three pending issues. The issues center around the programs China implemented in order to phase in the opening up of its economy. China has tightly regulated quota systems to allow foreign investors access to its onshore markets. The first program China launched was the Qualified Foreign Institutional Investor program, QFII, which gives specific foreign institutions access to the onshore markets. The second program to launch was the Renminbi Qualified Foreign Institutional Investor Program, RQFII, which is issued primarily to Chinese asset managers, and has been the catalyst for the launch of onshore China funds. China is gradually shifting focus from the QFII and RQFII programs in favor of even more accessible “connect” programs. The first connect program to go live was the Shanghai-Hong Kong Stock Connect that linked the Shanghai Stock Exchange to the fully internationally accessible Hong Kong Stock Exchange. We believe the Shenzhen-Hong Kong Stock Connect program should follow soon, which will make the entire onshore market fully accessible to international investors. The three issues: Quota Allocation Process: In its announcement MSCI stated that QFII and RQFII quota is still an issue because: “Large investors should be given access to quota commensurate with the size of their assets.”7 We believe this issue will be settled in the near future because quota restrictions are consistently being loosened. Capital Mobility Restrictions: The Shanghai-Hong Kong Stock Connect has a daily limit on the amount of stocks that can be purchased, which, if reached, could leave managers without access. MSCI would like to see this limit removed. Additionally the QFII program has a weekly redemption window, which MSCI would like to see increased to a daily window. Beneficial Ownership: Unlike ETFs and mutual funds, investors in separate managed accounts own the actual underlying securities held by their custodian. MSCI wants to ensure that investors with separate accounts are confident in their ownership in Chinese stock. Before the June 9th announcement there were lingering questions around how the onshore markets would be phased in. MSCI clarified that initially 5% of the onshore Chinese equities’ free float market cap would be included into their broad indices and that this weight will be increased incrementally. At full inclusion, China’s weight within MSCI Emerging Markets would be 43.6% overall, 20.3% Hong Kong listed companies, 20.5% onshore Chinese companies, and 2.8% U.S.-listed companies7. An incremental increase of onshore equities within broader indices is a logical strategy based on the large amount of money needing to be reallocated. We previously wrote about how the lack of a formal announcement on the Shenzhen-Hong Kong Stock Connect program could be problematic for inclusion. We suspect an official announcement about the launch of this program in the next several months. Ultimately the impediments are coming down as MSCI calls the launch of the Shenzhen-Connect program “imminent” and believes “further liberalization of the RQFII program”7 is coming. China’s leadership is motivated to continue opening up its economy to international investors. Having China’s onshore markets included into international indices helps bolster this goal. We believe investors should consider taking a position in the onshore China markets today as their inclusion within broad MSCI indices – and the accompanying international fund flows – are imminent and China is enacting policies to sustain the onshore market rally. 1 Return based off the MSCI United Arab Emirates IMI Index from January 2012 to May 2014. Definition: The MSCI United Arab Emirates Investable Market Index is designed to measure the performance of the large, mid, and small cap segments of the UAE markets. With 22 constituents, the index covers approximately 85% of the UAE equity universe. 2 Return based of the MSCI China A International Index from start of market rally 3/1/2014 through 5/31/2015. MSCI China A International Index Definition: The MSCI China A International Index captures large and mid-cap representation and includes the China A-share constituents of the MSCI China All Shares Index. It is based on the concept of the integrated MSCI China equity universe with China A-shares included. 3 Source: World Bank as of 2013 4 Source: World Bank as of 2013 5 Source: China Securities Depository and Clearing Corporation as of 5/2015 6 Source: CEIC Data as of 2/5/2015 7 Source for quote – MSCI, “Results of MSCI 2015 Market Classification Review” 6/9/2015 8 MSCI as of 6/2015 Disclosure: I am/we are long KBA, KEMP, KCNY, KFYP, KWEB. (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. Additional disclosure: ©2015 KraneShares Carefully consider the Funds’ investment objectives, risk factors, charges and expenses before investing. This and additional information can be found in the Funds’ prospectus, which may be obtained here: KBA, KFYP, KWEB, KCNY, KEMP Read the prospectus carefully before investing. Investing involves risk, including possible loss of principal. There can be no assurance that a Fund will achieve its stated objectives. The Funds focus their investments primarily with Chinese issuers and issuers with economic ties to China. The Funds are subject to political, social or economic instability within China which may cause decline in value. Fluctuations in currency of foreign countries may have an adverse effect to domestic currency values. Emerging markets involve heightened risk related to the same factors as well as increase volatility and lower trading volume. Current and future holdings are subject to risk. Narrowly focused investments and investments in smaller companies typically exhibit higher volatility. Internet companies are subject to rapid changes in technology, worldwide competition, rapid obsolescence of products and services, loss of patent protections, evolving industry standards and frequent new product productions. Such changes may have an adverse impact on performance. The ability of the KraneShares Bosera MSCI China A ETF to achieve its investment objective is dependent on the continuous availability of A Shares and the ability to obtain, if necessary, additional A Shares quota. If the Fund is unable to obtain sufficient exposure due to the limited availability of A Share quota, the Fund could seek exposure to the component securities of the Underlying Index by investing in depositary receipts. The Fund may, in some cases, also invest in Hong Kong listed versions of the component securities and B Shares issued by the same companies that issue A Shares in the Underlying Index. The Fund may also use derivatives or invest in ETFs that provide comparable exposures. The ability of the KraneShares FTSE Emerging Markets Plus ETF to achieve its investment objective is dependent, in part, on the continuous availability of A Shares through the Fund’s investment in the KraneShares Bosera MSCI China A Share ETF and that fund’s continued access to the China A Shares market. If such access is lost or becomes inadequate to meet its investment needs, it may have a material adverse effect on the ability of the Fund to achieve its investment objective because shares of the KraneShares Bosera MSCI China A Share ETF may no longer be available for investment by the Fund, may trade at a premium to NAV, or may no longer be a suitable investment for the Fund. The KraneShares FTSE Emerging Markets Plus ETF and KraneShares Bosera MSCI China A Share ETF may be concentrated in the financial services sector. Those companies may be adversely impacted by many factors, including, government regulations, economic conditions, credit rating downgrades, changes in interest rates, and decreased liquidity in credit markets. This sector has experienced significant losses in the recent past, and the impact of more stringent capital requirements and of recent or future regulation on any individual financial company or on the sector as a whole cannot be predicted. These ETFs may also invest in derivatives. Investments in derivatives, including swap contracts and index futures in particular, may pose risks in addition to those associated with investing directly in securities or other investments, including illiquidity of the derivatives, imperfect correlations with underlying investments, lack of availability and counterparty risk. The use of swap agreements entails certain risks, which may be different from, and possibly greater than, the risks associated with investing directly in the underlying asset. The KraneShares E Fund China Commercial Paper ETF is subject to interest rate risk, which is the chance that bonds will decline in value as interest rates rise. It is also subject to income risk, call risk, credit risk, and Chinese credit rating risks. The components of the securities held by the Fund will be rated by Chinese credit rating agencies, which may use different criteria and methodology than U.S. entities or international credit rating agencies. The Fund may invest in high yield and unrated securities, whose prices are generally more sensitive to adverse economic changes. As such, their prices may be more volatile. The Fund is subject to industry concentration risk and is nondiversified. The KraneShares E Fund China Commercial paper ETF invests in sovereign and quasi-sovereign debt. Investments in sovereign and quasi-sovereign debt securities involve special risks, including the availability of sufficient foreign exchange on the date a payment is due, the relative size of the debt service burden to the economy as a whole, and the government debtor’s policy towards the International Monetary Fund and the political constraints to which a government debtor may be subject. In order to qualify for the favorable tax treatment generally available to regulated investment companies, the Fund must satisfy certain income and asset diversification requirements each year. If the Fund were to fail to qualify as a regulated investment company, it would be taxed in the same manner as an ordinary corporation, and distributions to its shareholders would not be deductible by the Fund in computing its taxable income. Narrowly focused investments typically exhibit higher volatility. Internet companies are subject to rapid changes in technology, worldwide competition, rapid obsolescence of products and services, loss of patent protections, evolving industry standards and frequent new product productions. Such changes may have an adverse impact on performance. The KraneShares ETFs are distributed by SEI Investments Distribution Company, 1 Freedom Valley Drive, Oaks, PA 19456, which is not affiliated with Krane Funds Advisors, LLC, the Investment Adviser for the Fund.

Ormat Technologies: Overpriced In Light Of Industry Headwinds

Summary Geothermal power generation will likely stagnate or outright decline in the coming years, putting Ormat Technologies in a bad position. Ormat’s strategy of expansion could backfire if subsidies/incentives dry up, which has a high likelihood of happenings given the arrival of more promising alternative energies. With stagnating revenues and industry pressures, Ormat is much too expensive at a P/E ratio of 40. The geothermal power industry has seen some impressive growth over the past few years, and is currently an important part of the renewable energy mix. By harnessing the enormous amounts of thermal energy stored in the earth, clean energy can be produced in relative abundance. Ormat Technologies (NYSE: ORA ) is a standout in the geothermal space, with approximately 2 GW in power plants supplied worldwide. Although Ormat has grown tremendously over the past few years, there are reasons to believe that it is headed for a long-term decline. While many have touted geothermal’s potential on the basis that there are terawatts of thermal energy that could theoretically be harvested, the technology it takes to actually harness this energy may be questionable in the long run. On top of this, rapid battery innovation may take away geothermal’s big advantage of having base-load qualities. Once other forms of renewables, e.g. wind, will be able to cost effectively store energy, geothermal loses its base-load edge to other potentially more promising clean energies. Ormat is especially vulnerable given that it is relatively more expensive than its peers. Technology Risks Geothermal technologies are especially capital intensive, as massive amounts of resources are needed to build geothermal plants. Ormat’s fast expansion rate could ironically be a negative for the company. If Ormat overextends its reach to more questionable regions in terms of profitability, its expensive geothermal plants could end up costing the company in lost sunk costs if subsidies dry up in the future. Given how many other forms of clean energies are showing more growth potential, namely wind and solar PV, future alternative energy subsidies/incentives will likely be concentrated on these clean energy technologies. While Ormat’s own growth projections of the geothermal electricity and product segments are optimistic, with the global geothermal markets growing eight-fold by 2020, such projections are likely overestimations given that more promising energy technologies are abound. In addition to the fact that other forms of clean energies look to have more inherent growth potential, geothermal is a centralized energy generation technology. If the future energy landscape is indeed one dominated by more distributed forms of energy, this is just one more negative for the geothermal industry. With prime geothermal locations hard to come by and costs likely to be increasingly less competitive compared to other alternative energies, Ormat is facing an uphill battle. Although geothermal technologies are nowhere near mature and still have much more room for improvement, geothermal likely remains a niche market. While the hype surrounding ORA is somewhat justified given its status as the second largest geothermal company in the U.S. and its general cost competitiveness against it peers, it is likely overvalued given its pessimistic growth prospects. With technologies as large and unwieldy as those in geothermal plants, there are much better ways to go about clean energy production. Ormat’s own geothermal growth projections are likely too optimistic in light of industry pressures. While geothermal has indeed grown over the past couple of years, as is clearly shown in the graph below, such growth is likely not sustainable. Source: Frost & Sullivan Analysis Growth Prospects At a P/E ratio of 40 , investors are much too optimistic about Ormat’s growth potential. Given how Ormat’s growth has stagnated in recent years, with both its 2013 and 2014 revenues hovering around the mid-$500M level, it seems unlikely that the company will fulfill such lofty growth expectations. With Q1 revenues at $120M, this growth slowdown trend seems to be continuing. Although Ormat is focusing on expanding by increasing its geographical reach, the company should have a hard time growing in the mid/long term. Ormat’s revenues from third-party sales, which constitute a sizable portion of the company’s total revenues, have long stagnated around the $180M-$200M range. Its products, which make up for a majority of its revenues, have just recently started slowing down. On top of this, 2015 is the first year in a long time where its product sales could actually come in lower than sales in 2014. While Ormat has considerably outperformed the broader market over the past few years, it would not be surprising to see the company underperform moving forward. Although Ormat is highly diversified on the global scene, this may not matter for much longer as the global energy market seems to be gravitating towards solar PV in particular. Many governments are increasingly looking towards solar PV as the main long-term answer to global warming and pollution, which means that geothermal will increasingly be relegated towards more niche situations. While a case could certainly be made that Ormat will have a long-term place in the energy landscape, the company does not seem to be a wise investment on balance. Conclusion Ormat’s long-term prospects are not looking too bright in the long term. While geothermal will likely end up playing a permanent role in the renewable landscape, Ormat is valued much too high. At a market capitalization of $1.89B and a P/E ratio of 40, investors are putting too much confidence in the company’s growth potential. With stagnating revenues and the rise of more promising alternative energies, Ormat will have very little chance of beating the market in the future. There is a high probability that geothermal is not the disruptive technology that many investors are hoping it to be, with Ormat likely to be one of the first to feel the effects of a possible decline in geothermal. 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.