Tag Archives: seeking-alpha

Time To Bring Active Back Into A Portfolio?

The U.S. stock market has advanced steadily over the past six years, a rally fueled partly by unusually accommodative monetary policy and notable for its near absence of volatility. But while stocks in general have rallied since the economic recovery began to take hold in 2009, many active portfolio managers have struggled to deliver investor returns in excess of the broader market, according to a BlackRock analysis of data accessible via Bloomberg. Many factors have been cited for this persistent underperformance , including higher fees and risk aversion in the aftermath of the financial crisis. However, another contributing factor has arguably been the Fed’s extraordinarily easy monetary policy suppressing volatility and hindering active managers’ ability to generate excess returns via security selection and portfolio tilts. Regardless of the cause, the value proposition of active management simply hasn’t materialized in recent years. However, with the Federal Reserve (Fed) poised to begin raising rates as early as next month , investors will have to adjust to more modest returns from U.S. stocks as well as brace for heightened volatility. This could create an opportunity for an active management approach. As Kurt Reiman and I write in our new Market Perspectives paper, ” A Quantum of Solace: Can the return of volatility revive active management “, we may be entering a more favorable environment for active manager performance. Based on our analysis using Bloomberg performance data for the S&P 500 Index back to the mid-1990s, there’s some evidence that managers’ ability to beat benchmarks comes in cycles. In fact, two somewhat interrelated variables do a reasonably good job of explaining the performance of active managers relative to their benchmarks: the annual change in volatility and the annual change in cross-sectional dispersion. (Cross-sectional dispersion measures the spread of asset returns or, in the case of the S&P 500 Index, the tendency of individual company returns to diverge from the average index return.) As the chart below shows, we found that periods of rising volatility and heightened cross-sectional dispersion coincided with manager outperformance in large-cap U.S. stocks. (click to enlarge) Looking forward, both volatility and cross-sectional dispersion are likely to eclipse the levels experienced in the past few years for large-cap U.S. stocks. This means that, in an environment where returns are harder to come by, investors may want to consider an active manager to source some returns and take idiosyncratic risk. That said, we’re not advocating that investors abandon the benchmark-replicating approach. With bull market and economic expansion more mature, blending active management exposures – whether through actively-managed exchange-traded funds (ETFs), multi-asset managers, traditional active equity managers or other sources – with benchmark-replicating vehicles will become increasingly important for meeting return objectives and controlling risk. The bottom line: The more muted return prospects for traditional assets from here and rocky road ahead warrant a more thoughtful approach to blending active and passive investing in a portfolio . Kurt Reiman, a Global Investment Strategist at BlackRock working with Chief Investment Strategist Russ Koesterich, contributed to this post. This post originally appeared on the BlackRock Blog.

Differentiating Between Emerging Markets For Better Returns

Summary Emerging markets are often grouped together, but it’s better not to. Changes in monetary policies may be upon us and some countries should do better than others. Countries with sizable deficits are more likely to experience problems and should be avoided. The year 2015 has been a forgettable one so far for many emerging markets. For instance, the iShares MSCI Emerging Markets ET F (NYSEARCA: EEM ), which is the leading ETF for emerging markets is down by 11 percent this year when it comes to liquidity. By comparison, stock markets in countries such as the U.S. and Japan are at record levels. Some people may therefore feel that emerging markets are more of a bargain and have more upside still left in them. A long position in emerging markets is an option worth exploring from this standpoint. On the other hand, some may argue that the worst is not over for emerging markets and there is still some downside left. Avoiding long positions or even initiating short positions in emerging markets is the way to go if one agrees with this viewpoint. A third option is to break down emerging markets into smaller groups and pick the one that is most likely to do well in the future. The group that is most likely to underperform is to be avoided or even shorted as an alternative or as an addition to long positions in emerging markets. How to differentiate between emerging markets While they may be grouped together under a single name, the fact remains that emerging markets are more often than not very different from one another. Some countries have little if anything in common with other emerging markets despite all of them being referred to as emerging markets. It may therefore be a good idea to think of emerging markets not as a single group, but rather as several distinct groups. There are many ways one could divide emerging markets into separate groups. For instance, some may be democratic countries, while others are more autocratic. Some rely heavily on the export of raw commodities, while others depend on the export of manufactured goods. There are lots of options if one wants to break down emerging markets into smaller groups. However, one way that should be given extra consideration is to divide countries based on whether they run a surplus or a deficit. More specifically, does a country run a current account surplus or a current account deficit and why should it matter? Why it matters whether countries have a current account surplus or deficit Countries with significant current account deficits tend to borrow heavily relative to the size of their economy, usually from foreign sources of capital. For many years, this wasn’t such a big issue due to the prevalence of very low interest rates in the U.S. This forced many to look at alternative places with higher yields. Many emerging markets offered such a destination. However, the Federal Reserve is widely expected to begin raising interest rates, which will make it more expensive to borrow. Monetary conditions have actually already tightened even though the policy of zero interest rates is technically not yet over. Capital outflows have picked up in a number of emerging markets as foreign capital is anticipating the next move by the Fed. In this environment where borrowing is increasingly problematic, countries with a current account surplus should be more resilient to higher interest rates than those with chronic deficits. The latter will have to make more adjustments to the existing structure of their economy than the former and this may cause a divergence in how countries perform going forward. Deficit countries do have a number of options when it comes to dealing with higher interest rates. For instance, they could try to reduce their imports and the need for hard currency to pay for these imports. Large reserves can also provide relief. Even so, surplus countries should have a much easier time as their transition period should be shorter and less complicated than those that have to fix or at least try to reduce their deficits. A major advantage for the former in comparison to the latter. Emerging markets ranked by surplus or deficit The table below lists 15 of the most prominent emerging markets, starting from those with the largest current account surplus to those with the biggest deficit. These countries combined make up 96.33 percent of EEM. Based on these numbers, Taiwan should have the least amount of trouble dealing with the Fed raising interest rates. South Africa is the one that looks the most vulnerable as of right now. Mexico may have a bigger deficit, but it’s also a bigger economy. Country GDP Current account surplus/deficit (USD) Taiwan 489B 19.67B South Korea 1410B 10.61B Russia 1861B 5.4B Thailand 374B 1.56B Malaysia 327B 1.21B Philippines 285B 0.95B China 10360B 0.63B Turkey 800B 0.09B Poland 548B -0.96B Chile 258B -2.59B Indonesia 889B -4.01B Brazil 2346B -4.17B India 2067B -6.2B South Africa 350B -8.68B Mexico 1283B -8.86B How to position yourself with regard to emerging markets One drawback of an ETF such as EEM is that it can get dragged down by a few bad apples. Some countries may do very well within the basket, but their performance can get negated by other countries that are doing poorly. A possible solution to this issue would be to take out the bad apples and leave only the good ones. If someone agrees with the thesis that emerging markets with big deficits will have a harder time with higher interest rates, then it’s best to avoid these countries and stick with the ones that run sizable surpluses. The latter are much less likely to experience any setbacks resulting from changes in global monetary policies. As such, they’re more likely to outperform resulting in better returns.

Valuation Dashboard: Industrials – Update

Summary 4 key fundamental factors are reported across industries in the Industrial sector. They give valuation status of an industry relative to its historical average. They give a reference for picking stocks in each industry. This is part of a monthly series of articles giving a valuation dashboard in sectors and industries. The idea is to follow up a certain number of fundamental factors for every sector, to compare them to historical averages. This article covers Industrials. The choice of the fundamental ratios used in this study has been justified here and here . You can find in this article numbers that may be useful in a top-down approach. There is no analysis of individual stocks. You can refine your research reading articles by industry experts here . A link to a list of stocks to consider is provided in the conclusion. Methodology Four industry factors calculated by portfolio123 are extracted from the database: Price/Earnings (P/E), Price to sales (P/S), Price to free cash flow (P/FCF), Return on Equity (ROE). They are compared with their own historical averages “Avg”. The difference is named with a prefix “D” before the factor’s name (for example D-P/E for the price/earnings ratio). It is measured in percentage for valuation ratios and in absolute for ROE. The industry factors are proprietary data from the platform. The calculation aims at eliminating extreme values and size biases, which is necessary when going out of a large cap universe. These factors are not representative of capital-weighted indices. They are useful as reference values for picking stocks in an industry, much less for ETF investors. Industry valuation table on 11/25/2015 The next table reports the 4 industry factors. For each factor, the next “Avg” column gives its average between January 1999 and October 2015, taken as an arbitrary reference of fair valuation. The next “D-xxx” column is the difference between the historical average and the current value, in percentage. So there are 3 columns relative to P/E, and also 3 for each ratio. P/E Avg D- P/E P/S Avg D- P/S P/FCF Avg D- P/FCF ROE Avg D-ROE Aerospace&Defense 22.02 18.02 -22.20% 1.19 1.02 -16.67% 21.02 21.28 1.22% 7.89 9 -1.11 Building Products 28.48 20.14 -41.41% 1.28 0.64 -100.00% 33.72 22.38 -50.67% 9.91 6.07 3.84 Construction&Engineering 23.7 18.3 -29.51% 0.43 0.48 10.42% 18.32 19.81 7.52% 2.76 5.98 -3.22 Elec.Equipment 21.46 18.31 -17.20% 1.51 1.64 7.93% 27.36 21.88 -25.05% -8.4 -3.3 -5.1 Ind. Conglomerates 41.07 20.45 -100.83% 2.54 1.3 -95.38% 33.63 29.98 -12.17% 1.88 12.12 -10.24 Machinery 19.26 18.25 -5.53% 1.09 0.9 -21.11% 27.38 21.81 -25.54% 9.65 8.72 0.93 Trading Companies&Distri 15.36 17.14 10.39% 0.6 0.7 14.29% 12.99 25 48.04% 9.18 8.61 0.57 Commercial Services&Supplies 22.1 20.86 -5.94% 1.17 1.03 -13.59% 24.19 19.84 -21.93% 2.15 3.99 -1.84 Professional Services* 23.25 24.04 3.29% 1.46 1.22 -19.67% 21.24 17.43 -21.86% 7.36 3.09 4.27 AirFreight&Logistics 23.07 21.06 -9.54% 0.66 0.57 -15.79% 21.72 32.87 33.92% 11.93 11.12 0.81 Airlines 12.46 15.18 17.92% 0.97 0.41 -136.59% 19.15 12.37 -54.81% 34.11 3 31.11 Marine** 12.92 14.04 7.98% 0.81 1.41 42.55% 15.89 23.27 31.71% -15.58 6.05 -21.63 Road&Rail 16.88 19.17 11.95% 1.22 0.86 -41.86% 34.67 36.17 4.15% 16.97 9.43 7.54 Transport Infrastructure** 7.01 23.6 70.30% 1.06 1.19 10.92% 5.37 20.8 74.18% -1.33 -3.22 1.89 *Professional Services: Avg since 2008. **Factors may vary a lot for some industries with a low number of stocks or a lot of outliers. Valuation The following charts give an idea of the current status of industries relative to their historical average. In all cases, the higher the better. Price/Earnings: Price/Sales: Price/Free Cash Flow: Quality (ROE) Relative Momentum The next chart compares the price action of the SPDR Select Sector ETF ( XLI ) with SPY (chart from freestockcharts.com). (click to enlarge) Conclusion Industrials have slightly out-performed the broad market in the last 3 months, but underperformed it in the last 6 months. The 5 most prominent S&P 500 industrial companies in the recent rally have been General Electric (NYSE: GE ), Southwest Airlines (NYSE: LUV ), Norfolk Southern Corp (NYSE: NSC ), Raytheon (NYSE: RTN ), United Rentals (NYSE: URI ). LUV and RTN have hit new all-time highs, GE is close to its 2008 top. At industry level, Trading Companies and Transport Infrastucture are the only 2 industries with the 3 valuation ratios pointing to underpricing, and a quality level above the historical average. The industries with an improvement in valuation factors since last month are Trading Companies, Commercial Services and Supplies, Marine. There may be quality stocks at a reasonable price in any industry. To check them out, you can compare individual fundamental factors to the industry factors provided in the table. As an example, a list of stocks in Industrials beating their industry factors is provided on this page . If you want to stay informed of my updates on this topic and other articles, click the “Follow” tab at the top of this article.