At Astor we are known for creating portfolios of ETF’s using employment trends as a key factor. Research and history have proven that employment trends are an excellent indicator of the long term direction of the economy and sectors. Of course it is not a one-to-one correlation and sometimes employment trends lag a bit, but for my money sticking with the employment trend keeps you out of trouble.
Look at recent history for a few examples. Employment trends kept me out of trouble in late 2000, sitting out much of the pain of the dot com bust. Fast forward seven years, and identifying a contracting labor market in late 2007 just before the subprime debacle saved you a lot of pain, fortuitously. Now that the current recovery is well underway and an expansion is upon us, employment trends can help balance a portfolio by investing in the sectors with the greatest employment growth.
With the latest data on the US labor market released last Friday, new clues as to where the best opportunities lie are available. This will most likely be a very boring, albeit useful and informative article. I promise to have a bit more wit and even humor in the other article posted during the month. There will be, of course, short term opportunities presented with other data points, political events and economic releases, as well as cute moves to capture short term fluctuations using ETFs. My hope is to regularly identify these opportunities as they present themselves. All that withstanding, the employment report is still the grand daddy of reports to build a road map to long term directions and sustained investment goals and objectives.
As I review the latest report areas of strength, those that jump out are the following:
•Healthcare – added 34,000 jobs. Investors can purchase the iShare Dow Jones Healthcare index (IYH) to get exposure to this hot sector.
•Manufacturing – added 33,000 jobs last month. A way to play that growth is in the MZG, the claymore Morningstar super sector of companies that make stuff.
•Construction- Although construction added 33, 00 jobs, recall that it lost 2,200 jobs in January so I would not jump on board yet in this area or related business.
•Transportation – Added 22,000 jobs mostly in trucking. The iShares IYT is an excellent ETF to capture this growth. With energy prices on the rise, this will be counter intuitive and should climb the preverbal wall of worry.
The big losers (from a jobs stand point) were state and local governments which have shed 377,000 jobs since the peak in 2007. I would be careful here and not rush to sell securities related to these municipalities, such as MUNI which is the ETF that tracks the muni bond market. The default rates are very low for munis and one or two bad apples should not spoil the whole bunch, but it could add unnecessary volatility to your portfolio (read opportunity as well).
Our lesson from an employment perspective is that if you add exposure to sectors that are adding jobs and reduce to the sectors that are losing jobs, you portfolio should have lower risk and volatility. After all, job growth is a sign of health and confidence, and pockets of strength are always good. Of course there is no magic bullet that can prevent the economy from losing steam and reversing course but these sectors tend to hold up better in a down turn and run farther in the expansion.
Sunday, March 20, 2011
Monday, March 14, 2011
The Time and Place
Much has been written to vilify levered ETFs. In fact, many blame them for the equity market volatility of recent years, specifically the flash crash of May 2010. I find this generalization frustrating. After all, it is just about math.
Leveraged ETFs may not track the index exactly over the medium to long-term. They may even be downward-sloping, meaning they are more likely to go down rather then up due to the effect of daily rebalancing. But, again, it is just math. The daily rebalancing impacts the long-term return and if the market is not trending it has a negative impact on price performance in comparison to the corresponding benchmark. That said, leveraged ETFs have a definite time and place and the best use is to capture short-term moves. With reduced capital requirements, an investor can hedge an entire portfolio without having to sell or raise cash. Or, if an investor is expecting a short-term move (up or down), and wants to take advantage of the short-term volatility it can be done with limited stress on the funding levels. Whether you are a hedger or an outright speculator, there is a benefit to be had from a product like this.
This is all a long lead-in to a recent phenomenon I have noticed in the major indices that have been occurring on the first day of the month. An abnormally high percentage of each month’s return, in the S&P 500 for example, has occurred on the first day of the month. Since the bottom was reached in the S&P 500 in March 2009, we have had 23 first days of the month. Of those 23 periods, the first day of the month has been the same direction as the rest of the month 17 times, or 73.9% of the time. The average return of each month since then (4/1/2009) is 2.35%. The average return of the first day of these months is 0.8%, or 34%. If we look at these numbers since January 1, 2010, these figures become more significant even. In the 14 measurable periods since then, the average monthly return for each month has been 1.35%. The average return for the first day of each month has been 1.05%, a staggering 76%.
There is an additional, equally alluring component to the “first of the month” phenomenon of late. Since April 1, 2009, 82.6% of the “first days” (23 total) have been positive, averaging 1.33%. Of the four days that were negative, the average return is -1.71%. The average return for all days in this sample was 0.81%, with the best day at 2.95% and the worst at -2.58%. A more recent view of this trend paints a similar, more compelling picture. Since January 1, 2010, 12 first days of the month have seen the S&P 500 rally, with only two showing a decline. The average return on positive days has been 1.4%, with a -1.02% on the two down days. The best day in this sample is 2.95% still, with the worst day at -1.72%.
I believe this pattern is due to two things; bullish consensus with low conviction, thus creating a chasing effect on the first day of the month as frustrated investors that missed yet another positive month just buy everything as the new month gets under way, and simply a bull market trend. Bringing this exercise full circle, whatever the reason for this might be if this pattern continues into March this is the perfect use of levered ETFs to capture this pattern. Investors can buy highly levered ETFs like UPRO and SQQQ which give triple leverage to the long side of the S&P 500 and NASDAQ 100, respectively. Since this trade is trying to capture the movement of a single day this is the perfect scenario for these products. While I am not suggesting this pattern should continue to work, and of course past performance is not indicative of future results, if you wanted to “go for it” this is a time and place for levered ETFs. In the spirit of full disclosure, my logical mind would not typically invest much capital on a pattern that I can’t explain. It is hard to ignore what I would dismiss a statistic of this significance to mere coincidence,
More interesting is you can sit out the rest of the month which will clearly reduce the risk/return profile as the lowest risk position is out. So with month end around the corner and the first day’s pop to follow you might want to keep your powder dry.
Leveraged ETFs may not track the index exactly over the medium to long-term. They may even be downward-sloping, meaning they are more likely to go down rather then up due to the effect of daily rebalancing. But, again, it is just math. The daily rebalancing impacts the long-term return and if the market is not trending it has a negative impact on price performance in comparison to the corresponding benchmark. That said, leveraged ETFs have a definite time and place and the best use is to capture short-term moves. With reduced capital requirements, an investor can hedge an entire portfolio without having to sell or raise cash. Or, if an investor is expecting a short-term move (up or down), and wants to take advantage of the short-term volatility it can be done with limited stress on the funding levels. Whether you are a hedger or an outright speculator, there is a benefit to be had from a product like this.
This is all a long lead-in to a recent phenomenon I have noticed in the major indices that have been occurring on the first day of the month. An abnormally high percentage of each month’s return, in the S&P 500 for example, has occurred on the first day of the month. Since the bottom was reached in the S&P 500 in March 2009, we have had 23 first days of the month. Of those 23 periods, the first day of the month has been the same direction as the rest of the month 17 times, or 73.9% of the time. The average return of each month since then (4/1/2009) is 2.35%. The average return of the first day of these months is 0.8%, or 34%. If we look at these numbers since January 1, 2010, these figures become more significant even. In the 14 measurable periods since then, the average monthly return for each month has been 1.35%. The average return for the first day of each month has been 1.05%, a staggering 76%.
There is an additional, equally alluring component to the “first of the month” phenomenon of late. Since April 1, 2009, 82.6% of the “first days” (23 total) have been positive, averaging 1.33%. Of the four days that were negative, the average return is -1.71%. The average return for all days in this sample was 0.81%, with the best day at 2.95% and the worst at -2.58%. A more recent view of this trend paints a similar, more compelling picture. Since January 1, 2010, 12 first days of the month have seen the S&P 500 rally, with only two showing a decline. The average return on positive days has been 1.4%, with a -1.02% on the two down days. The best day in this sample is 2.95% still, with the worst day at -1.72%.
I believe this pattern is due to two things; bullish consensus with low conviction, thus creating a chasing effect on the first day of the month as frustrated investors that missed yet another positive month just buy everything as the new month gets under way, and simply a bull market trend. Bringing this exercise full circle, whatever the reason for this might be if this pattern continues into March this is the perfect use of levered ETFs to capture this pattern. Investors can buy highly levered ETFs like UPRO and SQQQ which give triple leverage to the long side of the S&P 500 and NASDAQ 100, respectively. Since this trade is trying to capture the movement of a single day this is the perfect scenario for these products. While I am not suggesting this pattern should continue to work, and of course past performance is not indicative of future results, if you wanted to “go for it” this is a time and place for levered ETFs. In the spirit of full disclosure, my logical mind would not typically invest much capital on a pattern that I can’t explain. It is hard to ignore what I would dismiss a statistic of this significance to mere coincidence,
More interesting is you can sit out the rest of the month which will clearly reduce the risk/return profile as the lowest risk position is out. So with month end around the corner and the first day’s pop to follow you might want to keep your powder dry.
Friday, March 11, 2011
The Not-So-Secret Alpha Weapon
As the equity markets around the world turned higher in Q1 2009, and were followed by the economy soon after, many investment managers began to lag the broad averages/benchmarks as a result of being defensive. (Can you blame them?) Figuring out how to play catch up was the question, and many investors turned to emerging markets as the secret weapon. And why not? The story sounded good. Most avoided the domestic financial crush simply by not having a banking system that could support leveraged “ponzi paper” that the US and Europe were good at creating. They didn’t have the same issue we had with deficits and housing. They did not avoid the global slowdown 100%, however, their growth potential as a whole looked outstanding as the world rebounded, and they were going to lead us out of the recession.
Emerging markets were going to be the next big thing in the investment world and the upside opportunity appeared limitless. The beta of these markets is historically higher than the developed markets, and as momentum turned it seemed like the perfect trade, creating an allocation opportunity to add portfolio alpha. Emerging markets’ correlation to US stocks grew, but who cares about diversification when everything is going up, right? ETFs became the vehicle of choice for investing in emerging markets and the growth in these products swelled, ultimately breaking into the top tier by fund assets, alongside the SPDR S&P 500 ETF Trust (SPY) and the SPDR Gold Trust (GLD).
As 2010 was a grind up to new recovery highs was complete the tortoise (developed market equities) strolled passed the performance finish line ahead of the hare (emerging markets). But from the recovery lows the previous two years we still saw a large disparity in returns between these two brtheren. To be sure, the total return of the iShares MSCI Emerging Market Index (EEM) from the beginning of March 2009 through the end of 2010 was 131.5%. This compared to a 77.47% return for SPY and a similar 77.59% return for the iShares MSCI Developed Markets ETF (EFA) over the same period. As we enter 2011 and assets continue to balloon, fundamentals are no longer supporting such an large allocation to emerging markets versus developed markets as the recovery matures. The commodity story, which helped bolster resource-producing economies and their currencies, has become long in the tooth and political issues are causing excess volatility. Fundamentals do matter as do valuations. As the slow and steady improvement in the US economy hits stride, the surer bet right now is the tortoise. Year-to-date through 2/9/10 has said it all. EEM is down 4.47% compared to a 5.18% gain in SPY. As we review the fundamentals that drive US stocks, even after the lost decade, they are positively sloped and respond in kind to growing and improving economic fundamentals. This is not always the case (yet) for emerging economies. It has yet to be proven conclusively that these equity markets reflect their economies for any continued period. In fact, I am not even sure emerging market equities are positively sloped. They present great runs followed by almost equal declines. So as the train gets crowded and is about to leave the station, smart money is (or should be) rotating out of emerging equities and into more developed markets and larger capitalization stocks. There will be a place and time to re-enter emerging markets for the “beta trade”, but that may be a few quarters and maybe up to few dozen percentage points from here.
Emerging markets were going to be the next big thing in the investment world and the upside opportunity appeared limitless. The beta of these markets is historically higher than the developed markets, and as momentum turned it seemed like the perfect trade, creating an allocation opportunity to add portfolio alpha. Emerging markets’ correlation to US stocks grew, but who cares about diversification when everything is going up, right? ETFs became the vehicle of choice for investing in emerging markets and the growth in these products swelled, ultimately breaking into the top tier by fund assets, alongside the SPDR S&P 500 ETF Trust (SPY) and the SPDR Gold Trust (GLD).
As 2010 was a grind up to new recovery highs was complete the tortoise (developed market equities) strolled passed the performance finish line ahead of the hare (emerging markets). But from the recovery lows the previous two years we still saw a large disparity in returns between these two brtheren. To be sure, the total return of the iShares MSCI Emerging Market Index (EEM) from the beginning of March 2009 through the end of 2010 was 131.5%. This compared to a 77.47% return for SPY and a similar 77.59% return for the iShares MSCI Developed Markets ETF (EFA) over the same period. As we enter 2011 and assets continue to balloon, fundamentals are no longer supporting such an large allocation to emerging markets versus developed markets as the recovery matures. The commodity story, which helped bolster resource-producing economies and their currencies, has become long in the tooth and political issues are causing excess volatility. Fundamentals do matter as do valuations. As the slow and steady improvement in the US economy hits stride, the surer bet right now is the tortoise. Year-to-date through 2/9/10 has said it all. EEM is down 4.47% compared to a 5.18% gain in SPY. As we review the fundamentals that drive US stocks, even after the lost decade, they are positively sloped and respond in kind to growing and improving economic fundamentals. This is not always the case (yet) for emerging economies. It has yet to be proven conclusively that these equity markets reflect their economies for any continued period. In fact, I am not even sure emerging market equities are positively sloped. They present great runs followed by almost equal declines. So as the train gets crowded and is about to leave the station, smart money is (or should be) rotating out of emerging equities and into more developed markets and larger capitalization stocks. There will be a place and time to re-enter emerging markets for the “beta trade”, but that may be a few quarters and maybe up to few dozen percentage points from here.
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