Month: August 2017

InnOvation Capital & Management, LLC

IntelDigest

LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR

AUGUST 30 , 2017

Contact Richard Power with comments or questions. IntelDigest  is intended for the use of our clients and colleagues.  Material may not be reproduced, forwarded or shared without express permission.

We will continue, over the next several weeks, to discuss prospects for The Economy and Investing for the remainder of this year.  September has historically been a difficult month for investors, and the length of the current Bull Market causes nervousness among analysts.  So, we will follow these matters closely and devote each weekly issue of IntelDigest  to investment matters through the end of September.

It would surprise no one if stocks were to experience a 10% correction sometime in the next two months.  However, that is NOT what we anticipate for the markets.  We have written that:

“…. expect the stock market to stay strong through the end of this year, attributable in part to a ‘melt-up in earnings.’  We have experienced the second-longest Bull Market in history, but this Bull is still pretty healthy.  Plus, interest rates remain at historically low levels.”

We believe that the single most important factor in the current market climate is  Interest Rates.  While ultra-low rates have done immense damage to fixed-income investors over the last several years, investors in equities have done very well.  There have simply been no easy options for investors, so they have invested heavily in stocks and stock funds, driving Price-to-Earnings Ratios to unusually high levels.

There is no chance of large or frequent increases in interest rates at any time in the near future.  So, we expect that stocks will continue to be the “only game in town” for the remainder of this year.

We will stay invested, but keep an eye on our Stop Losses.  If the market continues to “melt up,” we will ride the last few months of the Bull Market.  If we encounter a correction, we will follow our Stop Losses and take profits.

Consumer Sentiment

Another positive note for the Economy is a renewed confidence among Consumers, which can be attributed to higher job creation and a lowering in the “official” unemployment rate, trends which have been improving steadily over the last few years.

According to The Conference Board, consumer confidence has attained the highest level since July, 2001.  It had bottomed in February, 2009, at the depths of the Great Recession.  Economists pay attention to these numbers because consumer spending accounts for 70% of U.S. economic activity.

News from Jackson Hole

The annual meeting of central bankers at Jackson Hole, Wyoming is a closely-watched event every Summer.  Leading officials from the Federal Reserve and foreign central banks get together at the foot of the Grand Tetons to discuss interest rates, the world economy, and financial regulation.

A notable participant at the conference this month was Mario Draghi, President of the European Central Bank (ECB), who clearly signaled that the ECB would continue its program of monetary accommodation.  This would keep bond yields in Europe extremely low.

This is yet another motivator for higher stock prices.

Bullish Catalysts for Stocks

Among the other bullish catalysts for stocks to run higher: low inflation, a lower US Dollar, lower energy prices, and the prospect of lower taxes by next Tax Season.

We have also discussed, in the August 9 issue of  IntelDigest, the fact that the stock market is shrinking:

“The number of publicly-traded companies … represented by individual stocks … has contracted significantly in the last two decades.  In 1997, there were nearly 7,500 publicly-traded stocks;  today, there are fewer than 3,600.  In addition, many companies have bought back millions of shares of stock since the market downturn in 2008.

One explanation for the market run-up of the last eight years:  a diminished supply of stocks available for purchase, and investor demand for equities because ultra-low interest rates ravaged the fixed-income markets.”

Some analysts call this the “washing machine” market.  There is more money sloshing around (Demand) and chasing fewer and fewer companies (Supply).  The stock market is buoyed by this sea of Demand.

More next week …..

 

 

InnOvation Capital & Management, LLC

 IntelDigest

LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR

AUGUST 23 , 2017

 

Contact Richard Power with comments or questions. IntelDigest is intended for the use of our clients and colleagues.  Material may not be reproduced, forwarded or shared without express permission.

 

 

We continue on the theme of  Investing and the Markets  in this issue of  IntelDigest.  Over the “Dog Days of Summer,” we have re-published a series of articles from the IntelDigest archive discussing investment theses for 2017, and covered the topic of Exchange Traded Funds (ETFs) in two new issues in August.

This issue will be shorter than usual, concentrating on the broad market climate for the rest of 2017 and into 2018. Over the next few weeks, we will analyze specific opportunities in the markets … in technology, biotech, interconnected systems, and commodities … explain the blockchain and cryptocurrencies … and discuss the market for autonomous vehicles.

Today, we’ll discuss both the short-term Market “Melt Up” on the positive side, and warn of troubles to come … probably in 2018 … because of endemic problems related to Debt.

 

Market “Melt Up”

As we discussed in the August 9 issue, there are well-known market strategists who expect the stock market to stay strong through the end of this year, attributable in part to a “melt-up in earnings.”  We have experienced the second-longest Bull Market in history, but this Bull is still pretty healthy.  Plus, interest rates remain at historically low levels. For these reasons, we wrote in our April 26 issue:

“As we expect 2018-19 to feature both a Credit Default Crisis and a cyclical Recession, we think that these last few months of the expansion bring us the best opportunity for significant investment gains for quite a while.”

So, with Stop Losses on our portfolio tightened up, we expect to ride the last few months of the Bull Market.

 

Reckoning and Recession

Our long-term thinking must acknowledge the endemic problems in the U.S. economy.  The economy has been fueled by Debt for much of this century.

On the corporate side, American businesses have borrowed vast sums of money in recent years.  Some of those funds have helped to grow companies;  some have been used to buy back shares.  Too many companies have used borrowed funds to pay dividends or enhance the “bottom line” without actually growing the business.

Individuals have also borrowed heavily during this period. American consumers now carry more than a $Trillion of credit card debt.  Total household debt … including housing, auto loans, student loans … now exceeds the Debt that Americans were carrying when the Financial Crisis hit in 2008.

Fortunately, we are still in an era of ultra-low interest rates. Despite raises in the Fed Funds Rate over the last nine months, that rate still stands no higher than 1.25%.  Any interest rate increases over the coming years will be slow and infrequent, because the economy and markets would incur significant damage if rates rise too fast.

The governors of the Federal Reserve know that the economy, the markets, and American borrowers … including Federal, state and local governments … need real interest rates to stay low.  This accommodates business growth, and consumer spending, and the ability of governments to pay the interest on their Debt.

Although the Fed talks a big game about its mandate to keep inflation in check, the governors know that Inflation is the only means by which we can manage the current massive debt levels.  If Inflation rises, the value of each U.S. dollar will go lower.  Each dollar of debt becomes smaller in an inflationary environment, and that much easier to pay off.

 

A Reckoning is surely over the horizon.  Whether the catalyst is an emerging-market recession or a monetary crisis or political chaos, eventually we will have to deal with massive Debt and unfunded liabilities.

But, in the meantime, this is how the system works.  So, “make hay” while you can.

 

 

 

InnOvation Capital & Management, LLC

IntelDigest

LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR

AUGUST 16 , 2017

Contact Richard Power with comments or questions.  IntelDigest is intended for the use of our clients and colleagues.  Material may not be reproduced, forwarded or shared without express permission.

 

We continue a discussion of Exchange Traded Funds (ETFs) in this issue of      IntelDigest.  ETFs are low-cost, “passive” investment funds which track particular benchmark indices.

 

Exchange Traded Funds

The number of ETFs has grown to almost 5,000 globally … approximately 2,000 in the U.S. … and continues to rise.  This is greater than the number of publicly-traded stocks.

ETFs represent an important investment tool for all investors, but especially those looking for an easy way to invest in a particular geographic region, market, sector, etc.  ETFs are simple to understand, and appeal to investors who may have been disappointed by the relatively high fees and underperformance of “active” funds, where fund managers select stocks to include in the fund.

The amount of assets under management (AUM) held in ETFs now exceeds $3.4 Trillion, a 17-fold increase since 2003.  The growth of these funds … both in number and assets … has been staggering.

In the era of smartphones, we are accustomed to saying “There’s an app for that.”  There is now an Exchange Traded Fund for virtually all asset classes, many of them very narrowly focused.  For example, there’s now an ETF that focuses investment only on companies in the ETF industry!  Some very small, niche-market ETFs have attracted significant capital.

 

The Downside of ETFs

The growth of ETFs is part of the larger trend of “passive investing.”  But, there is a potential downside to passive investing, and some unintended consequences.

“Passive investing” means using a “buy-and-hold” strategy by investing in an exchange traded fund or index fund which simply tracks an index.  We are experiencing a boom in passive investing.  Over 40 percent of all funds under management in U.S. equities are passive investments;  by some Industry estimates, that number will grow to 50 percent by 2018.

At some point, if too many investors follow the same benchmark, the benchmark becomes the tail that wags the dog.  The flood of money into index-tracking funds has a huge impact on overall market liquidity, and is distorting the valuation of stocks.

Consider that Vanguard Group (one of the largest investment companies in the world) now owns five percent or more of 491 stocks in the S&P 500.  And,
Vanguard now owns almost seven percent of the entire index, according to the Financial Times.  Since 2009, investment clients at Bank of America have dumped $200 Billion of individual stocks, and purchased $160 Billion of ETFs

ETFs now comprise 24 percent of trading in U.S. equities, according to the Financial Times.

 

Cause for Concern

There is concern on Wall Street that passive investing is undermining basic market principles … share prices of good companies should rise in value as their businesses grow, and bad companies should go bust.  The grandfather of passive investing, Vanguard Group founder John C. Bogle, thinks that indexing can get too big for its own good.  “What happens when everybody indexes?” he asks.  “Chaos, chaos without limit.  You can’t buy or sell;  there is no liquidity, there is no market.”

With passive investing, many investors focus less on company fundamentals.  They throw their money at index funds, rather than doing the hard work of determining which companies are well-run and growing, which shares are cheap and which are overvalued.

Too often, no one is “kicking the tires” on sectors or companies to examine fundamentals.  Passive funds simply invest in dozens or hundreds of stocks at a time, with capital allocated to each stock depending on nothing more than their market capitalization.

In a recent Wall Street Journal article titled, “The Dying Business of Picking Stocks”:

“Passive funds are designed only to match the markets, so investors are giving up the chance to outperform them.  And, if fewer managers are drilling into financial reports to pick the best stocks and avoid the worst – index funds buy stocks blindly – that could eventually undermine the market’s capacity to price shares efficiently.”

 

 

How to Invest

As in all things, Moderation is the key.  Take advantage of the ease and low cost of exchange traded funds, but don’t use them exclusively.

Always do your homework with ETFs, just as you would with any individual stock.  Read the prospectus, and know exactly what index the ETF tracks, and how closely.  Some ETFs suffer from “tracking error,” so don’t assume anything … read the reports!

Be skeptical of exotic ETFs.  As the ETF market has grown, sponsors have developed more exotic … and risky … products to stand out in the increasingly-crowded field.  Some of the most risky are the “Leveraged” ETFs which seek to double or triple the returns of an index, and “Inverse” ETFs which seek returns in the opposite direction from an index (for example, if the underlying index goes down, the ETF goes up).  These ETFs use “derivatives.”  You remember reading about those in the context of the 2008 Financial Crisis!

If you are not an investing professional, your best strategy is still Diversification.  Spread your eggs among several baskets … and watch the baskets closely!  That is still the time-honored method of earning good returns in complex and uncertain markets.

 

 

 

InnOvation Capital & Management, LLC

IntelDigest

LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR

AUGUST 9 , 2017

 

Contact Richard Power with comments or questions. IntelDigest  is intended for the use of our clients and colleagues.  Material may not be reproduced, forwarded or shared without express permission.

 

We return to “Investing and the Markets” in the next few issues of  IntelDigest.  In the last three weeks, we have run a series of articles from the  IntelDigest  archive;  those articles … originally published in April/May … addressed investment in specific sectors.  Today, we begin a series analyzing market trends for the rest of 2017 and into 2018.

 

Market “Melt Up”

In recent interviews, veteran market strategist Ed Yardeni, of Yardeni Research, has lent support to the thesis that the stock market is more likely to keep rising through the rest of this year.  Yardeni noted that the recent record highs for the Dow Jones, Nasdaq, and S&P 500 indices were not driven by a surge in valuation multiples.  Rather, he described a “melt-up in earnings” … a bullish sign for the remainder of the year.

“The fundamentals are just cranking along at a decent pace here.  Earnings are doing remarkably well given that the economic data looks kind of slow.  But, somehow or another, companies are generating good revenues and good earnings.  I think that’s because the global economy is doing reasonably well,” said Yardeni on the CNBC  Futures Now program.

Although the three major indices are taking a breather this week after surging in July, all are likely to resume an upward trend after Labor Day.  We wrote in our April 26 issue:

“As we expect 2018-19 to feature both a Credit Default Crisis and a cyclical Recession, we think that these last few months of the expansion bring us the best opportunity for significant investment gains for quite a while.”

So, with Stop Losses on our portfolio tightened up, we expect to ride the last few months of the Bull Market.

Individual Stocks vs Stock Funds

The remainder of this letter will be devoted to Exchange Traded Funds (ETFs), which are low-cost, “passive” investment funds which simply track particular benchmark indices.

The number of publicly-traded companies … represented by individual stocks … has contracted significantly in the last two decades.  In 1997, there were nearly 7,500 publicly-traded stocks;  today, there are fewer than 3,600.  In addition, many companies have bought back millions of shares of stock since the market downturn in 2008.

One explanation for the market run-up of the last eight years:  a diminished supply of stocks available for purchase, and investor demand for equities because ultra-low interest rates ravaged the fixed-income markets.

Exchange Traded Funds

By contrast, the number of exchange traded funds (ETFs) has grown to almost 5,000 … greater than the number of publicly-traded stocks … and continues to increase.

ETFs represent an important investment tool for all investors, but especially those looking for an easy way to invest in a particular geographic region, market, sector, etc. The amount of assets under management (AUM) held in ETFs now exceeds $3.4 Trillion, a 17-fold increase since 2003.

ETFs are simple to understand, and appeal to investors who may have been disappointed by the relatively high fees and underperformance of “active” funds, where fund managers select stocks to include in the fund.  ETF sponsors can make the case:  why pay more in fees to underperform when you can track the benchmark for nearly free?

Considerations in Choosing ETFs

In choosing an ETF investment, you must carefully consider the cost, liquidity, and makeup of the fund.  There is a great deal of overlap in exchange traded funds.  Different funds may track the same underlying index.  And, as mentioned above, there are actually more funds than there are publicly-traded stocks being tracked!

Most important … be sure to do your homework and understand exactly what the fund does.  What companies comprise the underlying basket of securities?  Does the fund seek to replicate a standard benchmark index, such as the S&P 500?  Or, does it follow a very specific sector, such as cybersecurity or cloud computing companies?

What costs are associated with the investment?  ETFs charge a fixed-percentage annual running cost to shareholders, referred to as the “expense ratio.”  ETFs typically charge less than 0.50% of AUM, compared to actively-managed funds which may charge more than twice that rate.

ETF sponsors can usually afford to bring the expense ratio even lower because of economies of scale.  As an ETF gathers more assets under management, costs as a proportion of the overall fund size decrease.  Because the fund is simply tracking an underlying group of stocks, there are negligible transaction costs.

In addition, greater competition in the fund industry puts downward pressure on expense ratios.  Investors are ever more cognizant of the diminishing effects of fees on their return.  If you are looking at two near-identical ETFs which track the same index, which one would you choose?  The fund with the lower expense ratio will win out more often than not.

But, keep in mind that different underlying ETF assets come with different associated expense ratios.  If an ETF holds a wide range of emerging market stocks, the expense ratio would be higher than a fund tracking a standard benchmark index.  It is more expensive for an asset manager to replicate a basket of stocks across multiple exchanges, and the expense ratio reflects that.

The Vanguard funds are generally recognized as cost-effective ETFs.

Finally, one must be concerned with the liquidity of a potential ETF investment.  Liquidity is the ease with which you can buy and sell a security in the market without affecting its underlying price.  Some ETFs can suffer from a lack of liquidity.

Examine the financial statements of any fund in which you have interest.  A fund with Billions of Dollars in assets under management (AUM) usually will have no liquidity problem.  A fund with considerably less AUM is more risky.

Also, examine the underlying securities in the fund.  A basket of large-cap equities in developed markets is safer and more liquid than an ETF holding small companies in less stable sectors or geographical regions.

If you choose to buy a relatively illiquid ETF, please be sure to use “limit” orders.  When placing an order to buy or sell, specify the maximum purchase price (or minimum selling price) that you are willing to accept.