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Sunday, June 30, 2013

No Surprise Here


Amid the recent turmoil in financial markets, investors are finding some refuge in cash, analysts say.
Bond and stock mutual and exchange-traded funds saw outflows of $19.96 billion in the week ended Wednesday, according to Thomson Reuters unit Lipper. This data covers funds that report weekly.
That's the biggest outflow since August 2011, as the euro-zone debt crisis was intensifying and worries about the U.S. debt ceiling were coming to a head.
Some of the money went into money-market funds, which took in $5 billion during the week, according to Lipper. It's likely that billions more flowed into cash or directly into short-term debt, said Matthew Lemieux, a senior research analyst at Lipper. The WSJ Dollar Index rose 1.6% in the period.

Tuesday, June 25, 2013

Bloomberg On Positioning For Rising Rates

I have been writing abouut reducing duration in bond portfolios for at least a year.  my bolds

Where Bond Investors Are Hiding From the Threat of Rising Rates

If the financial markets were a horror show (and sometimes they are), investors know what would be behind that white hockey mask today. The killer stalking portfolios would be revealed as...rising interest rates. 
So far this year, $16.3 billion has gone into fixed-income exchange-traded funds designed to have low sensitivity to interest rates, according to Bloomberg data. That's a 35 percent jump since the end of last year. And while articles like this one come out at least once a month, and there have been false alarms about rising rates, the ETF flows -- which many consider to be the smart money -- show that investors are seriously creeped out.
The latest scare sending them into these (jargon alert) "short duration" ETFs is the nearly 40 percent jump in the 10-year Treasury yield to 2.14 percent. The move took place in just one month. Duration is a measure of how sensitive a bond is to an increase in interest rates. For example, if your bond ETF has a duration of 6 years, that means the price would go down six percent for a 1 percent increase in interest rates. Start doing the math on that and you can see why people are getting jittery.....
The SPDR Barclays Short-Term High Yield ETF (SJNK) is a short-duration kid brother to the SPDR Barclays High Yield Bond ETF (JNK). The portfolio of $10 billion JNK, the largest high-yield bond ETF in the world, would lose 4.3 percent in value for a 1 percent rise in interest rates (a duration of 4.3 years). SJNK's portfolio has a duration of two years and a yield of 6.12 percent -- just below JNK’s 6.4 percent yield.The similar yields are one reason JNK has seen $1.7 billion in outflows this year.
SJNK's low duration explains why its total return has been better recently compared to JNK's -- 3 percent this year, versus 2.3 percent for JNK. In the past month, which has been tough for junk bonds, SJNK is down 0.98 percent, while JNK is down 2.41 percent. Of course, while these ETFs ratchet down interest rate risk, they still have the credit risk that comes with junk bond investing.

Monday, June 24, 2013

The Flaws in Dividend Growth Investing…and The Likely End of The Fad and “Sure Thing”

The low interest rate environment and once in decades situation where dividend yields were above bond yields for the broad indices and individual companies has spurred a “new investing philosophy” of “dividend growth investing”. With interest rates in an up cycle as Warren Buffet said “when the tide goes up we will see  who is naked.

This “strategy” seems to be all over the blogosphere.e Typical is seeking alpha’s popular “dividends and income section” . Unfortunately, but not surprisingly the financial services industry has fed the bandwagon bring ing out a seemingly endless number of dividend and dividend growth ETFS and actively managed funds.  Brokers/Salespeople were happy to feed the frenzy as well without much deep analysis of the pitfalls of such an approach

Since this crew gets pretty abusive when its views are challenged I’ll post this on my own blog

Here for example is a methodology  common in the analysis of dividend growth: investing  in the blogosphere :
  • Pick a stock and assume that if one bought a stock and owned it for decades the “dividend growth” of reinvesting the income will produce a secure income stream for retirement.
  • Make sure when you buy the dividend stock you hold your dividends and wait till that stock is a “bargain” which of course you will know and time extremely well. This means of course that you are not reinvesting the dividend but trading with the dividend . Thus  the growth of an investment  with dividend reinvestment is not your strategy at all. So those numbers don’t of a long term position with dividends reinvested and doesn’t match  the “dividend growth” strategy at all certainly not a DRIP strategy.
  • In figuring out what future dividends that will fund the retirement  the methodology of calculations is a bit fuzzy to say the least.
 The analysis takes a lump sum purchase at the beginning of the investment period calculate what the dividend stream will be decades later at retirmen and presto you have a cash flow to fund retirement.
Of course this assumes that you have enough cash to purchase that amount of shares decades prior to retirement. In other words in your 20s you have a massive sum to put into your account. Seems to me most people I have met are struggling to generate cash flow above their expenses to cover those massive student loan bills…a massive lump sum ? maybe for trust fund babies who never had to worry about cashflows in retirement…or in their 20s.
Oh and that amount used in the calculation is way to large to put in an IRA so most of the dividends will be taxed along the way. And if you’re a high earner in NY or Silicon Valley you’re paying local AND federal tax on those dividends…so knock some more money off that “dividend growth “ calculation in the real world.
  • I could do a similar argument for a total return investor:
I can assume a lump sum at retirement equal to the lowest 30 year return of the s+p 500 or even a 60/40 stock bond allocation reinvest the dividends automatically and don’t touch the principal.  Take even the worst 30 year period since the depression (actually longer ) and you will come up with a sufficient sum for retirement. In fact a simple present value calculation will give you that lump sum you need.
At retirement pull your retirement cash flow out of dividends interest and capital gains you earned over 30 years…all at likely at a lower marginal tax rate than your current rate
…and if you retire to Nevade, Florida or Texas  from say California or NY you avoid the state tax on interest dividends and capital gains.
In other words there is not magic formula to fund a retirement need….unless you inherit at 25 or 30 a sum large enough so it will grow over 30 years to an ample retirement nest egg (add in some savings of your own along the way) . Otherwise it’s not as easy as “dividend growth investing”. Its pretty much the same problem for the much disdained “total return investor” in the view of this group of dividend growth zealots as for them.
I notice that the dividend income section of seeking alpha has lost regular postings form many  of the fans of dividend growth investing. I think we have the updated version of the famous shoeshine boy story with Joseph Kennedy and the well know dictum when it shows up on the cover of Business Week or Time it’s a sure sign of time to go in the opposite direction, Substitute blogger s that are do it yourselfers/neophytes and chat rooms for the 2 above and you have the 21st century equivalent.
As interest rates reverse course and start to provide yields equal to or higher than equity dividends this dividend growth” strategy will look less attractive. And there is no way around the fact that future returns on a stock are low when you buy them at a high valuation The dividend growth favorites, usually conservative slow growing stocks that trade at low p/es have been trading at high valuations during this time of “dividend growth investing”.
No surprise then to look at this graph comparing returns of utility stocks (XLU) a traditional sector bought for its dividends, HDV the high dividend ETF and VTI the total stock market index and to note that when interest rates turned abruptly higher in the beginning of May stocks bought for their dividend suffered the most. It’s actually no surprise to anyone who has taken a financial markets class and paid attention when the dividend discount model of stock valuation was taught.
Here is an explanation of the model from  investopedia .
 They note it is..
“…one of the oldest, most conservative methods of valuing stocks - the dividend discount model (DDM). It's one of the basic applications of a financial theory that students in any introductory finance class must learn

And here’s the chart of HDV high dividend, XLU utilities and XLP consumer staples another favorite of dividend growth investors compared to VTI the overall US market since May 1 when interest rates started their sharp ascent.

No doubt  some may argue this short term movement is irrelevant. I view it as a fire drill although the market may stabilize or even recover we know from this move which sectors are most vulnerable to higher rates. Not just are these sectors most vulnerable to higher rates because of the simple math of the dividend discount model, the dividend growth investors bid them up in valuation.

Or one could look it quite simply. If dividends were touted as a bond substitute logically it would mean that if interest rate go up dividend stocks will suffer. After all would you rather own a 4% return on a treasury bond or a stock of a dividend grower" paying the same yield or lower. Back to reality stocks are riskier than bonds....period.

"A Stock Pickers Market"

If there is one standard refrain that one hears from active managers and the brokers who promote their funds it is the claim that "it is becoming a stock picker's market" other words its time to abandon passive asset class investing and pay that active manager to show his stock picking skills.

But the refrain seems to be reminiscent of the early days of the NY Mets when by early summer with the team's chances for reaching the playoffs already a mathematical impossibility...when fans would exclaim wait till next year.

It seems current market conditions once again show that the forecast of a "stock pickers market" have proven wrong.

Current Account: Risks of Too Much Oneness

Talk of a return to the “normality” of fundamentals-based investing—when the business cycle, balance sheets and valuations really mattered—is becoming more prevalent.
Unfortunately, right now it is just talk. A look at the cold, hard numbers shows that markets retain their annoying penchant for moving in lock-step.
Take U.S. stocks. In the prestimulus era, investors bought financial stocks, auto companies and technology whenever they thought the Fed would cut rates; materials and industrials companies when rate rises were on the way; and utilities and health care whenever they wanted to be supersafe. Not so now.
Correlations for the 10 industry groups in the S&P 500 were 83% on average (100% would mean perfect synchronicity, 0% no relation) last month, according to Mr. Colas.
Over the past two months, those relations have actually gotten tighter. In the “normal” days of the 1980s and 1990s, they were around 50%. Foreign stocks and U.S. equities also are moving like a Broadway chorus line, with correlations well above 70%.

As for stock pickers...the article includes an interesting table of the five stocks most highly correlated to the S+P 500 . #2 on the list Berkshire Hathaway with a correlation of .96. Buffett and Munger as  closet indexers ?

Sunday, June 23, 2013

The Financial Times on Emerging Markets

I gave my views on this subject in the last post. Here is John Authers of the FT

On Monday: Brave bargain hunters should look to emerging markets
By John Authers
Latest sell-off has created a few bargains for long-term investors
It is time to start combing the wreckage. That does not entail any bold prediction of an end to the sell-off that became frighteningly general following the Federal Reserve’s intervention last week. Timing is always difficult. But this sell-off has now lasted long enough to create a few bargains for those who can afford to hold on to their investments for a while.
The greatest factor in how investments fare in the long run is how cheap they are when bought. And on that basis, there is a case for emerging market equities.

Using the ubiquitous MSCI indices, and judging by price-to-book ratios, emerging markets are selling at their deepest discount to developed world stocks since September 2005

Wednesday, June 19, 2013

WSJ on Emerging Markets

June 19 WSJ

Emerging Markets Still Offer a Lure

Some Investors See Recent Losses as Just a Blip, Even as Fed Pullback Looms; 'Beautiful Opportunity'

.....Investors who are sticking with emerging markets said it is mostly short-term traders behind the recent selling. Of the most recent outflows from emerging-market stock funds, 70% came out of exchange-traded funds, vehicles widely used by individual investors, according to analysis of data from EPFR Global.
"You have a lot of investment tourists in emerging markets' local markets, and they decided…that their visas don't have much time left on it and they want to go back home," said David Rolley, co-head of global fixed income at Loomis, Sayles & Co., which manages $191 billion.

The article includes this interesting graph

Monday, June 17, 2013

Emerging Markets, Not for The Faint of Heart

I am a believer in an allocation to emerging markets—stocks not bonds—but it is certainly not for the faint of heart and even there is an economic/investing  long term rationale for holding them due to risk tolerance in terms of short term movements many investors should simply not own this asset class.
Emerging Markets are a perennial source of “hot money” flows buying at the top and selling at the bottom in performance chasing,.  Add in the short term traders and you have extreme volatility especially on the downside.
So this shouldn’t be a surprise from index

[Hot ETF Topics]

Investors this week have yanked $3 billion out of the iShares MSCI Emerging Markets Index Fund (NYSEArca: EEM), as well as money from other ETFs that canvass relatively risky pockets of the investment universe, such as high-yield debt, amid heavy selling in the past few days, especially in Japan.

Here’s a chart of EEM the emerging market stock index ETF, note the extremely high volume (scale at bottom of chart) of late and the massive spike in volume at the 2008 low…clearly this is not for the faint of heart…

Also of course one can see the big chains up through the recovery from the 2008 carsh and a disappointing recent 4 years especially compared to the SP 500
Here is the emerging markets index in green EEM) vs the S+P 500 (in blue SPY)for 10 years the growth of $100,000 investment. In other words $100,000 grew to $350,000 in emerging markets vs. $200,000 for the S+P 500

On the other hand here are  is the same comparison over the last 5 years $100,000 grew to $200,000 in the SP 500 and emerging markets did basically nothing.

Valuation Matters…In The Long Term
Of course such a large disconnect in price change creates a divergence in valuations as well.
The recent market declines in emerging markets and continued relative strength in the US market make emerging markets look quite reasonable relative to the US in terms of valuation
. Emerging markets ETF IEMG carries a p/ of just under 11 while the S+P 500 is trading at just under 15. If the bullish case for the US market is based at least in good part on potential for exports by US companies to the emerging markets…it’s hard to rationalize a decline in emerging markets because of weaker prospects for economic growth…somebody has it wrong or at least is looking short term and chasing momentum and recent market performance.
According to this article published by Bloomberg after the market close on  June 14 this low valuation has caught the eyes of some investors, Although I would be loathe to find a specific reason for a one day market move. If emerging markets move down in the next week it will hardly be related to a changed view of valuations. But the article does give an interesting relative measure of valuations.

Emerging-Market Equities Rebound After Valuations Slump

…The MSCI Emerging Markets Index added 0.6 percent to 1,008.92 in New York, after slumping the most since July yesterday. The decline drove the index down to 1.5 times net assets, compared with 1.9 for the MSCI World Index, the biggest gap since August 2005, according to data compiled by Bloomberg. ….

In my view price can deviate from value in the short term but in the longer term price reverts towards value. An article in the weekend WSJ  by Jason Zweig entitled

included the following observations on emerging markets with a similar view on valuations.

…..funds that invest in emerging-market stocks ($16.2 billion in over 20 weeks, $7.8 billion out in 15 days), emerging-market debt ($3.8 billion in, $999 million out) and Japanese stocks ($13.6 billion in, $437 million out), among other categories.
“As I visit clients world-wide, almost every single investor tells me the same thing,” says Brian Singer, who runs the $145 million William Blair Macro Allocation Fund, which invests in a variety of assets around the world. “The only place they’re seeing any opportunity is in the U.S.”
He adds, “If it’s the global consensus, you can be pretty sure it’s priced in”—meaning that the wise investor should shop beyond U.S. stocks.
Mr. Singer thinks stocks in Europe and in emerging markets have gotten much more attractive in the recent selloff. He projects future returns of up to 14.5% annually over the next eight years on European stocks (and at least 20% in the Italian and Spanish markets) and 11% on emerging markets.
U.S. stocks are at a price/book ratio—or market value relative to corporate net worth—of 2.3, or more than 10% higher than they were at year-end, calculates Ryan Larson, a vice president at Research Affiliates. The same ratio on emerging-market stocks has fallen below 1.5, from 1.6, making them more than one-third cheaper than U.S. stocks.

Over the same period, the dividend yield in the U.S. has dropped to less than 2.1% from 2.2%, even as the yield on emerging markets has risen to 2.9% from 2.7%.

Thursday, June 13, 2013

It's Usually No" Different This Time"

Among the strategies/products proposed and adopted among many investors in the search for yield have been alternatives to investment grade US dollar bonds in the treasury or corporate bond market.

Here are ETFs of categories that have been high on the "alternatives to generate income" list.and their returns since May 1

EMB and EMLC emerging markets bonds
PFF Preferred stock
PFM Dividend  Achievers Stock ETF
PFF Preferred Stocks
VNQ Reits

The traditional " strategy to insulate a portfolio from rising rates is to shorten maturities. Below are returns the same period for
SHY short term US treasuries
VGSH short term US Govt bonds
VCSH Short term investment grade bonds
SJNK Short term high yield bonds

As The Bond Market Turns...Investors Show They are A Fickle Bunch

I  was never a fan of Pimco Total Retun Fund when it was just a mutual fund and its new ETF option hasn't changed my mind although at least the management fees are much lower.. My problem isnt the manager Bill Gross but the fact that as a 'go anywhere, do everything fund it can be anywhere (including out of ) the bond market. So you are counting on Bill Gross not getting the returns of the bond market as a whole. For the simplest way to postion a bnd allocation AGG the total bond market index merits a good look. At least you wont underperform the bond market.

Based on recent performance this 'a surprise to me

The Pimco Total Return ETF (NYSEArca: BOND) broke its impressive asset-gathering streak with its first monthly outflows ever in May. Those losses have been compounded by BOND bleeding $119 million in the first five days of June.

Monday, June 10, 2013

Some Good Advice on Long Term Investing from the Pages of the Wall Street Journal


Volatility Isn't the Enemy

Once investors accept that volatility isn't the enemy, advisers should focus on two things to help them stay comfortable in the market. First, make sure clients have enough liquidity to meet their needs through downturns, so they don't have to sell when the market bottoms. Second, make sure they're comfortable with their portfolio's assets and allocations. That way, clients won't be tempted to sell in a panic if the market turns down.
Investors and advisers should also make sure that portfolios are truly diversified. Looking at the asset-class breakdown may not tell the whole story. For example, an asset class called hedge funds may actually be highly correlated to equity markets and not all that different from other investments.
and here

Voices: Larry Swedroe, on Overvaluing Growth Stocks

Investors have two problems. The first is that they love assets that look like lottery tickets–the ones with the potential to be a home run. They want to buy into the next Google. That preference has led these stocks to have prices that are too high, and historically that has led to lousy returns.
The second problem is that investors typically fail to understand that reversion to the mean for growth stocks is quicker than people anticipate, so growth doesn't last long. People end up overpaying for growth because they don't understand how rapidly excess earnings can disappear. Knowing this, advisers should direct their clients to a portfolio that takes this into account, fits their individual situation and doesn't overvalue growth stocks.

Thursday, June 6, 2013

This Shouldnt Really Be Much of A Surprise

Looking at this chart of investor flows into equity mutual funds:

...and this chart of the sp 500

I dont find this particularly surprising:

Look Out Below: ‘Thundering Herd Is Moving the Wrong Way’

Seems like that thundering herd that fueled the massive inflows into stocks thus 

far this year are having second thoughts:

“Our clients just aren’t convinced that even some moderate to soft economic news is going to keep the Fed from paring back its policies,” Bliss said. “They’re getting nervous about staying long this market after such a big rally.
“The thundering herd is moving the wrong way. They’re taking some chips off the table to re-evaluate their positions.”
which creates a shorter term chart that looks like this

Tuesday, June 4, 2013

Emerging Markets Bonds Not A Great Asset Class to Choose in the Search for Yield

From Bloomberg

Turkish Yields Surge Most on Record as Protests Hit Lira, Stocks

The yield on benchmark two-year lira bonds rose 71 basis points to 6.78 percent, the biggest jump since at least April 2005 when Bloomberg began compiling the data. The benchmark stock index plunged 10 percent, the most in a decade, and the lira weakened for a fifth day, sliding 0.8 percent to 1.8903 per dollar at 5:30 p.m. in Istanbul, a 17-month low.

The  largest (by assets) emerging markets bond funds is EMB is has a
6.8% allocation to Turkey, price decline since May 32 is 3.6%  current yield 4.35 so most of the yield has been wiped out (in total return )in a week

EMB now has a total return ytd of  -5%
SJNK short term high yield has a similar yield it's risk and return are compared to EMB below.

I have written before that Emerging markets bonds whether denominated in dollars or especially if denominated in foreign currency are a poor choice to pick up yield given the additional risks vs dollar bonds and suggested looked at domestic high yield bonds, particularly low duration as an alternative.

wsj website June 5

Investors baffled by Turkey Protests

Some Gleanings from the WSJ of the Last Few Days

I think I can remember the last time I saw a headline like didnt't end nicely WSJ May 31
The 100% Stock Solution

....and so much for taking advice from a professional in a newspaper for your asset allocation. I dont have time to go through all my objections to a portfolio like this and I dont want to beat up too much on a colleague.. But the advisor has apparently bought into the latest" it's different this time" mantra "bonds as a substitute for stocks". As is usually the case this works for awhile and the outcome ultimately is not pretty. Stocks are not bonds or a substitute for them.

I have been expecting this for quite awhile..and it could be just the beginning.

Dividend Stocks Fall Victim to Fed

Utilities, REITs, Other Sectors That Benefited From Aggressive Bond-Buying Program Take a Hit

Stock investors are getting a taste of what could be in store with a sustained rise in bond yields.
A month of sharply climbing U.S. Treasury yields culminated last week in an abrupt selloff among stocks that had been posting big gains thanks to demand from income-hungry investors.
Hardest hit were utilities, telecommunications stocks and real-estate investment trusts, all of which had benefited from the Federal Reserve keeping government-bond yields at rock-bottom levels. The Fed's extraordinary stimulus policies, which have pumped billions of dollars into the financial markets, had caused investors to seek out income in riskier fare, such as stocks that pay high dividends.

Monday, June 3, 2013

Is Minimum Value Overvalued ? The Debate Begins

I have some questions about this issue and hopefully will get a chance to write about it. Meantime over at the ishares blog, they make the argument that while minimum value carries a high valuation vs the market cap weighted index (which in my view is highly valued) the valuation is justified given profitability. I'm not so sure.

From the article

 the chart below shows the profitability (measured as Return-on-Assets) as well as the valuations (measured as Price-to-EBITDA) across a range of developed countries [2] as of the end of April. Close to 75% of the variation in valuation can be explained just by looking at the aggregate profitability level, with every percentage point in additional profitability explaining about 2 points worth of additional valuation. The US cap-weighted benchmark is on the “expensive” side with a valuation ration of 8.16x but this is partly explained by profitability levels higher than that of the average developed country.

The chart also shows that the minimum volatility index is indeed more expensive than the benchmark, but the aggregate profitability of the portfolio of companies in the minimum volatility index is also higher than the benchmark. Indeed, the minimum volatility exposure seems better valued in the sense that its higher profitability would justify higher valuations given the observed relationship between valuations and profitability across developed countries

On the other hand....Index Universe takes the other side here e

Hot ETF Topics


When Low Volatility Bites Back
By Elisabeth Kashner | June 03, 2013

Related ETFs: SPLV / USMV / LGL

They ask some very interesting questions. Could it be a case of too short a set of data or is it in this case really "different this time" ?

These analyses are quite sensitive to the time periods chosen. Other analyses, using more variables and longer time periods, have come to different conclusions. But in terms of the simple question, "Could I have done just as well by investing 70 percent of my cash in the S&P 500 and the balance in T-bills?", the answer is a definite maybe.....

And if price reverts to mean valuation this is troubling

So, what explains low volatility's outperformance for much of the past four years?
500 vs low vol: 2006 - 2013
The principle "the observer affects the observed" could be at work here.
Simply put, after the housing crash, playing defense is the new offense, and investors have been piling in. Many portfolio managers have hopped on the defensive bandwagon, adding allocations to high-yielding dividend stocks and to low volatility. In the process, a strange thing has happened to low volatility valuations—they're really not cheap anymore.
As of June 2, 2013, U.S.-focused large-cap and total-market volatility funds have posted some chunky price-to-earnings (P/E) ratios:

Fund/IndexP/E Ratio
MSCI USA Investable Markets Index19.63
MSCI USA Large Cap Index17.48
iShares MSCI USA Minimum Volatility Index Fund (USMV)19.18
SPDR Russell 1000 Low Volatility Fund (LGLV)19.80
PowerShares S&P 500 Low Volatility Fund (SPLV)20.63

Indeed, SPLV's and LGLV's P/E ratios are notably higher than those of their parent index's large-cap universes. To be fair, the Russell 1000 dips well into the midcap space by many definitions, but excludes small-caps. Even compared with the overall U.S. equity market, LGLV looked expensive.
More at index universe here another excellent analysis. The inflows in this strategy have been big:
Low-volatility strategies such as the PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV) and the iShares MSCI USA Minimum Volatility ETF (NYSEArca: USMV) have been incredibly popular with investors this year. But these funds have started to show underperformance that might sully their appeal.
SPLV is by far an investor favorite. With more than $4.9 billion in assets and average daily trading volume north of $80 million, there’s little question that the fund is well liked by investors
With the big inflows to this and to dividend stocks funds and ETFs it may get ugly as the tide turns.