Tag Archives: stocks

Market Lab Report – Premarket Pulse 12/14/15

Major averages took it on the chin Friday on higher volume. The S&P 500 and NASDAQ Composite both broke below major support levels as the S&P dove below its 200-day moving average and the NASDAQ its 50-day moving average. Oil and other commodities continued their downtrends due to lack of demand in the face of a looming global recession combined with oversupply as OPEC voted to maintain current production levels. High-yield “junk” bonds also had a nasty day as one major high-yield fund moved to liquidate while simultaneously blocking investors from redeeming their stakes in the fund. Thus the markets are suffering crisis situations on several different levels. Such days as that seen Friday have preceded eventual major sell offs in the US stock market that often materialize within a few months or less. The Federal Reserve concludes its meeting this Wednesday. The market assumes it will raise rates, but with the recent weakness in the markets and ongoing weakness in the global economy, the Fed may have no choice but to hold off on any rate hikes. Updates on the Models VIX Volatility Model based on long term tests shows substantial profits overall. That said, all strategies go through periods of drawdowns. Such periods fortunately have not lasted longer than typically a few months. The model’s current drawdown started in early September, shortly after the model was shared on the website. Here’s an update we provided on October 23: http://www.virtueofselfishinvesting.com/reports/view/important-update-on-vix-volatility-model-vvm Based on back tests going back many years, I expect this difficult period to come to an end sooner than later. That said, the past cannot always predict the future, so patience during prolonged periods of difficulty is warranted. VIX Volatility Model remains in cash for now as the markets have been very noisy. While constructive volatility can yield steep gains such as in 2011 or more recently earlier this year, it is best to wait out the brief periods where the model does not have the odds on its side. The model needs to see advantage before issuing a buy or sell signal. While US markets this year have been unusually trendless, much of it has been surprisingly profitable with respect to the model’s performance tests. While the model remains in beta for now, the last three signals occurred after the fail safes were implemented. Total loss was just -2.8%. It is constructive that members can see how the model performs under one of the most challenging environments. So despite the noisy markets, and despite the three signals being losers, the total loss came to just -2.8% as expected based on backtests. Meanwhile, the model has had healthy gains prior to August of this year in backtests after the fail-safes were worked into the strategy. While this year has been one of the most challenging for market timing and hedge funds of all stripes, such periods always come to an end. When it comes to the markets, the only thing that doesn’t change is change. MDM is longer term so to avoid getting whipsawed repeatedly, especially in a year such as this one, it stays on its signals longer than normal. Do look at its overall long term track record vs the Nasdaq and S&P 500 to gain a clearer picture on the models strengths and weaknesses. When it comes to catching intermediate to longer term trends, the model will get whipsawed like it has this year. Also, in the last couple of years, the markets have become far more manipulated by central banks thus shallow floors form even when all signs point to a much worse correction. Likewise, normal sustained uptrends have also been nearly non-existent. Sharp moves in either direction often come without warning off lows or off highs which explains why this year has been one of the most challenging in decades. Thus our greater focus on individual stocks and, more recently, the VIX Volatility Model given its performance up through August of this year with the implemented fail-safes. Note, the reports emailed out on the VIX model prior to the last three signals did not contain the implemented fail-safes as we have discussed in a prior VIX model update.

High Dividend Yield ETFs Deserve Further Inspection

Summary These four dividend ETFs include 3 with extremely high dividend yields for an equity fund without REITs. SDOG comes up as my favorite after I looked through the allocation strategies each fund was using. FVD reports a net expense ratio of .65% in their fact sheet. Yahoo reports a .70% net ratio for the fund. With the exception of SDOG, the ETFs currently have very high allocations to the consumer defensive sector and the utility sector. One of the areas I frequently cover is ETFs. I’ve been a large proponent of investors holding the core of their portfolio in high quality ETFs with very low expense ratios. The same argument can be made for passive mutual funds with very low expense ratios, though there are fewer of those. In this argument I’m doing a quick comparison of several of the ETFs I have covered and explaining what I like and don’t like about each in the current environment. Ticker Name Index SDOG ALPS Sector Dividend Dogs ETF S-Network® Sector Dividend Dogs Index FDL First Trust Morningstar Dividend Leaders Index ETF Morningstar Dividend Leaders Index PEY PowerShares High Yield Equity Dividend Achievers Portfolio ETF NASDAQ US Dividend Achievers® 50 Index FVD First Trust Value Line Dividend ETF Value Line(R) Dividend Index By covering several of these ETFs in the same article I hope to provide some clarity on the relative attractiveness of the ETFs. One reason investors may struggle to reconcile positions is that investments must be compared on a relative basis and the market is constantly changing which will increase and decrease the relative attractiveness. Dividend Yields I charted the dividend yields from Yahoo Finance for each portfolio. The First Trust Value Line Dividend ETF is the weakest of the batch on dividend yields. The yield isn’t weak overall, but it is lower than I would have expected. (click to enlarge) Expense Ratios The expense ratios run from .40% to .70% according to Yahoo Finance. (click to enlarge) I thought the expense ratio for FVD seemed a little too high at .70% so I decided to pull up their Fact Sheet through MorningStar which indicates a net expense ratio of .65%. For consistency sake I’ve stuck with the values reported by Yahoo in the chart, but it appears the fund is reporting a lower net expense ratio. I also checked the ETF through Charles Schwab and saw a .65% ratio there. Sector I built a fairly nice table for comparing the sector allocations across dividend ETFs to make it substantially easier to get a quick feel for the risk factors: (click to enlarge) First Glance FDL and PEY get some immediate respect from me for their very high allocations to the consumer defensive sector. It is also notable that FLD, PEY, and FVD all use heavy allocations to utilities. While several dividend ETFs include at least some allocation to real estate, there was a 0% allocation for the first 3 ETFs. As we get into ETFs with higher expense ratios, it is worth noting that many may have more complicated weighing structures that will materially vary over time and therefore the investor needs to either buy in completely to the strategy of the fund or keep an eye on the sector allocations or both to prevent becoming overweight on specific sectors. SDOG SDOG uses the most even allocation strategy out of all the funds. I have to admit that I like that part of their strategy. I wondered if that was random chance or if the company was doing it intentionally, so I pulled up the quarterly factsheet . It turns out that this is an intentional choice and that the portfolio is designed to maintain that allocation: “SDOG provides high dividend exposure across all 10 sectors of the market by selecting the five highest yielding securities in each sector and equally weighting them. This provides diversification at both the stock and sector level.” FDL The allocations for FDL feel pretty heavy on communication services to me, but each fund here changes their positions materially over time. The process for building the index includes a “Proprietary multi-step screening process”. There are a couple other comments, but in general it seems the system is designed to create a bit of a black box. Investors that want to read further into it can check out the fact sheet . PEY PEY is based on the NASDAQ U.S. Dividend Achievers 50 Index. Both the fund and index are reconstituted each year in March and the positions are rebalanced on a quarterly basis. Again, it is possible for the sector allocations to change materially which makes it important to look into the positions regularly. I appreciate funds that opt for a strategy with more rationality behind it than “the portfolio is market-cap weighted, we don’t do anything”. On the other hand, when the fund does not appear to be using strict sector weight limits it creates some risk of having more concentration than I would want in the portfolio. The yield is great and I really like the current allocations, but there is a material risk of the portfolio changing significantly in March. On the positive side, since the index is only reconstituted once in March each year investors can take a look at which securities were selected and decide if they feel comfortable holding that portfolio. If the investor believes in rebalancing, then the expense ratio on the fund may be significantly cheaper than the commissions the trader would incur. FVD The allocation process for FVD is also fairly complex. The index is based on whittling down the available universe of stock securities based on their Value Line® Safety Rating. After the available universe has been screened, the fund picks the companies with dividend yields that are higher than average for the S&P 500. To avoid allocation to smaller companies, anything with a market cap below $1 billion is removed from consideration. What do You Think? After looking through the allocation strategy for each fund, I think SDOG is my favorite of the batch. Which dividend ETF makes the most sense for you?

Vanguard’s Total Bond Market ETF Is A Great Fund For Investors Seeking Higher Quality

Summary BND offers a very low expense ratio that allows the interest to reach shareholders. The biggest risk factor for the fund is the diverging interest rate policies in the U.S. and Europe leading to potentially higher levels of volatility in rates. The exposure to MBS is unfortunate given the options investors have for using mREITs to acquire MBS at a discount to book value. Vanguard Total Bond Market ETF (NYSEARCA: BND ) is a solid bond fund. As I’ve been searching for appealing bond funds, I’ve found some of my favorites are from Vanguard. Given my distaste for high expense ratios, it should be no surprise that the Vanguard products would be appealing. Some funds are able to offer low expense ratios and mitigate their risks by strictly dealing in the most liquid bonds where pricing is most likely to be efficient and relying on the market to ensure that the risk/return profile is appropriate. Generally I favor ETFs that have low expense ratios and strictly deal in highly liquid bonds where the pricing will be more efficient. The expense ratio for BND is a .07%. This is one of the funds that falls into my desired strategy of using highly liquid securities and a very low expense ratio to rely on the efficient market to assist in creating fair values for the bonds. Yield The yield is 2.45%. The desire for a higher yield should be fairly easy for investors to understand. Bond funds that offer a higher yield are offering more income to the investor. Unfortunately, returns are generally compensating for risk so higher yield funds will usually require an investor either take on duration risk or credit risk. In many situations, an investor will take on a mix of the two. Junk bond funds generally carry a high degree of credit risk but low duration risk while longer duration AAA corporate funds have only slight to moderate credit risk combined with a significant amount of duration risk. Theoretically treasuries have zero credit risk and long duration treasuries would have their risk solely based on the interest rate risk. The yield for BND is coming primarily from the interest rate risk on the fund. The average duration is 5.8 years and the average effective maturity is 8 years. Fluctuations in the interest rate environment will be a major source of changes in the fair value of the fund. Duration The following chart demonstrates the sector exposure for this bond fund: At the present time I’m concerned about taking on duration risk in early December because of the pending FOMC (Federal Open Market Committee) meeting. I believe it is more likely than not that we will see the first rate hike in December. I think a substantial portion of that probability has already been priced into bonds, so investors willing to take the risk prior to the meeting could see significant gains if the Federal Reserve does not act. The very interesting thing we are seeing in the interest rate environment today is a divergence in policy between the domestic interest rates and the interest rates in Europe established by the ECB (European Central Bank). The ECB has announced another decrease in their short term rates to negative .30% while the Federal Reserve is planning to increase short term rates. That disconnect is going to make bond markets very interesting over the next few years. Credit Risk The following chart demonstrates the credit exposure for this bond fund: High quality corporate debt may often show significant correlation to treasuries but it offers higher yields. The biggest weakness for a high quality corporate debt fund is the fact that some bonds may still fall into lower credit quality and eventually default. Even if the fund sells the bonds before they default, they will receive a much lower fair value for those bonds when the market assess that the bond is riskier. I find high credit quality corporate debt to be a fairly attractive space for bond investing because it offers higher yields than treasuries but is unlikely to suffer from high default levels. By combining high credit quality corporate debt with treasury positions BND is able to create a higher yield than the fund would otherwise have while maintaining exceptionally high credit quality overall. The one notable concern I have in this regard is that over 20% of their “U.S. Government” debt is coming through the form of mortgages, and investors have access to mREITs that are trading at enormous discounts to book value. Conclusion I’m not a fan of holding the MBS at book value, but other than that I find the fund to be a solid choice for bond investors. It offers a reasonable yield for the very low credit risk on the fund and a very low expense ratio so the interest from the securities is actually reaching the shareholders. The biggest risk here, in my opinion, is the challenges we may see in the interest rate environment as the United States and Europe intentionally move in the opposite directions.