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Stocks Or Bonds?

I was writing to potential clients when I realized that I don’t have as much to write about my bond track record as I do my track record with stocks. I jotted down a note to formalize what I say about my bond portfolios. One person I was writing to asked some detailed questions, and I told him that the stock market was likely to return about 4.5%/year (not adjusted for inflation) over the next ten years. The model I use is the same one as this one used by pseudonymous Philosophical Economist . I don’t always agree with him, but he’s a bright guy, what can I say? That’s not a very high return – the historical average is around 9.5%. The market is in the 85th-90th percentiles of valuation, which is pretty high. That said, I am not taking any defensive action yet. Yet. But then it hit me. The yield on my bond portfolio is also around 4.5%. Now, it’s not a riskless bond portfolio, as you can tell from the yield. I’m no longer running the portfolio described in Fire and Ice . I sold the long Treasuries about 30 basis points ago. Right now, I am only running the credit-sensitive portion of the portfolio, with a bit of foreign bonds mixed in. Why am I doing this? I think it has a good balance of risks. Remember that there is no such thing as generic risk . There are many risks. At this point, this portfolio has a decent amount of credit risk, some foreign exchange risk, and is low in interest rate risk. The duration of the portfolio is less than 2, so I am not concerned about rising rates, should the FOMC ever do such a thing as raise rates. (Who knows! The economy might actually grow faster if they did that. Savers will eventually spend more.) But 10 years is a long time for a bond portfolio with a duration of less than 2 years. I’m clipping coupons in the short run, running credit risk while I don’t see any major credit risks on the horizon aside from weak sovereigns (think the PIIGS), student loans, and weak junk (ratings starting with a “C”). The risks on bank loans are possibly overdone here, even with weakened covenants. Aside from that, if we really do see a lot of credit risk crop up, stocks will get hit a lot harder than this portfolio. Dollar weakness and US inflation (should we see any) would also not be a risk. I’ve set a kind of a mental stop loss at losing 5% of portfolio value. Bad credit is the only significant factor that could harm the portfolio. If credit problems got that bad, it would be time to exit, because credit problems come in bundles, not dribs and drabs. I’m not doing it yet, but it is tempting to reposition some of my IRA assets presently in stocks into the bond strategy. I’m not sure I would lose that much in terms of profit potential, and it would increase the overall safety of the portfolio. I’ll keep you posted. That is, after I would tell my clients what I am doing and give them a chance to act, should they want to. Finally, do you have a different opinion? You can email me, or you can share it with all of the readers in the comments. Please do. Disclosure: None.

The Long Norway/Short Sweden Pairs Trade – Still Viable In Light Of Declining Markets?

Macro, currencies, arbitrage, statistical analysis “}); $$(‘#article_top_info .info_content div’)[0].insert({bottom: $(‘mover’)}); } $(‘article_top_info’).addClassName(test_version); } SeekingAlpha.Initializer.onDOMLoad(function(){ setEvents();}); Norway’s stock market has come under short-term pressure owing to growth concerns arising from lower oil prices. I still maintain that Norway’s stock market is undervalued relative to Sweden’s. However, it could take longer than anticipated for the Norwegian market to reach fair value. On June 3 , I had published an article arguing that a possible pairs trading opportunity exists through taking a long position on the Norwegian stock market through the iShares MSCI Norway Capped ETF (BATS: ENOR ) and a short position on the Swedish stock index through the iShares MSCI Sweden Index Fund* (NYSEARCA: EWD ). However, for this month we have seen the Norway ETF decline by 3.35 percent from $25.02 to $24.18, while the Swedish ETF has also declined by 2.57 percent from $34.97 to $34.07. The drop in Swedish stock market performance was not surprising and in line with my initial expectations. I had previously anticipated that lower than expected growth could translate to lower stock market returns as a result, and this has been the case for the month of June; with the consumer confidence indicator falling to 97.9 this month from a previous 99.0 in May. However, the decline in Norwegian stock market activity was less anticipated. Firstly, it appears that the Norwegian economy as a whole is still sensitive to oil price fluctuations, as the overnight deposit rate was cut to 1 percent this month as the effects of lower oil prices begin to take their toll on economic growth. Moreover, while lower wage growth remains a concern, house prices continue to rise in Norway which may give rise to speculation of a credit bubble similar to that of Sweden. For instance, it is anticipated that on the whole, Norwegian citizens now owe creditors twice as much as they make in disposable incomes. Additionally, house prices have increased by 7.5 percent in May from the previous year. In this regard, does the aforementioned pairs trading strategy still hold merit? It does if you have patience. Norway’s stock market remains undervalued on a P/E basis, and a major reason behind my bullish view on Norway was that various companies in the oil and financial sectors trade at lower than average P/E ratios while continuing to show impressive returns. However, it could take longer than anticipated for fair value to be reached as Norway grapples with short-term economic problems. In this context, this pairs trading strategy is best oriented over a longer-term horizon; i.e. 1 year or longer. *Note: The iShares MSCI Sweden Index Fund is not an inverse ETF and an investor would need to short-sell to take a short position in this instance. 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. Share this article with a colleague

Solid Growth Outlook Is One Reason Among Many To Buy PPL Corp.

Summary Growth investments directed at becoming a regulated utility company and recent competitive business spin-off will ensure earnings growth in the years ahead. Transformation into 100% regulated utility will ensure cash flow stability and strengthen EPS. PPL currently offers an attractive dividend yield of 4.90%, and remains on track to consistently increase dividends in years ahead. I reiterate my bullish stance on PPL Corporation (NYSE: PPL ); the company is moving ahead with its long-term growth generating investments in order to better its operational performance and keep its financial growth momentum healthy. Moreover, with the completion of its competitive business unit spin off, PPL has increased its focus on regulated utilities, which will mean more upside for its future earnings growth. Considering the fact that the company has been improving its regulated operations and is continuing with growth investments to expand them further, I believe PPL’s cash flows will remain strong in the years ahead, which will ensure the sustainability of its future dividend payments. Furthermore, the company’s future dividend growth is expected to improve. Growth Initiatives Remain On Track In the recent past, utility companies have been making infrastructure development spending to expand their operational bases. As per EIA reports, utility companies’ growth investments will help increase electricity generation in the U.S. by 1.1% and 0.9% in 2015 and 2016, respectively. Moreover, EIA reports have predicted that the increased generation capacity will help utilities raise retail residential prices in 2015 by 1.1% and in 2016 by 1.8%. Given this constructive utility sector’s rate outlook, I believe that utility companies will continue with their infrastructure development projects, which will portend well for earnings and cash flow growth of the industry in the years ahead. As far as PPL is concerned, under its robust strategic growth efforts, the company has been making growth investments towards the development of its transmission and distribution networks in order to capitalize on the available growth potentials. In the past decade, PPL had invested almost $4.7 billion for network rebuilding and up-gradation and it expects to make an additional $5.7 billion of investment over the next five years. As part of its growth investment plan, the company had previously invested in the Susquehanna-Roseland power project, which will strengthen its regulated transmission operations in the region. Moreover, the $1.4 billion power-line construction project will benefit the customers by delivering them power without putting an extra burden on other regional power lines. Moreover, PPL’s $563 million worth Kentucky-based combined natural gas cycle plant Cane Run 7 will be operational soon. These ongoing investments in construction projects will serve as an important means of regulated rate base growth in the years ahead, which will benefit the company’s top-line and will strengthen its cash flows. The following chart shows that PPL’s management expects healthy, regulated rate base growth over the next five years. Source: Company’s Earnings Presentation Making its moves towards generating regulated rate base growth, PPL has filed a rate base increase case with the Pennsylvania Utility Commission (PUC) on an estimated ROE of 10.95%; if approved, the rate hike will add revenues of almost $167.5 million per year, after coming into effect on 1st January 2016. I believe that the rate increase will in fact improve its cash flows, which will back its ongoing growth investments. Moreover, the company, combined with other parties of LG&E and KU generation stations, has reached a settlement agreement of raising electric and gas rates by $132 million. Effective from 1st July 2015, the new rate hike will help it recover the cost of constructing Cane Run natural gas plant and will better its long-term earnings growth prospects. Furthermore, as part of its plan to focus on a broader regulated asset base, PPL recently completed the spinoff of its competitive energy business by combining with River Stone Holdings, and formed a separate entity named Talen Energy Corporation. I believe that after the spinoff, PPL being solely focused on regulated asset base, will strengthen its top-line and bottom-line numbers, and its cash flow certainty will improve, which will support its dividend growth. Safe & Sustainable Dividends PPL has been making attractive cash returns to its shareholders by regularly returning cash flows in the form of dividends. During 1Q’15, dividend payments made by the company were $250 million, up 6.8%, year-over-year. Moreover, PPL had recently announced its quarterly dividend payment of $0.3725 per share , which translates into a healthy dividend yield of 4.90% . Moving ahead, AEP’s cash flow will improve, which will help PPL make regular dividend payments. Owing to the company’s correct growth measures, I believe the company’s future cash flows will remain strong, which will allow the company to consistently increase dividends. Guidance Due to the company’s strong financial performance and due to its attractive, planned infrastructure development projects, the management’s confidence in PPL’s earnings growth prospects have been restored, due to which they have reiterated their previously earnings guidance. The company continues to believe that its EPS for full year 2015 will remain in a range of $2.05-to-$2.25 . Moreover, PPL’s management remains confident about achieving its long-term annual earnings growth rate 4%-to-6%. Risks The company’s future financial performance remains exposed to a risk of increase in regulatory restrictions. Moreover, any laxness shown by the management during the execution of its well thought-out capital expenditure plan will hurt PPL’s long-term earnings growth potentials. In addition, unforeseen negative economic changes, currency headwinds and unfavorable weather changes are key risks that might hamper the company’s future stock price performance. Conclusion I am bullish on PPL; the company has an attractive growth outlook. PPL’s growth investments directed at becoming a regulated utility company, and the recent competitive business spin-off have directed it in the direction of earning better revenues and experiencing earnings growth in the years ahead. In fact, transformation into a 100% regulated utility will ensure cash flow stability and strengthen its EPS, which makes it attractive for dividend-seeking investors. The company currently offers an attractive dividend yield of 4.90%, and remains on track to consistently increase dividends in the years ahead. 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.