Tag Archives: stocks

Dual ETF Momentum September Update

Scott’s Investments provides a free “Dual ETF Momentum” spreadsheet which was originally created in February 2013. The strategy was inspired by a paper written by Gary Antonacci and available on Optimal Momentum . Antonacci’s book, Dual Momentum Investing: An Innovative Strategy for Higher Returns with Lower Risk , also details Dual Momentum as a total portfolio strategy. My Dual ETF Momentum spreadsheet is available here , and the objective is to track four pairs of ETFs and provide an “Invested” signal for the ETF in each pair with the highest relative momentum. Invested signals also require positive absolute momentum, hence the term “Dual Momentum.” Relative momentum is gauged by the 12-month total returns of each ETF. The 12-month total returns of each ETF is also compared to a short-term Treasury ETF (a “cash” filter) in the form of iShares Barclays 1-3 Treasury Bond ETF (NYSEARCA: SHY ). In order to have an “Invested” signal, the ETF with the highest relative strength must also have 12-month total returns greater than the 12-month total returns of SHY. This is the absolute momentum filter which is detailed in depth by Antonacci, and has historically helped increase risk-adjusted returns. An “average” return signal for each ETF is also available on the spreadsheet. The concept is the same as the 12-month relative momentum. However, the “average” return signal uses the average of the past 3, 6, and 12 (“3/6/12″) month total returns for each ETF. The “invested” signal is based on the ETF with the highest relative momentum for the past 3, 6 and 12 months. The ETF with the highest average relative strength must also have an average 3/6/12 total returns greater than the 3/6/12 total returns of the cash ETF. Portfolio123 was used to test a similar strategy using the same portfolios and combined momentum score (“3/6/12″). The test results were posted in the 2013 Year in Review and the January 2015 Update. Below are the four portfolios along with current signals: (click to enlarge) As an added bonus, the spreadsheet also has four additional sheets using a dual momentum strategy with broker specific commission-free ETFs for TD Ameritrade, Charles Schwab, Fidelity, and Vanguard. It is important to note that each broker may have additional trade restrictions and the terms of their commission-free ETFs could change in the future. D isclosure: None. Share this article with a colleague

2 Sectors To Explore When Rates Rise

Though the recent market selloff and declining inflation expectations have lowered the probability of the Federal Reserve (Fed) raising rates right away, the exact timing of the hike isn’t as important as the market implications of moderately higher interest rates, which are expected to eventually arrive. While the recent market selloff and declining inflation expectations have lowered the probability of a September Federal Reserve (Fed) rate rise, “good enough” U.S. economic data still support Fed liftoff occurring later this year. However, the exact timing of the hike – September, December or even early 2016 – isn’t as important as the market implications of moderately higher rates, which are expected to come sometime soon. Though the Fed is likely to raise rates gradually, higher short-term rates will ripple through the markets and affect a wide range of financial assets, including stocks. The actual liftoff event will most likely lead to more short-term U.S. stock market volatility , so investors should expect a continued bumpy ride in the months ahead. That said, I do see potential opportunities in two particular U.S. sectors. Technology Sector Technology companies hold a staggering 40 percent of the total corporate cash reserves in the U.S., according to Forbes, so they’re much less vulnerable to rising rates than debt-laden firms, such as utilities, according to Bloomberg data as of 07/13/2015. Their strong cash positions mean they have the potential to continue on with their shareholder-friendly policies , such as share buybacks, dividend increases and M&A activity. In addition, while tech valuations have risen in recent months , current levels suggest that there may be additional room to run. As of last month, tech companies, as measured by the S&P 500 Information Technology Index, traded with a 6 percent price-to-earnings (P/E) discount to the S&P 500, well below the trailing 10-year average of a 12.7 percent P/E premium, according to Bloomberg data. Financials Sector (Excluding Rate-Sensitive REITs) For some financial institutions, namely banks, higher rates could potentially translate into higher revenues. In an environment of rising rates, the difference between what banks make from lending (their revenue) and what they pay for deposits (their costs) may increase, so banks potentially stand to increase profits. In addition, in anticipation of higher rates, many banks have begun to reposition their balance sheets toward variable rate loans, so they won’t be locked into low interest rates, and they’re hedging their interest rate exposure, according to banks’ most recent earnings reports and earnings calls with analysts. It’s also worth noting that U.S. financials were the bright star of second-quarter earnings – roughly 60 percent of financials beat revenue expectations, well above the overall sector average, according to Bloomberg data. Beyond strong earnings, financials also represent a relative bargain compared to some other sectors. For instance, the financial sector is still among the cheapest S&P 500 sectors in both P/E and price to book (P/B) terms, and its P/B ratio is just half that of the broad U.S. market, according to Bloomberg data. Finally, both U.S. technology and U.S. financials are cyclical sectors. When the economy is strong, as it tends to be in a rising rate environment, cyclical stocks typically outperform . In contrast, defensive sectors (think utilities) tend to outperform the broader U.S. market when economic growth slows, and as rates rise, they can be vulnerable, given that they may have significant debt loads. Exchange traded funds (ETFs), such as the iShares U.S. Technology ETF (NYSEARCA: IYW ) and the iShares U.S. Financial Services EFT (NYSEARCA: IYG ), can provide access to the U.S. Tech and U.S. Financials ex-REITs sectors. This post originally appeared on the BlackRock Blog.

Looking At SCHZ In The Context Of A Diversified Portfolio

Summary SCHZ has done an exceptional job of allocating the portfolio across different debt instruments. The maturities of the portfolio also offer a high degree of diversification. SCHZ is a great option for investors that want to use a larger allocation to bonds in their portfolio. Investors that only use a bond allocation for negative correlation to their equity investors may want to stick to long treasury securities. Investors should be seeking to improve their risk adjusted returns. I’m a big fan of using ETFs to achieve the risk adjusted returns relative to the portfolios that a normal investor can generate for themselves after trading costs. I’m working on building a new portfolio and I’m going to be analyzing several of the ETFs that I am considering for my personal portfolio. One of the funds that I’m considering is the Schwab U.S. Aggregate Bond ETF (NYSEARCA: SCHZ ). I’ll be performing a substantial portion of my analysis along the lines of modern portfolio theory, so my goal is to find ways to minimize costs while achieving diversification to reduce my risk level. Expense Ratio The expense ratio on SCHZ is only .05%. Since bond yields remain very low, it is especially important for bond funds to have very low expense ratios. A bond fund with weak yields on the securities and high expense ratios would offer investors a terrible investment. While the yields on SCHZ are limited as the portfolio holds a large amount of high quality debt in a market that is holding yields down, the low expense ratio remains a very attractive feature. Allocations The sector diversification within the ETF is very impressive for a bond fund. If an investor wanted to simply grab one bond portfolio, this would be an option for doing it all in a single purchase. My personal preference is to use more than one bond fund to make it easier to target different parts of the yield curve and create more diversification benefits for the portfolio, but I do think this is one of the better “one stop shopping” options. (click to enlarge) Maturity In addition to having a large degree of diversification within the type of debt instruments, the maturities of those instruments are also highly diversified to reduce volatility stemming from twists in the yield curve. (click to enlarge) Building the Portfolio I put together a hypothetical portfolio using only ETF’s that fall under the “free to trade” category for Charles Schwab accounts. My bias towards these ETFs is simple, I have my solo 401k there and recently moved my IRA accounts there as well. When I’m building a list of ETFs to consider I want to focus on things I can trade freely so that I can keep making small transactions to buy more when the market falls. Within the hypothetical portfolio there are no expense ratios higher than .18%. Just like trading costs, I want to be frugal with expense ratios. The portfolio is fairly aggressive. Only 30% of the total is allocated to bonds and I would consider that the weakest area in the portfolio. I’d like to see more bond options (with very low expense ratios) show up on the “One Source” list for free trading. (click to enlarge) A quick rundown of the portfolio The Schwab U.S. Dividend Equity ETF (NYSEARCA: SCHD ) is a dividend index. The Schwab U.S. Broad Market ETF (NYSEARCA: SCHB ) is a broad market index. The Schwab U.S. Large-Cap ETF (NYSEARCA: SCHX ) is focused on blended large cap exposure. The Schwab International Equity ETF (NYSEARCA: SCHF ) is developed international equity. The Schwab Emerging Markets ETF (NYSEARCA: SCHE ) is emerging market equity. The Schwab International Small-Cap Equity ETF (NYSEARCA: SCHC ) is developed small capitalization equity. The Schwab U.S. REIT ETF (NYSEARCA: SCHH ) is domestic equity REITs. is a remarkably complete bond fund. The SPDR Barclays Long Term Treasury ETF (NYSEARCA: TLO ) is a long term treasury ETF. The PIMCO 25+ Year Zero Coupon U.S. Treasury Index ETF (NYSEARCA: ZROZ ) is an extremely long term treasury ETF. Notice that the 3 international equity ETFs have only been weighted at 5% while the broad market index has been weighted at 25%. I find heavy exposure to international equity to bring more risk than expected returns so I try to keep my international exposure low. I prefer no more than 20% in international equity. Plenty of domestic companies already have enormous international operations so the benefit of international diversification is not as strong as it would be if the markets were isolated from each other. Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. When TLO and ZROZ post negative risk contribution it is because the negative correlation to most of the equity holdings results in the long term treasury ETFs reducing the total portfolio risk. In my opinion, this is the best argument for including them in the portfolio. Correlation The chart below shows the correlation of each ETF with each other ETF in the portfolio and with the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ). Blue boxes indicate positive correlations and tan box indicate negative correlations. Generally speaking lower levels of correlation are highly desirable and high levels of correlation substantially reduce the benefits from diversification. (click to enlarge) Conclusion SCHZ offers investors a remarkable amount of diversification within the holdings. The diversification can be seen in the allocations to different types of debt instruments and to different maturities. The weakness in this otherwise exceptional fund is that including non-treasury debt makes it more susceptible to weak performance when the market becomes more timid. The exposure to credit risk is represented by the correlation for SCHZ to major indexes like SCHB and SCHD running in the -.23 to -.27 range. Those are good negative correlations that improve risk adjusted returns across the portfolio, but the negative correlation is much weaker than it is for ETFs that are focusing on treasury securities like TLO or ZROZ. On the other hand, if an investor wants a simple option for grabbing diversified bond exposure with lower volatility, SCHZ stands out as a very solid option that can fit nicely into a wide variety of portfolios. The question an investor must answer in buying into a bond ETF is “What is the purpose of this allocation”? If the desire is low volatility for the fund while the investor collects the interest income, then SCHZ should be a strong candidate. If the investor is simply trying to acquire negative correlations to other equity positions, then using longer treasury securities make more sense. In my opinion, investors assigning a higher portion of the portfolio to bonds will benefit more from SCHZ because the low volatility of the fund will be more important. Investors focused heavily on equity and only using bonds for negative correlations may want to focus on longer treasuries that use more volatility and negative correlation to counteract negative movements in equity markets. I’ve been contemplating buying some SCHZ for my portfolio; however I’m also running a portfolio that is heavily overweight on equities and light on bonds which pushes me towards using the treasury options for the stronger negative correlations. Disclosure: I am/we are long SCHB, SCHD, SCHF, SCHH. (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: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.