Anyone in the investment industry not living under a rock has had an intense conversation with a client about the merits of passive exposures in investment portfolios. The cacophony of articles on this topic is both silent and deafening. Most include little proof for assertions of market efficiency and parrot a conglomeration of statements parsed from other articles. As a result, passive investors improperly forego dramatically higher potential returns for seemingly low cost market exposure.
Massive amounts of wealth are seeking equity income from a limited opportunity set. Valuations are rising. ETFs are faddish. Rates are poised to go up. I present five words of caution and make four suggestions for equity income investors.
A search for all equity ETF's available to U.S. investors in Bloomberg leads to a list of 969 candidates, a surprisingly large number of options for a relatively new investment vehicle. With investors seeking alternative income solutions in a low rate environment, most may be surprised to find that the perception of choice among ETF's is a mirage.
There is one trend in particular that I have been watching—the relationship between bond yields and equity valuations. Traditionally, there is a somewhat positive relationship between the two, but massive monetary policy intervention has thrown everything out of whack.
Quite often, investors get mired in the particulars of individual stocks. Sometime its best to take a step back to observe broad trends. Looking at corporate uses of cash over the last two decades, with a focus on the last few years, findings suggest that it is more important than ever for equity investors to evaluate quality metrics like balance sheet strength, quality of earnings, and corporate allocation policies.
Does the economic cycle have any bearing on investment success? Macro investment houses have constructed intricate frameworks to understand the “economic machine,” but economic data are notoriously prone to revisions, lags, and adjustments in measurement through time—none of which are suitable for timely and reliable investment signals. Certain fundamental characteristics—not economic variables—drive stock returns. This piece identifies investment themes that deliver persistent outperformance in multiple different economic environments.
We know from an untold number of academic papers that small stocks are supposed to outperform large stocks. Yet, the last five years have proven to be very different as the largest stocks have dramatically outperformed. Reversion to the mean and improved relative valuations argue for a look at the small cap space.
In my last two posts, I explored a fad which has washed over the investment community--low volatility investing. In my first post, I looked at the historical performance oflow volatility stocks and found outperformance to be inconsistent. I then established in my last post that Low Volatility investing is likely just value investing in re-packaged, and expertly marketed, form. In this final post, I relate the finding to the popular USMV ETF.
In a previous post, I looked at the historical performance of investing in low volatility stocks and identified that outperformance from the factor tends not to be very consistent over time, but is instead clustered. That raised some questions on whether volatility is a true investment factor, or if it's positive benefits are the product of other, more robust, investment factors.
What do snake oil and low volatility investing have in common? In a series of posts, I'll take a look at the low volatility phenomenon. In this fist post, I look at low volatility investing from a historical perspective.
One of the most common factors I get asked about in my travels is Sales Growth. One would think that investing in companies with massively growing sales is a great idea. Maybe they just signed a huge contract, or that new product toy was a holiday favorite. Unfortunately, companies whose sales are growing the fastest tend to be about as likely to succeed as this inexperienced skier circa 2004.
Be weary the current rally. Short covering is playing a prominent role. Market pundits have been talking about the outperformance of heavily shorted stocks for weeks. Make no mistake, short covering is a key factor in the market rally, but the decline of pessimism is ultimately a good thing for long-term investors.
Confounding, uncertain and volatile markets have left many investors wondering what glimmer of hope to hold on to. It isn't yet evident to investors, but in some respects the market is returning to normalcy.
Self-control, along with intelligence believe it or not, is one of the characteristics most commonly associated with success according to research. In this volatile market, self-control is an utmost requirement. It is typically after a drawdown such as the one we've experienced since July that investment strategy begins to come into question.
About this time each year we make resolutions regarding our future goals. We sign up for gym memberships, and swear off those unbreakable habits. We promise to eat salads for lunch, spend more time with family, and read a book a month. All of these things take time, and a lot of it, but require a paradigm shift.
Large growth stocks are winning the battle this year...by a lot. The Russell 1000 Value Index is down -7.3%, while its Russell 1000 Growth Index counterpart is up +2.6%. Tech heavyweights are crushing the competition, but at what price?
The Fed is in quite a predicament. Economic cycles typically last seven to ten years. The current cycle will be seven years old in early 2016. Humans have known of this cyclical pattern quite literally since the Book of Genesis--seven years of fat, seven years of famine. At some point, the current bull will yield to a bear market as all bull markets have.
The mettle of investors has been severely tested over the last few weeks. Since the market's recent June highs, a litany of issues in Greece, Iran, and China have plagued the stock markets. Emerging markets have reached bear market territory while U.S. large cap indices have broached the "correction" juncture. U.S. small cap is in a bear market as well. Long term U.S. Treasuries have rallied. The dollar has weakened. Commodities, including oil, have tanked. It's enough to make an investor's head spin.
A friend of mine recently asked what implications exist for the Chinese Yuan devaluation— specifically as it relates to Iran Nuclear negotiations. I had not thought about the connection until being asked the question. After thinking about it, I settled on "significant".
Small capitalization stocks are an interesting breed. This portion of the markets contains thousands of names that are unloved and unappreciated. The space is a treasure trove for long-term and disciplined individual investors.
Almost nobody can resist the allure of a market appreciating at triple digits. The rapid increase in the Chinese equity market is driving up global valuations. Even index players are getting into the game. FTSE, the index provider for the popular Vanguard Emerging Market ETF (VWO) has decided to include Chinese A shares in its indexes–further proof that owning a market-capitalization weighted index may be a poor investment strategy. The tech and small cap heavy Shenzhen exchange trades at a price to earnings ratio of 50x. The Shanghai exchange trades at at 33x, and the Hong Kong exchange is at 20x.
Corporate executives have two key objectives: generating profits and allocating firm capital to maximize those profits. A key consideration is whether to finance those objectives through operating cash flow, debt issuance or equity issuance. Given that interest rates are at all time lows and the FOMC is poised to tighten monetary policy, investors should understand the impact of rising interest rates on corporate earnings and profit margins. Below, I look at trends in profit margins, the cost of debt over the last five decades, and the implications for earnings.
The Dollar Index (DXY) just recorded the 3rd strongest nine month move back to 1967. It appreciated 23.3% from July 2014 to March 2015. In a few short quarters investors have forgotten about the persistent 50 year weakening of the dollar, shown below. The recent move appears on first glance to bear the distinction of being the lone cyclical strengthening which occurred PRIOR to an actual Fed Funds rate hike. One could easily argue, however, that the tapering of quantitative easing served as the de facto rate "hike".
OPEC announced last week that they don’t see oil prices trading at $100 again in the next decade. Miraculously, the consortium is now considering a return to production limits as the best means to influence market prices of oil. Even in its most optimistic assessment in a new report, OPEC only sees oil rising to $76 in 2025, according to the Wall Street Journal.