davidgfabian

[davidgfabian]

Forecasting where the market will end up in 2016 is a very difficult task, as innumerable variables will intercede over the course of the next twelve months. The actions of the Federal Reserve in particular are going to be a heavy influence on income investors as they seek to position their portfolios for capital preservation and dependable dividend streams.

If 2015 has taught us anything it’s that there is a high degree of risk in individual high yield sectors such as master limited partnerships and junk bonds. These groups have erased years of accumulated gains in a manner of months as credit headwinds weigh on investors’ minds. In addition, the trendless direction of interest rates will likely lead to above-average volatility in high quality fixed-income holdings as well.

My top income themes for 2016 are centered around large, diversified, and proven investment vehicles that circumvent the hit-or-miss proposition of individual sectors. That may seem boring to those who like to tempt fate with the glory of a turnaround story or make assumptions in continued strength of momentum names.

[davidgfabian]

Can You Handle An All Weather Portfolio?

This post was originally featured on the Investor Insights blog.

The internet is buzzing this week about an article written by Tony Robbins touting an “all weather” portfolio developed by famed hedge fund investor Ray Dalio.  While Tony is certainly a polarizing figure and life coach, the real meat of this story is in the structure of an investment plan to ride out any storm.  

The summation of the strategy is that investors should balance their risks by investing in a diversified base of stocks, bonds, and commodities to ride out anything the market throws your way.  By doing so you are able to sidestep concerns of inflation, deflation, growth trends, and other cyclical forces taking an adverse toll on your returns.

He recommends a portfolio of 30% U.S. stocks, 15% intermediate-term treasury bonds, 40% long-term treasury bonds, 7.5% gold, and 7.5% commodities.  The overweight nature of bonds is designed to counteract the volatility of stocks and commodities, which he implies is an area that many people take too much risk with.  Additionally he recommends that you rebalance the portfolio on a regular (at least annual) basis.

Over a historical 30-year time frame from 1984 to 2013, the portfolio produced stellar results of nearly 10% per year with the worst down year being 2008 when the model dropped just 3.93%.  Those are impressive and consistent returns with very little downside volatility.

Ben Carlson of the blog, A Wealth of Common Sense, did an excellent review and back test of the strategy through multiple time frames that is worth a read as well.

For those that are interested in implementing this strategy, take a look a the following 5 ETFs:

Vanguard S&P 500 ETF (VOO) iShares 7-10 Year Treasury Bond ETF (IEF) iShares 20+ Year Treasury Bond ETF (TLT) SPDR Gold Shares ETF (GLD) iPath Dow Jones-UBS Commodity Index Total Return ETN (DJP)

These are funds with low expenses, established track records, high liquidity, and cover the essential components of the all weather portfolio.  However, there are many other alternatives that may make more sense depending on your experience or preference.

While it may seem easy on the surface to implement a portfolio of this design, especially using low-cost ETFs, I have some concerns about this strategy that might not make it perfect for everyone.

Concern #1:  Investor Psychology

It’s easy to say on paper that you can handle the volatility and want that promised 10% return going forward, but its another thing to experience it in real life.  During periods of stock market downturns, inflationary cycles, and other stumbling blocks you are going to see individual investments in that portfolio produce adverse results.

The premise is that one investment zigs, while the other zags and they offset each other in a complementary manner.  However, most investors aren’t disciplined enough to hold GLD and DJP through the last three years as they drop like a stone.  In addition, you will be buying more on the way down to stay in line with your asset allocation objectives, while selling down the stocks and bonds that are performing well.

You have to be 100% committed and disciplined to the portfolio over a long period of time in order for it to produce the type of results that you desire.  In my experience, the majority of investors are more short-term focused and pay too much attention to the price swings of individual positions.  This leads to performance chasing and asset allocation shifts at inopportune times.

Concern #2: Regular Rebalancing

Rebalancing the portfolio on a regular basis is another key component of this strategy that many investors don’t take the time to do.  They like to let their winners run and cut their losers quickly.  In order to produce a successful outcome, you will be forced to reduce exposure to the strongest performers and buy more of the funds that are lagging their peers.

Staying in line with the correct asset allocation targets allows for each holding to affirmatively offset its peers at the appropriate times.  One advantage of this methodology is that it can be more tax efficient than trading on a whim.  You just have to be more proactive about this chore in order for it to succeed.

Concern #3: Investment Selection

Investment selection is something I find to be lacking in this strategy as well.  There is no mention of international investments for instance.  One option to consider is splitting the 30% stocks into 15% VOO and 15% Vanguard FTSE All-World ex-US ETF (VEU) or iShares MSCI EAFE ETF (EFA).  That would provide an additional level of diversification, while still maintaining a similar asset allocation profile.

I would avoid adding in other sector or alternative areas of the market as they may produce unintended consequences.  The goal is to stay simple and broad with your exposure to produce the most efficient returns and make things easy to track.

The Bottom Line

The bottom line is that this style of passive investing with regular rebalancing takes more grit and determination than you might think.  One option to consider is hiring an advisor as an objective fiduciary to implement this plan on your behalf.  Alternatively, there are many other multi-asset investment strategies that produce solid results with low volatility.  The key is finding your style and what you will be able to live with over the long haul.

[davidgfabian]

Observations of Risk, Reward, and Expectations Using ETFs

This post was originally published on the Investor Insights blog.

The concept of symmetry when it comes to risk is something that most investors overlook.  I have found that most people hone in on one aspect of an investment that looks attractive or dismal rather than taking a holistic approach to their analysis.

More speculative plays offer an attractive reward component, however they can also result in spectacular downside.  Conversely, conservative investments may not offer quick profits, but won’t lead to sleepless nights over double digit losses either. There is always a trade off on the risk versus reward scale that can significantly alter your end result.

Getting overly wrapped up in recent performance, dividend yields, or other narrow dimensions of an investment are likely to get you into trouble over time.  This is because your decisions will be based on greed or fear rather than selecting investments that work in harmony together to meet your individual needs.

I frequently run across this mistake with income investors that focus solely on yield rather than blending a quality mix of assets to balance out returns and diversify their exposure.  As a general rule it should be assumed, the higher the yield on an investment, the higher associated credit or business risk.

Holding large allocations to funds such as the iShares Mortgage Real Estate Capped ETF (REM), SPDR High Yield Corporate Bond ETF (JNK), and other credit or leverage heavy names can introduce your portfolio to higher than average volatility.  While the yields are attractive on a relative basis to an asset class such as Treasury bonds, risk dynamics will play a role in evening the playing field as interest rate and credit cycles evolve.

Another overlooked facet of successful portfolio management is managing expectations.  In my recent webinar, I detailed a conversation I had with a prospective client over who outlined the following parameters he desired for his accounts.

“If the market is up 20%, then I expect that you will meet or exceed those returns.  However, if the market is down 20%, then you should have significantly less losses on the downside”.

Sounds easy right?

In hindsight, it’s always clear to say where you should have bought and sold to make those perfectly timed executions or asset allocation shifts.  However, in reality the uncertainty of market dynamics make it much trickier to assume greater risk on the upside while hedging your exposure when the market is falling.

October is a perfect study in how quickly stocks can fake you out.  The SPDR S&P 500 ETF (SPY) dropped more than 10% from high to low and erased all of its gains of the year in the course of a month.  It then subsequently made up all those returns and blasted off to new all-time highs in a three week time span.  Those that sold on the way down and didn’t subsequently get back in were left in the dust on a relative basis as a result of their risk adverse approach.

While I am a big fan of managing risk in a portfolio, there is always a trade off when you sell an investment that it could subsequently turn and rebound on you.  That is why it is imperative you have a disciplined approach to get you back into the market at a predetermined level if you do decide to sell.

Along those same lines, ETFs offer the ability to structure your asset allocation to take advantage of high beta or low volatility stocks within the context of your risk parameters.

If you desire exposure to companies showing relative strength or momentum characteristics you may be drawn to funds such as the iShares MSCI USA Momentum Factor ETF (MTUM) or Powershares S&P 500 High Beta Portfolio (SPHB). Both ETFs use performance screening methodology to select stocks with a higher sensitivity to the market’s machinations. The goal of these strategies is to provide greater upside potential, which may also result in leadership on the downside as well. That’s the tradeoff you assume when selecting a more performance-driven index.

On the flip side, seeking lower volatility investments such as the iShares MSCI U.S. Minimum Volatility ETF (USMV) will allow you to keep correlation with stocks in a more conservative wrapper. This ETF seeks to minimize peaks and valleys in your portfolio by selecting stocks with fewer price fluctuations. A more reserved ETF of this nature may ultimately lag its peers on the way higher because it is focused on minimizing downside risk.

The bottom line is that before you buy or sell any investment, ensure that you are doing so for the right reasons and doing so with a comprehensive game plan in mind. This will ensure that your portfolio is in line with your risk tolerance and objectives as well as help remove emotional triggers from your decision making process.

[davidgfabian]

Major Buy Signal No One Is Talking About?

I like to look at various cycles in my work and one you’ve probably heard of is the Presidential cycle.  This looks at what the S&P 500 (SPX) does every four years of a President’s term.  In general, the second year (where we are now) of the cycle tends to be the worst and the third year tends to be the strongest.  You’ve probably heard that many times before.

Well, we are currently in the second year of Obama’s second term.  So really, this can also be looked at as year six of his term.  Doing this shows much different results than what the average second year of all terms have done, as year six is actually extremely bullish.

Here are all the sixth years of the Presidential cycles going back to 1950. Each one is positive and the average return is 23.24%.  

Now take a look at the chart above.  The average year six bottoms right around now and has a furious rally into the end of the year.  Did history just repeat?  Each data point on the orange line on the chart above presents the average for each day of the year from the years 1958, 1986, 1998, and 2006 (all sixth years of the Presidential cycle).

Lastly, please note that year six for Nixon would have been ‘74 (Ford) when the SPX dropped nearly 30%.  Also year six for JFK would have been ‘66 (Johnson) when the SPX dropped nearly 20%.  Including those years would have given much different results, but I’m only looking for returns of the same President in office during year six.  

[davidgfabian]

It’s Going To Be Another Wild Wednesday

This week marks another release of the monthly FOMC statement, which traders have all come to associate with heightened levels of volatility throughout the entire asset class spectrum.  These Wednesday rituals are typically marked by a slow sideways trade followed by a flurry of activity when the announcement hits the wires. 

Everyone wants to digest the subtle text nuances on the fly and position appropriately for the coming ramp or slump.  This all happens in a matter of minutes and leads to false moves in both directions – ultimately confounding bulls and bears even further. 

Leading into this mini tornado, we are watching momentum leaders such as the PowerShares QQQ (QQQ) lose traction as high flying biotechnology and internet stocks take a breather.  This is being complimented by continued weakness in the iShares Russell 2000 ETF (IWM), which has not been able to make any forward headway all year. 

In addition, the price action in treasury yields is showing signs that the bond market is anticipating the Fed’s exit from quantitative easing.  Since the end of August, the CBOE 10-Year Treasury Note Yield (TNX) has risen from a low of 2.35% to its current 2.6% level in just a few short weeks.  Traders have been selling both investment grade and high yield bonds despite the consensus that a traditional rate hike will not occur until well into 2015. 

This puts both the stock and bond market in a precarious position heading into the Wednesday deliverance, particularly because they have been trading in tandem all year.  We could conceivably enter a period of rising bond yields and falling stock prices if both sides get spooked by unexpected language or actions by the Fed this week. 

Another area that will likely see extra volatility will be the SPDR Gold Shares ETF (GLD), which has been persistently weak this over the last three months.  GLD recently fell to prices not seen since January of this year on the back of a tremendous rally in the U.S. dollar index.  Despite several failed rally attempts, gold bugs have been unable to mount a significant comeback in the yellow metal this year.  However, don’t count out the possibility of a counter-trend rally in this space as a function of pervasive negative sentiment reversing course. 

While I don’t recommend making any knee jerk reactions to the Fed statement, paying close attention to changes in price action and respecting risk management levels should be a part of your game plan.  This may include shifting your asset allocation in favor of a more conservative mix or taking advantage of any dislocations in price to pounce on new opportunities.

The key is to stay balanced and disciplined with your investment decisions over the coming days, particularly in light of the seasonally weak September period.

[davidgfabian]

A Closer Look At The Japanese Yen Breakdown

The recent confirmation of additional interest rate reductions and quantitative easing measures by the ECB has significantly altered the landscape of forex markets.  In the midst of tremendous relative strength in the U.S. dollar index and subsequent collapse in the Euro currency, one important dynamic has been largely overlooked. 

The Currency Shares Japanese Yen Trust (FXY) has recently broken to new multi-year lows on the back of this shift from foreign developed currencies to U.S. dollar denominated assets.  The Yen currently makes up 13.60% of the PowerShares U.S. Dollar Bullish Index Fund (UUP) and its recent weakness has contributed to this broader shift in forex sentiment. 

FXY lost 1.16% in the month of August and with today’s move, is now below its 2013 low and in negative territory for the year.   When coupled with a downward sloping trend line, the technical picture for FXY looks quite bleak at the moment. 

So where are the silver linings in this period of currency upheaval?

Foremost, from a short-term perspective the recent sharp decline is moving into an oversold state.  The relative strength index is pegged to an extreme reading that typically indicates a counter-trend bounce is on the near horizon.  This may provide an opportunity for short-term traders to capitalize on a rebound or allow for a better opportunity to establish new short positions. 

There are a number of ways to play a falling Yen in the event this trend continues for the foreseeable future.  One potential strategy involves the WisdomTree Japan Hedged Equity Fund (DXJ).  This ETF incorporates a basket of Japanese equities and short Yen positions as a method of hedging currency fluctuations.  Because of the Yen weakness, DXJ is once again pulling away from a traditional basket stocks such as the iShares MSCI Japan ETF (EWJ).

No matter how you ultimately position your portfolio to capitalize on these trends, make sure you keep a close eye on these key currency indicators as they will likely impact other asset classes as well. 

[davidgfabian]

How This Unique Dividend ETF Is Quietly Killing The Competition

This article was originally posted on the Investor Insights blog.

Dividend ETFs come in all shapes and sizes these days, but finding one that is truly unique is harder than it seems. All of the largest and most well-established funds are based on uninspiring benchmarks that have risen to the point where their yields barely scratch 3% annually.

That’s certainly nothing to write home about when you are constructing a portfolio to deliver sustainable income. In addition, most conservative income investors are concerned about their ETFs holding up under the rigors of interest rate fluctuations and stock market volatility. This is serious money that you can’t play around with if you are in retirement or working on building your nest egg to make it through your golden years.

Traditional dividend index funds can make solid foundations for equity exposure, market correlation, and modest yield. However, they may not have everything you need to satisfy the craving for above-average income and asset-class diversification. To enhance those factors within your portfolio, an innovative dividend approach may be justified.

One ETF that has quietly pulled away from the pack of generic equity-income competitors over the last year is the Global X Super Dividend U.S. ETF (DIV). This fund tracks the INDXX SuperDividend U.S. Low Volatility Index that tracks the performance of 50 equally weighted common stocks, MLPs, and REITs that rank among the highest dividend paying securities in the United States. In addition, to be included in DIV, these securities have to be considered to have lower relative volatility than the market.

This unique combination of assets has proved to generate a very strong 30-day SEC yield of 5.78%. Furthermore, dividends from DIV are paid monthly to shareholders, which may be an attractive quality for those that are seeking a more consistent stream of income than typical quarterly distributions.

Because DIV has only been in existence approximately 17 months, there is not a long track record of performance from which to measure its success against other benchmarks. However, according to my research, this ETF has beat all unleveraged dividend equity-focused ETFs over the last year. A comparison of DIV to the iShares Select Dividend ETF (DVY) and Vanguard High Dividend Yield ETF (VYM) shows just how strong this outperformance has been.

DIV has really broken away from the pack in 2014 because of its exposure to REITs, MLPs, utilities, and energy stocks. These sectors came into the year relatively undervalued and have shown remarkable strength as investors have piled into these defensive areas of the market as interest rates have fallen.

I like the unique aspect of exposure to both real estate investment trusts and master limited partnerships in the DIV portfolio because they help boost the yield and diversify the asset class spectrum. This is especially important when the portfolio is more concentrated with only 50 total securities.

The unique style of this ETF may lend itself towards starting out as a tactical position within the context of a balanced income portfolio. Ultimately as price trends develop and more performance data is available, it may even work its way into a core holding with the goal of high monthly income and capital appreciation.

It’s also worth noting that DIV has a sibling ETF with a global slant in the Global X Super Dividend ETF (SDIV). This fund takes a similar approach to selecting high yielding equity securities in both the U.S. and abroad. This includes exposure to developed and emerging market nations.

Despite the relatively small asset base of $163 million, DIV has been a quiet performer with strong fundamentals that deserves to be on your equity income watch list. As always, I recommend that you place a trailing stop loss or other sell discipline on this ETF if you do decide to dip a toe in the water. This ensures you define your risk and guards against the potential for a selloff in the market.

[davidgfabian]

Treasury Trade Continues To Outwit Stock Mavens

Long-duration Treasuries continue to outwit even the most ardent stock bulls who were looking for rising interest rates to tip the scales in their favor.  The iShares 20+ Year Treasury Bond ETF (TLT) recently hit a new 2014 high amid strong demand for safe haven assets.  Surprisingly enough, this trade still has room to run on the upside despite having gained over 16% so far this year. A 3-year chart of TLT reveals there is plenty of space for a move back to $120, with an outside shot at $122 for those favoring further upside in Treasuries.  Downside support seems to be showing previous lows near $110 that may hold up again on a pullback as well. 

Heightened awareness of the Fed’s plan to exit it’s monthly bond purchases later this year has not slowed the counterintuitive bounce in fixed-income.  In fact, the consensus seems to be shifting to a mid-2015 rate increase, which will likely continue to support bonds through the remainder of the year.   So what’s driving this Treasury rally? Bonds came into the year with extremely negative sentiment after the drubbing they received in 2013, in addition to nearly every economist predicting that rates would be higher this year.  That seemed to tip the scales in favor of a counter-trend rally that has shifted the momentum to favor pairing fixed-income with equities as a volatility reducing tactic.   Another more recent development within fixed-income is the sell off in junk bonds creating some fervor.  Bond investors may look to pair the iShares High Yield Corporate Bond ETF (HYG) with TLT or a similar equivalent to hedge their credit exposure.  While this makes your portfolio more susceptible to interest rate risk, you ultimately reduce your exposure to defaults.   I have been an ardent advocate of sticking with a balanced portfolio allocation of equities and fixed-income despite the looming risk factors.  Both stocks and bonds are continuing to show price action that is indicative of long-term uptrends.  As a result, investors that have stuck with both asset classes benefit from diversification and lower overall volatility. 

[davidgfabian]

Utility Stocks Have Failed To Live Up To The Defensive Hype

Utility stocks have long been known as a defensive sector as a result of their sensitivity to interest rates, low volatility, and high dividend payouts.  Some investors have even gone so far as to compare utilities to bonds because they are often a safe haven during times of fear.  However, recent price action suggests that utility stocks are failing to live up to this stereotype.

Through the first six months of the year, the Utilities Select Sector SPDR (XLU) was the top performing sector of the market.  XLU notched a gain of 18.54%, which far outstripped both competing sectors and broad large cap equity indices.  This outperformance was a concern to many experts who noted that increasing demand for this defensive trade may be a precursor to corrective behavior by the broader market. 

Over that same time frame, the iShares 20+ Year Treasury Bond ETF (TLT) gained 12.86% and appeared to be showing a high level of correlation with XLU despite calls for rising rates at the beginning of the year.

All was well until XLU peaked in July amid technical signs of an exhaustive top.  At the same time we have seen strong demand for long-duration treasuries as a result of a flight to capital caused by heightened global equity volatility.

The decoupling of these price trends is a concern to conservative investors that were banking on utility stocks providing a counterweight to other high beta sectors of their portfolio.  In fact, XLU has been one of the leaders on the downside and is now more than 9% off its high.  For comparison sake, the SPDR S&P 500 ETF (SPY) is off just 3.3% from its all-time high. 

From a technical perspective, the chart of XLU has now resolved in a bearish head-and-shoulders pattern that is moving swiftly towards the 200-day moving average.  A break below that level may lead to another round of selling that tests the March low near $39.  The ramp up in volume also suggests sellers are exiting this sector in large quantities.   

While the price action in utilities is certainly concerning for those that came late to the party, I’m watching this sector as a potential buying opportunity moving forward.   

Fundamentally, the interest rate environment is still very accommodative and fiscal policy changes are still far off on the horizon.  In addition, the yields on these stocks are only getting better as prices continue to fall.  As an added bonus, utility stocks benefit from inelastic consumer demand to drive consistent revenue and profits. 

What we need to see is price stabilization in XLU that would mark a turning point and subsequent bottom.   This may resolve in a capitulation of selling pressure or a technical support level that leads to a turnaround in this sector and instills confidence to dip a toe in the water.  The zone between $39-$40 may prove to be the first line of support for utilities. 

Despite the lack of defensive prowess, XLU may well be an opportunity to seize in the near future as conditions continue to develop.

[davidgfabian]

I had some thoughts on this a couple years ago when I said the traditional hedge fund model was antiquated. I want to revisit the thread in light of a couple stories today.

First is here (WSJ paywall) — Goldman Sachs is pulling back on less-profitable clients and charging existing clients...

[davidgfabian]

The Golden Dragon Has Awakened

The Chinese regard the dragon as a symbol of potency, strength, and good luck in the context of their mythology.  From an investing standpoint, the China story has been anything but dragon-like over the last three years. 

In fact, the broad-based SPDR S&P China ETF (GXC) has a 3-year annualized track record of just 1.40% through June 30.  This ETF contains 285 Chinese companies with a particular emphasis on financial and technology sectors. 

The numbers become even more dismal when you pair down the universe to just large capitalization stocks.  The iShares China Large-Cap ETF (FXI) has an annualized track record of -1.88% over the same 3-year time period and +1.71% over a 5-year time span.

That’s certainly not an inspiring statistic given the strength of U.S. and European markets during that time frame.  While the potency of the China story may have worn thin with emerging market investors, a recent resurgence may be just what is needed to ignite this overseas opportunity.

Since hitting a low in May, GXC has jumped over 17% and broken out above its 2013 high.  In addition, we have seen a recent bullish “golden cross” technical chart pattern of the 50-day moving average crossing back above the 200-day moving average. 

For comparison purposes, the SPDR S&P 500 ETF (SPY) has gained just 3% over that same time frame and is starting to show signs of exhaustion as a result of recent volatility.   That relative strength compared to the U.S. is certainly a change in tenor from what we have seen in prior years. 

It’s also worth noting that both FXI and GXC experienced positive net inflows in July after sustaining heavy losses in the first six months of the year.  This may be the start of investors waking up to the idea of China and similar emerging markets as a value opportunity when compared to high-priced developed market alternatives. 

The biggest concern in the China space has been the under performance of consumer stocks as measured by the Global X China Consumer ETF (CHIQ).  This ETF tracks a basket of 40 consumer-driven companies that are domiciled in China or have their main business operations in the country. 

CHIQ has lagged many of the broader China indices and continues to trade below the flat-line in 2014.  Initial fears in the beginning of the year over a hard economic landing have more recently been overridden by positive manufacturing and real estate data that may ultimately lead to a perk up in this sector as well.  Surging consumer activity would be a catalyst for additional growth in other areas of the Chinese economy as well. 

The resurgence in the golden dragon economy should certainly be an investment theme to monitor over the second half of the year.  Investors that are seeking out core emerging market exposure may find this opportunity fits within their risk tolerance and portfolio discipline.