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Friday, April 13, 2018

Unusual Times in the Markets

This bloomberg article entitled

The Global Trading Map Looks Really Confusing Right Now


 explains several of them.

One stood out to me the volatility of emerging markets stocks is lower than that of developed markets (which is of course largely made up of the US).


Monday, April 9, 2018

Beware "Thematic" (trendy) ETFs


One of the ETF strategies least likely to succeed is one based on a theme. A recent case in point  is the eventshares Republican Policies ETF

According to the sponsors:

The EventShares Republican Policies Fund’s investment objective is to seek capital appreciation by investing in market segments that the Advisor believes will be impacted by the enactment of Republican Policies.

The fund gives:


Access to a diversified basket of companies and industries aimed to benefit from Republican Policies. The portfolio is rebalanced to maintain its tailored exposure around political narrative changes.


To say the least the "political narrative" of the current administrations political/economic policy is not exactly consistent. So its not surprising that the current focus towards trade policy has left the people at eventshares scrambling to respond.

Bloomberg (via Financial Advisor Magazine) Investment News)


Confused by the Trump trade policies? You’re not alone.
An ETF that’s designed to own stocks affected by Republican policies sees more risk than opportunity in the president’s tariff showdown with China and is taking cover -- just like most of the rest of the market....
The ETF hasnt exactly been attracting assets...it holds under $1 million
And if you think the Democrats will take over the House and be able to push their policies you can "flip" your trade and buy the eventshares Democratic Policy ETF.
No they are not offering an eventshares political stalemate ETF.





Thursday, April 5, 2018

First Quarter 2018 Review


Market Review First Quarter 2018

Both equity and bond markets showed negative performance for the quarter. The bond market continued to show response to the Federal Reserve policy of raising interest rates. Equities showed the impact of both higher interest rates and uncertainty over future economic/political policies.
Equity markets:  Stock markets showed extreme volatility as market participants displayed uncertainty towards future fundamentals. But just as important was the consequence of the large concentration of the market increases in the past year of a handful of stocks particularly those referred to as FAAMG (Facebook, Apple, Amazon, Microsoft and Google.
The concentration of this movement means that the S+P 500 has an extremely large weighting in these stocks. Furthermore, stocks in the technology sector have also increased in weighting over the past years. The large holdings in these stocks also come from holders of sector ETFs and actively managed funds chasing performance. The consequence is that when there is a selloff in these stocks there is a cascade of selling followed in turn by momentum traders.
Among these stocks Facebook and Amazon (and perhaps Google) may face regulatory challenges that may justify some revaluation of their stock value. Otherwise the overall earnings prospects for the technology sector remains in place.
The fundamentals of the US economy also  remain in place. But the potential challenges from poorly thought out trade policies hang over the market.
In sum, greater volatility can be expected and further declines in the market not unexpected particularly given the tendency of the market to develop a momentum of its own.
Among “smart beta” factors momentum continued to show outperformance despite the selloff in technology in March. Value and Quality showed strong relative performance in March.

Major US Market Indices
Symbol
Category
1Q 2018
1 year
3 year
SPY
SP 500
-1.0%
13.8%
34.3%
Mtum
Momentum
3.0%
29.6%
54.5%
Prf
US Large Value
-2.7%
9.8%
27.4%
QUAL
US Quality
0.2%
15.7%
36.3%
USMV
US Minimum Volatility
-1.2%
10.8%
32.9%
VBR
US Small Value
-2.1%
8.3%
25.5%

International Stocks
Influenced less by changes in US bond markets Asian markets continued their trend of outperformance vs.US stocks. Emerging markets and particularly Asia based on current market conditions are attractively valued vs the rest of the world…. but of course, the future of US Asian trade policy makes forecasts difficult at best.
The overall European Union stocks continued recent outperformance vs the US. Changes in trade policy, albeit to a lesser extent impact outlooks here as well. The European Central Bank has not moved to a tightening mode which is a positive. Germany underperformed the overall European Union likely due to domestic political developments. European stocks have continued to perform the index of all deloped markets. Emerging Asia has continued to outperform the rest of emerging markets.
Major International Indices
Symbol
Category
1Q 2018
1 year
3 years
VWO
Total Emerging Markets
0.9%
21.6%
24.5%
EFA
Total Developed Markets
-0.2%
14.9%
18.0%
GMF
Emerging Asia
2.0%
25.2%
30.6%
EZU
European Union
-0.1%
17.4%
18.8%
EWG
Germany
-3.0%
13.8%
12.4%

Bond Market
The Federal Reserve raised interest rates for the fourth time this year on March 21, the first time umder the new Fed Chairman Powell. While it seems near certain further hikes will occur this year the pace is uncertain much dependent on future data on inflation and the overall economy. The yield on the ten-year Treasury bond hit 2.95% at the end of February the high for 2018. It ended 2017 at 2.45%. At the end of the quarter it fell a bit to 2.74%. Shorter term rates have risen as well in what is called a “flattening/flat yield curve (narrowing of the differential between 2 years and 10-year interest rates) the two-year treasury reached a high 0f 2.30% on March 19, up from 1.88% at the end of 2017 and ended the quarter at 2.25%
Even with this development in the yield curve the bond allocation in portfolios benefitted from the strategy of keeping maturities/duration short. Short term high yield continued to perform strongly reflecting positive prospects for the economy.
Major Bond Market Indices
Symbol
Category
1Q 2018
1 year
3 years
AGG
Aggregate US Bond Index
-1.5%
1.1%
3.6%
BSV
Aggregate Short-Term Bonds
-0.5%
0.1%
2.1%
VCSH
Short Term Corporate Bonds
-0.7%
0.7%
4.4%
vgsh
Short Term Government Bonds
-0.2%
-0.1%
1.0%
SJNK
Short Term High Yield Bonds
0.2%
3.7%
10.8%

Looking Forward
As JP Morgan was famously said to have replied when asked for his market forecast his response was “they will fluctuate”.
It seems highly likely that those fluctuations will continue to be above historical levels going forward. The concentration of holdings in a few stocks and in the technology, sector will have an outside impact on returns. The growth of momentum traders both institutional and individual (many using ETFs) will be a short-term factor. More fundamental factors such as the uncertainties over trade policy and future interest rate changes will affect markets as well. A year of low single digits or negative returns should not surprise investors given the outsize gains of recent years.
Of course, the fundamental advice to investors is, as always to be comfortable to the level of risk in their portfolio and to stay the course. Given that short term fluctuations are best ignored.

Tuesday, March 27, 2018

I'm Still Confused by Wealthfront's Direct Indexing and Tax Harvesting


Robo advisor Wealthfront makes much of its strategy of direct indexing" purchasing individual stocks instead of broad ETFs which in turn allows more opportunities for tax loss harvesting as individual stocks fall..rather than only making exchanges between broad ETFs that have essentially the same index (total stock market ETFs ITOT and VTI for example).

As Wealthfront describes the strategy:(my bold)

Wealthfront 100 (WF100), Wealthfront 500 (WF500), and the Wealthfront 1000 (WF1000)

We call the up to 100 individual stocks owned as part of our Direct Indexing service the Wealthfront 100. When Direct Indexing employs 500 or 1,000 individual stocks, we refer to that collection of stocks as the Wealthfront 500or the Wealthfront 1000 respectively.

The individual stocks we buy are always selected to minimize tracking error with Vanguard’s Total Stock Market ETF, VTI, not based on their fundamentals or any perspective on whether they are fairly valued by the market. We harvest losses on individual stocks based on a threshold and use the proceeds to purchase other highly correlated stocks within the appropriate US stock index.

In some cases, we may purchase more of an existing holding. For example, if Coca-Cola misses an earnings estimate and drops precipitously in value we would sell Coke and use the proceeds to buy more PepsiCo to maintain the correlation with VTI in the absence of Coca-Cola.


The above may sound nice in theory but I am confused about how it would be implemented even in the case of Coca Cola and Pepsi other than that they make some competing soft drinks they are quite different companies with a large part of Pepsi's earnings from snack foods.

But that is trivial compared to week the one the market had last week. Facebook, the second  largest holding in the total stock market index

Here is Facebook stock over the last week (a 14% fall). It's hard to imagine how a strategy of direct indexing and daily (or even intraday) would work with Facebook. Which stock would reliably be chosen that had the same correlation with Facebook ?


Friday, March 23, 2018

No 2017 Was Not a Stock (or Bond) Pickers Market


Standard and Poors quarterly publishes their SPIVA report comparing the performance of actively managed funds vs their indices. And despite the fact that the active managers eash year proclaim "it's a stock pickers' market..the numbers show otherwise.

From Investment News

The S&P Indices Versus Active (SPIVA) report for 2017 shows growth fund managers improved markedly compared to their performance six months earlier. Over the one-year period, 63.08% of large-cap managers, 44.41% of mid-cap managers, and 47.70% of small-cap managers underperformed the S&P 500, the S&P MidCap 400, and the S&P SmallCap 600, respectively.
That's the good news.
Over the past five years and the past 15 years, no more than 16% of managers in any category of actively managed U.S. mutual funds beat their respective benchmarks. In the longer term, the best records went to large-company value managers, who had a 29.56% success rate against their benchmark over the past 10 years and a 14.29% success rate in besting their bogies over the past 15 years.
As for international stock funds:
Only small-cap international funds beat their benchmarks over the past 12 months. The majority of managers in large-cap international funds and emerging markets funds lagged their benchmarks. And for any period longer than three years, most international funds lagged their indexes.

The SPIVA website is here with much more data.
Interestingly composing a "smart beta" porfolio did perform well compared to the overal market. A portfolio equal weighted to momentum (mtum), quality (QUAL) minimum volatility (USMV) and value VLUE outperformed the S+P 500 25.2% vs 21.7% for the S+P 500.
4 factor portfolio (green) S+P 500 Blue
4 factor portfolio (green) S+P 500 Blue (total return top volatility bottom)
Over a 3 year period  2014 - 2017 the 4 factor portfolio outperformed the S+P 500 64.4% to 58.1%

\________________________________________________________________________

Bond managers did not perform much better last year. The passive Barclay’s US Government/Credit Long index outperformed nearly 97 percent of active investment-grade long funds in 2017

Wednesday, March 21, 2018

Momentum ETF (MTUM) is not Full of FAANG (Facebook,Apple,Amazon, Netflix and Google)





Because of its name many may assume that the momentum ETF from Ishares (ticker) is top heavy with technology stocks and in particular the FAANG stocks (Facebook,Apple,Amazon,Netflix and Google.

In fact tht is not the case. The methodology setting the components takes into account volatility as well as upward price momentum. That is in contrast to cap weighted indices like the S+P 500 (SPY), Nasdaq (QQQ) and Technology indices (XLK) Although its largest sector is technology(36%)  It only includes one stock: Apple which has the lowest p/e of the group.

Here are the top 20 holdings in Mtum:


Name
Weight (%)
Sector
JPMORGAN CHASE & CO
5.2
Financials
MICROSOFT CORP
5.2
Information Technology
APPLE INC
4.75
Information Technology
NVIDIA CORP
4.32
Information Technology
BANK OF AMERICA CORP
4.15
Financials
BOEING
4.05
Industrials
VISA INC CLASS A
3.59
Information Technology
UNITEDHEALTH GROUP INC
3.59
Health Care
MASTERCARD INC CLASS A
3.17
Information Technology
ABBVIE INC
2.91
Health Care
CITIGROUP INC
2.74
Financials
MCDONALDS CORP
2.38
Consumer Discretionary
HOME DEPOT INC
2.28
Consumer Discretionary
3M
2.27
Industrials
ADOBE SYSTEM INC
2.07
Information Technology
PAYPAL HOLDINGS INC
1.99
Information Technology
ABBOTT LABORATORIES
1.63
Health Care
CATERPILLAR INC
1.55
Industrials
TEXAS INSTRUMENT INC
1.44
Information Technology
MICRON TECHNOLOGY INC
1.33
Information Technology


In fact that is not the case. The methodology setting the components takes into account volatility as well as upward price momentum Although its largest sector is technology(36%)  It only includes one stock of the FAANG among its top twenty holdings: Apple which has the lowest p/e of the group.

Mtum actually includes a far smaller % of its holdings in the FAANG stocks than the S+P 500 whose top holdings are below

And not at all surprisingly the Nasdaq has an even higher weighting of FAANG stocks which make up 37% of QQQ (Nasdaq 100 etf)


The technology ETF (XLK) has  31% of its holdings in FAANG  ( and this despite the fact that Amazon and Netflix are in consumer discretionary not technology).

Because of this differential MTUM is far less sensitive to moves in the FAANG stocks..or to any single stock that loses price momentum.

Mtum also puts a sell discipline on investors. As a stock loses upward price momentum it automatically comes out of the MTUM portfoilio
On the other hand whether or not to sell one's exposure to the technology sector either by selling SPY and diversifying into other "smart beta" ETFs, or selling QQQ or XLK leaves the investor with a timing decision. And we know all the behavior pitfalls in market timing and buy/sell decisions. In fact MTUM is "on the opposite side" of the panic sellers since it automatically adjusts and rebalances to reduce holdings of stocks without positive price momentum

As Facebook took its major drop of 7% on March 19 here is what MTUM,SPY,QQQ, and XLK have looked like since March 12 total return chart and bar chart of same data

SPY(green) MTUM(Black), QQQ(gold) XLK (blue)
_______________________________________________

Total Return (top) Volatility (Bottom)



SPY(green) MTUM(Black), QQQ(gold) XLK (blue)