S&P Dow Jones Indices (S&P DJI), one of the world’s leading providers of financial market indices and a major player in the exchange-traded funds industry, has announced the launch of the S&P 500 Low Volatility Target Beta Index which has been designed to track the S&P 500 Low Volatility Index but maintain the same level of market risk as the S&P 500.
2013 was a great year for stocks, but less so for earnings. As a result, equity valuations rose sharply. Given higher multiples and the magnitude of last year’s rally, many investors are wondering whether the gains can continue, and just how high stocks can go this year.
I foresee U.S. equities posting more muted gains in 2014. Why? The interaction of two factors that defined the market last year – significant multiple expansion and higher interest rates – represents a headwind for stocks this year.
Most of last year’s stellar advance was powered by higher multiples. In other words, investors were willing to pay increasingly more for a $1 of earnings. Over the course of 2013 the trailing price-to-earnings (P/E) ratio on the S&P 500 rose from 14.2 to 17.50, a 22% increase. Based on P/E measurements, stocks are commanding the highest valuation since early 2010, when multiples were still high due to depressed earnings. Using a different metric, price-to-book, the S&P 500 is now trading at the highest multiple since before the financial crisis.
While I don’t believe that stocks are in a bubble, last year’s multiple expansion does matter for future returns. Historically, markets have done slightly worse in years following multiple expansion. Since 1954, the return, net of dividends, on the S&P 500 has averaged 5.85% following years in which stocks got more expensive. In contrast, the average return following multiple contraction was more than 10%. Admittedly, the results seem to be disproportionately impacted by a few bad years, such as 2000 and 2002. If instead of using average returns, you focus on the median – which is less impacted by outliers – the difference is smaller: 9% in years following multiple expansion and 12.5% in years following multiple contraction.
However, investors should still be a bit nervous for another reason. Not only did multiples rise last year, but interest rates increased as well. In the past, higher multiples and higher rates have represented a challenging combination. In those instances when multiples rose but rates were lower, the average return for the market was more than 9%, in-line with the historic average. In other words, to the extent that rates are dropping, rising multiples don’t represent the same degree of headwind as when rates are rising. However, in the 14 instances between 1954 and 2013 when multiples rose and interest rates rose, the average return on the S&P 500 in the following year was a relatively paltry 2.3%.
That said, I don’t believe that the U.S. market is necessarily condemned to a year of near zero returns. I expect U.S. stocks will finish 2014 with a mid- to high-single digit gain. First, rates are rising from unusually low levels. The yield on the 10-year note is still barely 3%, well below its 20-year average of 4.5%. At these levels, bonds still represent little competition for stocks. Second, a stronger economy this year should translate into faster earnings, which means stocks can advance without a further jump in valuations. Still, last years’ multiple expansion and higher rates arguably constitute a yellow flag for U.S. stocks. Given this, I continue to advocate that investors raise their exposure to international markets and focus on cheaper parts of the U.S. market, such as large and mega cap stocks and the technology and energy sectors.
Sources: BlackRock research, Bloomberg
As we approach the end of the year, it’s scorecard time once again – time to see how our predictions and projections for 2013 worked out. In my first blog post of the year, I explained what I thought the macro environment would look like and identified 3 strategies that I thought investors should consider as a result.
So how did I do? Interestingly, the year shaped up very much like I had expected, but the markets moved in an unexpected way. Economic growth was modest, so that turned out to be the right call. And the Fed did maintain their quantitative easing program, continuing to purchase both US Treasuries and mortgage-backed securities each month.
I had expected that the Fed’s decisions would keep interest rates relatively low. However, the tone and guidance provided by the Fed changed, and that resulted in an increase in interest rates. After trading below 2% for most of the year, Bernanke’s comments on tapering in May caused the 10 year Treasury to shoot up to 2.7% by early July, a rise of 100 basis points in just 2 months. That sudden increase in rates has led to negative returns for many fixed income portfolios, especially those with more interest rate risk.
Given that backdrop, let’s look back at the three strategies I outlined for investors at the beginning of the year and see how I fared:
- Focus on municipals and credit. Of the two, credit performed better, and actually outperformed US Treasuries during the year. But both asset classes were hit hard by the increase in interest rates and subsequent investor withdrawals. This was especially true in municipal bonds, where we saw outflows in both mutual funds and ETFs over the year (driven not only by the rise in interest rates but also by heightened credit concerns on the back of the City of Detroit filing for bankruptcy and fiscal concerns in Puerto Rico). Investors in less interest rate sensitive funds did better, with funds like the iShares Short-Term National AMT-Free Muni Bond ETF (SUB) and the iShares Floating Rate Bond ETF (FLOT) experiencing positive returns. Lower credit quality also fared well, like the iShares iBoxx $ High Yield Corporate Bond ETF (HYG). Because high yield has exhibited some equity-like properties, this served it well in 2013 as it was pulled up by the strong equity market and outperformed all other fixed income sectors.
- Look outside the US. This ended up being a mixed call as developed markets performed better than most U.S. markets, with funds like the iShares International Treasury Bond ETF (IGOV) down slightly. But emerging markets fell sharply, as evidenced by the negative returns of the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB). A combination of rising interest rates and a shift in EM sentiment hit the market hard in May and June and it never recovered.
- Rethink the role of Treasuries. Here I stressed the importance of diversification and the value that Treasuries can play in balancing portfolio risk and potentially evening out returns. This turned out to be true, but not necessarily in the way you might have imagined. The S+P 500 is up an amazing 29.11% for the year (as of 12/11/13). The Treasury market has done its job as a diversifier, returning -1.97% during that same timeframe. It’s a hard pill to swallow in such a strong equity year, but remember that diversification is a long term value proposition. If the equity markets were down and Treasuries up, investors would feel very differently.
So what can we take away from the year? Three important lessons for investors really stand out:
- The most important decision for any fixed income investor is how much interest rate risk they take on. You can make a lot of smart decisions, but if you get the rate call wrong it can undo everything else. If you are uncomfortable with that risk then don’t make any extreme interest rate bets with your portfolio.
- Forecasting the market environment is not just about market levels; sentiment also plays a huge role. With the Fed still very active with QE, what they say is in many ways just as important as what they do. Pay close attention to Fed messaging and how it evolves in 2014, because that could drive investor behavior and interest rate movements.
- Diversification is a two-way street. Yes, a diversifying asset can help moderate portfolio returns through time. However, by definition the diversifying asset should perform differently than other assets in your portfolio – meaning sometimes it will provide relatively positive returns, and sometimes it can drag portfolio performance. The latter was certainly the case for Treasuries in 2013. But over long periods, diversification can help produce higher risk-adjusted returns than a less diversified approach.
So what’s on tap for fixed income in 2014 and, perhaps more importantly, can I do a better job of predicting investment opportunities next year? I will cover this in my next post.
Past performance does not guarantee future results. For standardized performance for HYG, click on the ticker above. Index returns are for illustrative purposes only. Indexes are unmanaged and one cannot invest in an index. Diversification may not protect against market risk or loss of principal.
From Index Universe written by Rachel Revesz
|Written by Rachael Revesz|
|December 12, 2013 10:43 (CET)|
S&P Dow Jones Indices has launched five new Chinese equity indices which include both on and offshore securities.
The S&P Total China BMI Indices are an extension of the existing S&P Global BMI Index range, which covers around 10,000 stocks from developed and emerging markets.
The new Chinese indices include S&P China A BMI, S&P China A+B BMI, S&P Total China BMI, S&P Total China BMI + Hong Kong BMI, and S&P Total Greater China BMI. Together they provide exposure to large, mid and small cap stocks, both onshore and offshore China, as well as Chinese securities listed in countries like the US, Singapore and Taiwan.
“As China further opens its stock market to foreign investment, A-shares [on Shanghai and Shenzhen exchanges] are garnering increased attention from global investors looking to diversify their portfolios,” said Michael Orzano, associate director of global equity indices at S&P Dow Jones Indices. “This trend is making Chinese equity benchmarks that include both domestic and off-shore listings more relevant to investors around the world.”
From Vanguard Insights Blog:-
Vanguard analyzed all actively managed U.S. stock mutual funds that existed at the start of 1998 and found that very few beat their benchmarks over the following 15 years.
As shown in the illustration below, our research found that even among successful actively managed funds, the “road to outperformance” was beset by numerous and often long stretches of market-lagging returns.
The bottom line: Identifying winners in advance is a challenge, even for skilled investment managers. Even if you do manage to beat the market, you need patience to collect on that success.
1. The 10 funds had annualized excess returns closely matching the median for all 275 successful funds: 1.1 percentage points above the relevant benchmark.
About the indexes used in our calculations:
To measure the funds’ performances against market benchmarks, we chose indexes appropriate to their Morningstar, Inc., style boxes. When determining which index to use, we selected ones we deemed to fairly represent the characteristics of the relevant market, given the available choices during the period from January 1998 through December 2012. The indexes used for each style box are:
Large blend: Standard & Poor’s 500 Index through November 2002, MSCI US Prime Market 750 Index thereafter. Large value: S&P 500 Value Index through November 2002, MSCI US Prime Market Value Index thereafter. Large growth: S&P 500 Growth Index through November 2002, MSCI US Prime Market Growth Index thereafter.
Medium blend: S&P MidCap 400 Index through November 2002, MSCI Mid Cap 450 Index thereafter. Medium value: S&P MidCap 400 Value Index through November 2002, MSCI Mid Cap Value Index thereafter. Medium growth: S&P MidCap 400 Growth Index through November 2002, MSCI US Mid Cap Growth Index thereafter.
Small blend: S&P SmallCap 600 Index through November 2002, MSCI US Small Cap 1750 Index thereafter. Small value: S&P SmallCap 600 Value Index through November 2002, MSCI US Small Cap Value Index thereafter. Small growth: S&P SmallCap 600 Growth Index through November 2002, MSCI US Small Cap Growth Index thereafter.
All investing is subject to risk, including possible loss of the money you invest.
Past performance is no guarantee of future returns.
Source: Vanguard calculations using data from Morningstar.
Original article click here
That said, given the relentless rise in U.S. stocks, it’s hard to argue with the fact that certain market indicators, including a few valuation metrics, are flashing yellow.
To gauge when (and if) the market has officially tilted into bubble territory, I would suggest that investors focus on two sets of data: valuation and sentiment.
- Valuation. My main argument against a bubble in U.S. equities is that while valuations are no longer cheap, they are a far cry from previous peaks. However, some measures – notably the Tobin Q Ratio, gross domestic product (GDP) to market capitalization, and the Cyclically Adjusted P/E – are high, arguably too high.
I would pay particular attention to the Shiller P/E Ratio, which is a variation on the Cyclically Adjusted P/E or CAPE. This indicator is worth watching as it has historically correlated with long-term stock market returns. Today’s reading, in the mid 20s, suggests below average returns in coming years. A further advance would suggest a more serious problem. By way of comparison, the indicator reached a high of around 30 prior to the 1929 crash and was close to 45 in 2000.
2. Sentiment. While valuation is important, investors should also pay attention to sentiment. The goal is to gauge how – to steal a phrase – “irrationally exuberant” investors have become. In measuring sentiment, investors should focus on two types of indicators: what are investors doing and what are they thinking.
While there are dozens of different indicators, I’ll focus on two: put/call ratios and Bullish/Bearish Sentiment. The put/call ratio is a short-hand proxy for positioning among options traders. Lower readings correlate with more bullishness. The ratio was 0.48 at the end of November. While this is modestly below average, it is a far cry from the lows of early 2000. In other words, options investors are positioned bullishly, but not excessively so.
A second measure to watch is a survey conducted by the American Association of Individual Investors (AAII). The survey tracks the percentage of self-described bulls and bears. As of the end of November, the percentage of self-described ‘bulls’ was slightly more than 47%, while those characterizing their views as ‘bearish’ was at 28%. Again, both metrics suggest bullishness, but not craziness.
The bottom line is that there is no one indicator that will definitely answer the question: Are we in a bubble? Investors need to piece together a conclusion based on multiple measurements, using metrics about both valuation and investor behavior.
For now, the preponderance of the evidence still suggests that stocks are not so overvalued, nor investors so exuberant, as to justify the ‘B’ word just yet.
I have 26 bank accounts. I never meant for it to happen but it has. Fourteen are current accounts, eight savings, and four are cash ISAs.
That’s not counting the credit cards, broker accounts and other stuff I can’t remember any more.
For a long time it seemed normal. I only realised I was different when it slipped out recently in conversation. One friend said they were shocked.
That’s when I looked at myself in the mirror and I saw what they saw.
I’m a rate tart. I open bank accounts for money. For their competitive rates of interest. Once they’ve outlived their usefulness, I move on to the next. No emotion, no goodbyes, no looking back.
It’s just a transaction, right?
You know you want it
Nobody starts out thinking, “I want a massive collection of bank accounts.” You don’t think to yourself, “Wouldn’t it be great if I was the Imelda Marcos of online passwords?”
You start off small-time:
“I just want to get ahead.”
“I won’t have to do this forever.”
“It’s easy money.”
“Just one more won’t make any difference.”
And it’s so easy to find everything you need to get into it.
A Best Buy table puts you in touch with the right people. Even if you only look at it once a month, temptation soon comes your way.
And if you’re nervous – maybe it’s your first time – there are plenty of old hands out there to show you the tricks. You’ve just got to know where to look.
You open your first account and they pay you a sweetener to lure you in. An extra £100 or so because you’re fresh.
In the early days I was pulling down a few hundred extra quid a year in bounties alone.
But by the time you’re using a spreadsheet to keep track of it all, and standing orders to keep the money moving, and Google alerts so you don’t stay in the same place for too long…
…well, you know you’re not with Virgin anymore.
The rules of the game
I guess a lot of people don’t even know it’s possible to live like this. I read the stories in the papers about people getting 0.25% on their money and I laugh.
It’s not like that where I’m from. I can get you 3%, 4% easy.
It seems like a no-brainer when you put it that way. But not everyone could live the way I do.
There’s a price to pay, y’know? You’ve got to do certain things.
You need a bit of capital for a start.
£1,000 that you move from Peter to Paul – because you’re using current accounts as savings accounts. It sounds wrong, but that’s the way the world is these days. I didn’t make the rules, I’m just showing you how to work ‘em.
So everyone wants a piece of the pie, but you just give them the same old slice and keep it moving through the system so they don’t notice. Or maybe they do notice, I don’t know.
What I do know is: they don’t care.
Some places, the more ‘respectable’ ones, they like to make things harder. They want extras like direct debits on every account.
That’s easy. Just use a feeder savings account that sets up direct debits. There aren’t many, but you can find them, and you just channel £1 a time from one account to the other and back again. It’s like plumbing.
And if someone offers you a complimentary regular savings account – take it. You can get up to 6%! Sure, it’s only on a small bit of money, and they’re not as easy to get now, but you might as well take everything you can get.
Don’t forget cashback. Generally only the Spanish ones are into this, but look, as you get older you can’t afford to be too fussy, alright?
Money for old rope
What most people don’t realise is that you can double-dip. Triple-dip even.
Let’s say you can get 3% from a prospect but only up to £5K. They might allow you to open multiple accounts. Now you can get a good rate on £15K.
And the same people might go by a different name, so you can stash away another £15K.
And maybe they have yet another name. It’s more common than you might think. Everyone’s got something to hide, but that’s another story. Anyway that’s another £15K taken care of.
It helps if you’ve got a partner. It’s more lucrative if you work in pairs, y’know? You can cover more ground, recommend a friend, all that.
But even that will cost you. After a while, your ‘friend’ may not thank you for dragging them into your world.
Some people worry about their reputation: ruining their credit score and that kind of thing.
You’ve just got to keep your head down. Take it easy and don’t take on the whole world at once.
Keep it as straight as you can. Ditch old accounts when the interest drops… refuse overdrafts, credit cards, rates that are too good to be true, accounts with benefits… Stay away from the weird stuff, keep on moving, and you’ll be okay.
Don’t judge me
That’s pretty much all you need to know. Maybe more than you wanted to know, right?
Am I proud of it? Listen, I blame the Government. I didn’t ask to live in a zero interest world. Funding for lending has only made things harder.
I didn’t grow up dreaming of this. It’s not how I thought things would turn out.
You’ve just got to do what you’ve got to do. That’s it.
Long time readers know that I am a big fan of simple rules based portfolios, heck that’s behind most of everything I do, from the buy and hold and 13F portfolios of The Ivy Portfolio to the trend portfolios of a QTAA, to shareholder yield approaches to income. Frankly most all of the 2&20 world can be deconstructed More…
While the Dow Jones Industrial Average and the S&P 500 Index have been regularly notching record highs, the Nasdaq Composite made news last week, moving past the 4,000 mark for the first time in 13 years.
The last time the index was at these levels was September 2000, toward the end of the dot-com boom. In addition, broader market indices like the S&P 500 continue to post new record highs.
While valuations are less compelling than they were a year ago, equities still remain compelling alternatives to bonds and cash. Taking a closer look at the Nasdaq helps illustrate this point. The current trip above the 4,000 level looks quite different from what was happening in 2000 for two reasons:
1. Not frothy valuations. From a valuation perspective, the Nasdaq today trades at around 24x trailing earnings. That’s not cheap, but it’s below the index’s 18-year median of 30x trailing earnings and far below the 150x level the index touched the first time it crossed 4,000 in 1999.
2. A closer look at the technology sector. The technology sector is still a very heavy component of the Nasdaq, though less so today than 13 years ago, as Matt Krantz of USA Today and Barry Ritholtz recently pointed out, and it doesn’t look expensive. The sector is currently trading at around 17x earnings—roughly in line with the broader market and much less than the 67x earnings we saw in 1999. In fact, it’s one of the sectors I currently like.
So, simply put, while some areas of the market are looking frothy (including U.S. small-cap stocks and social media companies), today isn’t 1999 and we feel stocks aren’t in a broad market bubble.
Source: Weekly Commentary, Bloomberg
It is the professed belief of almost every economist, business person and politician that Australians require governments to achieve maximum improvement in their material standard of living. I’m not sure that’s true – but we’re about to find out.
Of late the econocrats have been warning that, unless we undertake major reform, national income will grow a lot more slowly in the coming decade than it did in the past one. According to Dr David Gruen, of Treasury, gross national income per person grew at an annual rate of 2.3 per cent over the past 13 years, but may grow by only about 0.9 per cent over the coming 10 years.
This projected slowdown is explained mainly by the switch from rising to falling prices for our mineral exports – that is, it focuses on income rather than production. It implies only a small slowdown in the underlying rate of growth in gross domestic product (GDP) per person, being based on the assumption that we maintain our long-run rate of improvement in the productivity of labour – an assumption some may question.
Reserve Bank deputy governor Philip Lowe says that, if we don’t achieve a substantial improvement in productivity, “we will need to adjust to some combination of slower growth in real wages, slower growth in profits, smaller gains in asset prices and slower growth in government revenues and services”.
So far, these supposedly dire warnings have met with a giant yawn from the public. And, assuming the slowdown comes to pass, I’m not convinced the public will notice it, let alone care. I doubt that we will retain the national resolve to implement the reforms economists say we need to keep incomes growing strongly, nor am I sure the economists’ favourite prescription would work. As for myself, I think slower growth could be a good thing.
Would the punters notice? Maybe not. Despite a decade of above-average growth in real income per person, most people would swear that, whoever had been benefiting from the resources boom, not a cent of it had come their way.
For at least seven years, the popular perception has been that people are struggling to keep up with the cost of living – that is, living standards are slipping. And get this: politicians on both sides, who profess to believe that rising living standards are governments’ raison d’etre, have fallen over themselves to agree – contrary to all the objective evidence – that times are tough.
Clearly, they believe failing to agree that times are tough is more likely to get them tossed out than falsely confessing to have failed in their supposedly sacred duty to keep living standards rising.
You may object that the punters’ failure to perceive that their living standards have been rising may not stop them correctly perceiving that living standards are now rising only slowly. But consider the United States, where real median household income has been flat to down for the past 30 years because almost all the real income growth has been appropriated by the top few per cent.
Have decades of failure to enjoy rising material comfort caused the American electorate to rise up in revolt? Not a bit of it.
It’s significant that the advocates of eternal growth never promote it in terms of rising affluence, but always in terms of the need to create jobs. Barring recession, there’s no suggestion production won’t be growing fast enough to hold unemployment at about 5 per cent over the decade.
Of course, a recession that led to rapidly rising joblessness would undoubtedly cause great voter disaffection, but that’s not what we’re talking about.
While it may be possible for the economic, business and political elite to agree their precious materialism has sprung a leak and that something must be done, that doesn’t mean they could agree on major reform; it’s more likely to lead to continued rent-seeking at the expense of other interest groups. If my share of the pie is bigger, what’s the problem?
Economists have no evidence to support their fond belief that the burst of productivity improvement in the second half of the 1990s was caused by micro-economic reform. But even if you share their faith, it’s a dismal record: if you undertake sweeping reform of almost every facet of the economy then, 10 to 15 years later, you get no more than five years of above-average improvement. What’s more, all the big reform has already been done.
With the global ecosystem already malfunctioning under the weight of so much economic activity, it’s time the age of hyper-materialism came to an end and we switched attention from quantity to quality.